NEWS | Wednesday, 05 December 2007

European economy suffering from fallout

Europe’s economy may be more damaged than the European Union has forecast by fallout from the U.S. housing slump as banks curb lending and accelerating price gains prevent central bankers from cutting interest rates, EU finance officials said.
“There may be a question mark over our hopes that Europe could decouple’’ from a U.S. slowdown, European Central Bank governing council member Christian Noyer told a conference in Paris yesterday.
Euro-area finance ministers endorsed an analysis by the International Monetary Fund suggesting that 2008 economic growth in the nations that use the euro will fall short of 2 percent for the first time in three years, Joaquin Almunia, EU Monetary Affairs Commissioner, said late yesterday in Brussels.
The growth slowdown comes as inflation picks up, posing a quandary for the ECB, which has refrained from following the U.S. Federal Reserve in cutting interest rates. The central bank is concerned that price gains may trigger an inflation spiral by stoking wage demands. Euro-area consumer prices jumped 3 percent in November from the year-earlier period, the biggest increase in six years, driven by higher commodity costs. The European Commission, the EU's executive agency, last month forecast a 2.2 percent expansion next year, down from estimated growth of 2.6 percent this year. Since then, a measure of European services expansion fell to the lowest in two years in November, while executive and consumer sentiment dropped to a 20- month low.
``With the present information our forecast would have lower figures for growth,'' Almunia said. ``We are facing downside risks for our growth scenario.''
The U.S. housing recession has made banks reluctant to lend to each other, pushing up borrowing costs around the world. Credit conditions have worsened in the past three weeks as more than $50 billion of writedowns linked to defaults on mortgages stoke concern about the strength of financial institutions.
Noyer, who is also governor of the Bank of France, said banks will be exposed to a ``triple shock'' of unwanted growth in their balance sheets, higher costs of capital and a deterioration in credit quality, resulting in higher lending rates.
``Quantitative constraints on credit distribution could be very damaging,'' he added.
How much the European economy suffers ``will depend on how credit markets evolve in the period to come,'' Noyer said. ``There will be pressure on banks' balance sheets.''
Three-month borrowing costs in euros rose today to their highest in more than six years, reaching 4.85 percent.