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      No springtime for the euro zone as risks abound

      No springtime for the euro zone as risks abound

      Concerns over sovereign debt, political instability and rising prices are continuing to put the brakes on business investment by corporates and subsequent job creation in the eurozone, according to Ernst & Young’s Spring Eurozone Forecast presented in Luxembourg. Ernst & Young warns that further interest rates rises could endanger the frail euro zone economy.

      The euro zone economy is growing at a much slower pace than expected with GDP estimated to increase by only 1.5% this year and 1.7% in 2012, according to Ernst & Young’s Spring Eurozone Forecast (EEF). Like last year, it is expected that GDP growth in 2011 will mainly be accounted for by exports, with world economic performance likely to remain robust, driven by both emerging markets and the US. Assuming that the nuclear situation is brought under control, the recent disasters in Japan are unlikely to have a significant impact. 

      Unemployment across the area is also likely to remain stubbornly high. Even looking ahead as far as 2015, EEF forecasts unemployment to be around 14 million, still well above 2007 levels. Marie Diron, Senior Economic Advisor to the Ernst & Young Eurozone Forecast says: “Although we still expect a muted recovery for the euro zone over the next 12 months that could easily be blown off course by global economic events or an escalation of the euro zone debt crisis.”

      Alain Kinsch, Country Managing Partner of Ernst & Young Luxembourg says, “Despite a pick up in the global economy, the Eurozone continues to face a challenging combination of concerns over sovereign debt, political instability and rising prices. Such an uncertain economic environment is continuing to put the brakes on business investment by corporates and subsequent job creation.”

      Raising further interest rates would be a mistake

      Despite the rise in inflation, EEF believes the interest rate rise decided by the European Central Bank on 7 April 2011, with subsequent rate rises expected later this year to try and dampen down the level of inflation, could potentially endanger the fragile economic recovery in the euro zone. 

      Alain Kinsch says that Ernst & Young does not believe inflation is a medium or long term concern; that is why further interest rate hikes would be a mistake. “We see no need for the ECB to make such a move as our forecast assumes that in 2012, as oil prices start to fall back, food prices return closer to fundamental levels and the effect of VAT increases from the beginning of 2011 disappear, inflation will again fall below 2%.”

      The negative impact of a sustained and deepening Middle East crisis could spread wider as it could trigger a reassessment of risks across financial markets, with share prices falling rapidly and risk premiums rising on a wide range of bonds. For the euro zone, this could mean very negative developments if it led to renewed escalation of the sovereign bond crisis. While EEF attaches a relatively small probability to such a scenario, the latest developments in Portugal are worrying and the consequences would be very serious. 

      Risks and uncertainties abound

      The economic recovery in the euro zone remains fragile and the fact that Portugal appealed for financial assistance could now raise further concerns regarding other euro zone economies. Marie adds, “Even if Portugal and the euro zone muddle through this particular crisis the outlook remains challenging with the likelihood of a two speed or even three speed Europe that we have forecast for the last twelve months becoming even more entrenched.”

      Amidst all the gloom, it is easy to forget that the Eurozone can still remain attractive to potential joiners. On 1 January 2011, Estonia became the zone’s 17th member and the benefits of joining such a large market a large market and a relatively stable currency are already apparent. Marie Diron explains, “Booming exports will push Estonian GDP growth to over 4% this year and there is no doubt that consumer confidence has been bolstered by Estonia’s entry into the euro zone”. CW

      (source: Ernst & Young Luxembourg)