Euro area 'faces lost decade'

Chris Dillow

Chris Dillow

Fears are growing that the eurozone could suffer a Japanese-style "lost decade" in which the economy stagnates for years.

A slew of surveys this week showed that the region's economy is slowing down: the purchasing managers' index of activity fell to a six month low; France's INSEE survey showed a drop in the business climate; Germany's Ifo survey showed firms' optimism falling; and although the National Bank of Belgium's business climate indicator rose only slightly and is still below the levels of three months ago. "The pace of recovery is slowing down," said Martin van Vliet at ING. He added that this news "will keep fears of a Japanification of Europe firmly alive".

One reason for this slowdown will be highlighted by next week's figures from the ECB, which are expected to show bank lending to the private sector continuing to fall.

With the economy close to stagnation, economists expect unemployment to stay high; latest figures show that 11.7 per cent of the workforce, or 18.8m people, are out of work. And this, they believe will keep inflation low with a risk of actual deflation – falling prices. Ruben Segura-Cayuela at Bank of America Merrill Lynch said spare capacity is "exceptionally high" everywhere except Germany, and that this will cause "persistently worrying disinflationary trends". This matters, because if inflation stays low the real burden of government debt in southern Europe will stay high and so the threat of another debt crisis will increase.

In response to this, said Mark McFarland at Coutts, the ECB will "have to keep rates at near zero for a prolonged period". And, he added, if there is another downturn it might have to undertake significant amounts of quantitative easing.

Economists believe this risk will be good for government bonds, especially in Germany. Although the prospect of interest rate rises in the UK and US could push bond yields up there, some expect investors to switch from those markets into European ones. David Owen at Jefferies said it's possible that 10-year German yields – which are now 1.3 per cent – could fall below 1 per cent.

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