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The pattern evident in fourth quarter GDP data is likely to be repeated in coming quarters: weak or dropping household consumption, contracting business investment, negative contributions from net exports and elevated government spending. Lower capacity utilisation suggests very little need to expand capacity Investment growth faces serious headwinds The sharp drop in activity during the fourth and first quarter has sent capacity utilisation spiralling. Not only is eurozone-wide capacity utilisation at record lows, it has plummeted at a record pace. Lower capacity utilisation suggests very little need to invest to expand capacity for quite some time. Moreover, profits contracted by a record 2.7 percent in Q4, while profit margins have been compressed for two quarters in a row. We have no doubts that this trend also continued in the first quarter. To top it off, credit conditions also tightened further at the beginning of the year, suggesting tougher times for those firms that are seeking to borrow to expand capacity. ECB President Trichet recently stated, for the first time in the crisis, that the ECB “has seen the first signs of falling credit flows reflecting supply-side factors”. All in all, investment growth faces serious headwinds, which is why we predict business investment to contribute negatively to GDP until 2010. Record contraction in profits Credit conditions still tightening Sources: <strong>Handelsbanken</strong> Capital Markets and Reuters Ecowin Rise in German short-time work provides a hint of things to come So far during the downturn, the rise in unemployment has been driven primarily by Spain. France first started to negatively contribute to employment growth in the fourth quarter. For the eurozone as a whole, yearly employment growth was zero in the fourth quarter. While this may be surprising to some, the historical pattern of activity, or rather between investment growth and employment growth, suggests a lag of two to three quarters. Even so, as profits are declining, it is only a matter of time before firms shed workers more aggressively to protect margins, causing employment to contract more visibly and unemployment to take to the sky. Rise in German short-time work suggests jumping unemployment soon The rise in German short-time work (Kurzarbeit) provides a strong hint of what is to come – the number of people participating in short-time work schemes has surged from 20,000 in September 2008 to almost 700,000 in February and March. As a result of the weaker labour market, wage growth is declining and looks set to decline throughout our forecast period. While debt servicing costs are naturally being reduced on the back of the ECB rate cuts and declining inflation supports purchasing power, other consumption fundamentals, such as credit conditions and household wealth, imply that consumption will nevertheless struggle. Even though eurozone households on average have saved a lot compared to their brethren in the UK or the US, savings rates have increased since the onset of the credit crisis in latesummer 2007. While savings rates could decline based on e.g. consumption smoothing arguments, we expect the most recent behaviour of households to be repeated in the near future, i.e. savings rates will remain elevated and could climb even further, especially as bal- 12 April 28, 2009
looning budget deficits imply higher taxes in the future, as does the pending demographic implosion. According to projections by the UN, the eurozone working age population will decline by around 0.2 percent per annum over the next ten years. Contribution to employment Surging short-time work Sources: Bundesagentur fur Arbeit, <strong>Handelsbanken</strong> Capital Markets and Reuters Ecowin Fiscal policy will be expansionary throughout our forecast horizon, with the lion’s share of the fiscal boost occurring in 2009 and 2010. On the whole, growth in government spending should average close to 2 percent y-o-y, providing a much-needed boost to demand. Inflation to become negative, albeit only briefly Inflation rates have continued to drop throughout the eurozone after the sharp plunge in commodity and energy prices during the second half of 2008. Headline inflation has dropped from a peak of 4.0 percent in July last year to 0.6 percent in March this year. While this is mostly due to the steep decline in oil prices (from approximately USD 140 per barrel to a low of around USD 30 per barrel in December), core inflation has also declined. In August 2008, core inflation (excl. food and unprocessed energy) stood at 2.6 percent compared to the latest reading of 1.5 percent. The negative impulse from lower commodity prices will gradually fade… …but lower resource utilisation implies intensifying disinflation The negative impulse from lower commodity prices will gradually fade over the year. In fact, current oil prices (USD 50) translate into positive inflation contributions from energy prices in December 2009. However, WTI oil for delivery in December trades at around USD 67 and the oil price curve implies a gradual rise in oil prices if interpreted outright. Also, our energy analysts expect oil prices to gradually climb to USD 70 during 2009, implying positive inflation contributions from energy in November. While lower commodity prices should impact inflation less negatively over coming quarters, disinflationary pressures are rising due to the continued drop in resource utilisation. Hence, the output gap is ballooning and will not start to contract materially until 2010 at the earliest. According to our forecast, HICP inflation should briefly drop below zero in June and July 2009. After that, inflation should gradually climb as the negative contributions from falling energy, commodity and food prices cease to affect the yearly calculations. Headline inflation should come close to two percent before year end. If oil prices fail to rebound, as we expect and as suggested by oil market curves, headline inflation is likely to enter negative territory in June and stay there until November. Nonetheless, if the output gap remains the main determinant of core inflation (as we expect it will), core inflation will gradually trend lower throughout our forecast period for the aforementioned reasons. As a result, headline inflation will start to trend lower again in early 2010 and then start to mimic the trend in core inflation. We do not want to downplay deflation risks given core inflation is likely to drop to zero during our forecast horizon, boosting the probability of a truly adverse deflation scenario. April 28, 2009 13
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Page 4 and 5: INTRODUCTION Who will pull the worl
Page 6 and 7: Emerging economies have been badly
Page 8 and 9: Consumer spending rebounded in Q1 U
Page 10 and 11: tion is due to the fall in oil pric
Page 14 and 15: Inflation forecast GDP forecast Sou
Page 16 and 17: Heavy falls in Investment and expor
Page 18 and 19: three quarters, the most rapid incr
Page 20 and 21: Gov’t finances and unemployment S
Page 22 and 23: this outlook, we also sketch an alt
Page 24 and 25: Finnish households have reduced the
Page 26 and 27: to the European Commission, capacit
Page 28 and 29: JAPAN Three more years of slump The
Page 30 and 31: EASTERN EUROPE Troubling times East
Page 32 and 33: CHINA Here’s one on the right tra
Page 34 and 35: Highly restrictive lending quotas w
Page 36 and 37: Slowdown to 5 percent growth in 200
Page 38 and 39: Aggressive cutting to catch-up with
Page 40 and 41: The ECB could adopt a policy of cre
Page 42 and 43: MONEY AND INFLATION Money matters W
Page 44 and 45: Money & price level in pooled data:
Page 46 and 47: spiral taking hold. In the late 199
Page 48 and 49: Global currency and interest rate f

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