Near-term Prospects for the Euro Region and Japan

by Inya Ivkovic, MA

Continuing my overview of macroeconomic factors around the globe, the next two regions of discussion are the European Union (EU) and Japan. Economic growth in Europe came to a standstill in late 2008, resulting in the region’s first recession since the Economic and Monetary Union was incepted in January 1999. After the EU GDP declined 0.3% in both the second and third quarter of 2008, it ended the year with a 1.8% decline and then followed up with a further 2.5% drop in the first quarter of 2009.

It shouldn’t come as a huge surprise that the weakness was widespread. European governments tried to stimulate consumer spending, but consumers were slow to respond, while businesses sharply withdrew from the playground. But that wasn’t what did it. It was the failure to reanimate Europe’s international trade that really tipped the scale. Indeed, in the fourth quarter of last year, the EU’s international trade plummeted a whopping 7.2%, and 8.1% in the first quarter of 2009.

Unfortunately, this rapidly declining pace is expected to continue through the second and the third quarter of this year, with the peak-to-trough decline hitting 5.5%, which is roughly one percent worse than the decline expected in the U.S. Although the economy is expected to stabilize by the end of the year, European output is not expected to make significant inroads until well into 2010. Simply put, the local policies appear insufficient to propel the demand, leaving the zone dependent on global economic recovery, and the U.S. in particular. As a result, economists expect EU GDP to decline 4.9% in 2009 and advancing negligibly by 0.3% in 2010.

As far as Japan is concerned, whatever momentum the country mustered in the first half of 2008 quickly evaporated, running Japan into a deep recession. GDP has now contracted for the fourth quarter in a row, declining 3.6% and 3.8% in the fourth quarter of 2008 and the first quarter of 2009, respectively.

For the past 12 months, domestic demand has been anemic, housing inconsistent, government spending insufficient, consumer consumption on the decline and business investment has been gasping for its last breath. But, as was the case in the Euro zone, all of the above was not what broke the camel’s back, but rather it was the sharply declining international trade. Japan’s exports stalled in the second half of 2008 and then the floor literally fell in, as exports declined 14.7% in the fourth quarter of 2008 and another 26% in the first quarter of this year, trimming off a total of seven percent off Japan’s GDP.

As there are mild signs of recovery in exports and manufacturing, the recession will likely continue to wreak havoc on Japan’s economy, with the peak-to-trough decline reaching almost 10%, nearly double that of the U.S. At the end of the year, the economy is expected to stabilize, but expansion is not going to be reappearing until the second half of 2010 in that corner of the world. In addition, any such recovery will be dependent on how quickly, or slowly, the global economy recovers.

Another problem Japan is facing is deflation, which is expected to continue for the near future. Since hitting -0.2% year-over-year in September 2007, headline inflation advanced to 2.3% in July 2008. However, that is very deceiving, since such performance reflected the run-up in energy prices. Excluding them and food, inflation rose from -0.3% year-over-year to only 0.2% over the same period. In other words, deflation never disappeared; it only masked itself in energy prices.