European recovery path in danger

The euro region’s path to recovery is facing a new challenge from Italy’s political stalemate.

Growth and job-creation in the 17-nation euro area were showing a mixed picture before the results of Italy’s vote sparked a new round of market turmoil on Feb. 27. While German and euro-region business confidence rose in February, services and manufacturing both contracted and the European Commission last week forecast the bloc’s first- ever back-to-back recession in 2013. While the euro’s appreciation this year could undermine exports, latest data suggest Germany is on the rebound. The commission cut its forecast for the German economy, Europe’s largest, to 0.5 percent growth this year, from 0.8 forecast in November, due to a drop in euro-area demand that damps export and investment. The election highlights the risk that Europe’s recovery turns into a slog lasting years, especially if voters continue to stream toward anti-austerity populists such as Italy’s Beppe Grillo, said economists from ABN Amro Bank to Daiwa Capital Markets. With European Central Bank interest rates already at record lows, officials may have little choice other than to let Europe grind its way out of the slump. “Even before the election, it was going to be a much harder story for the periphery to return to growth than for Germany,” said Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc. “If the Italy situation goes on for several months, it will begin to put back the European recovery.”

Investors across the euro region recoiled after the party of comedian-turned-politician Grillo won a quarter of the vote with a platform that calls into question Italy’s membership of the euro. That triggered Italy’s biggest bondmarket slide in 14 months, pushing the yield on its 10year bond as high as 4.9 percent. The yield on Portugal’s bond of similar maturity rose to 6.66 percent and the Greece’s 10-year yield climbed to 11.49 percent.

Higher borrowing costs come as some of the economic data in the past two weeks questions the optimism that has charged markets since ECB President Mario Draghi pledged in July to do “whatever it takes” to safeguard the euro.

The euro region contracted 0.6 percent in the fourth quarter, the most since the depths of the 2009 recession, the European Union’s statistics office said Feb. 14.

The euro region’s hobbling recovery contrasts with the rally in stocks and bonds since July. The Stoxx Europe 600 Index (SXXP) has jumped about 15 percent since then, while in January, the yield on Italy’s 10-year bond fell to the lowest since December 2010.

Those market rallies were fuelled partly by optimism about Germany’s economy, Europe’s largest. The Ifo gauge of business confidence rose to a 10month high in February and the ZEW index of investors’ sentiment reached the highest since 2010.

Economic confidence in the euro area increased more than economists forecast in February, the European Commission said yesterday. Its survey was conducted before the Italian election results.

Some economists have also pointed to falling wage costs in Portugal, Spain and Ireland as evidence that governments and executives are slowly refitting their recession-hit economies.

Irish labor costs have dropped 10.4 percent since the euro crisis broke out in 2009, European Commission data shows. In Spain, they have dropped 6.4 percent and in Portugal they have declined 5.8 percent. By contrast, labor costs in Italy have climbed 2 percent in the same period. Carmaker PSA Peugeot Citroen (UG) plan to bolster production at its plant in northern Portugal by 36 percent in 2013 and hire 300 new workers at a plant, the government said Feb. 22. Nissan Motor Co. (7201) said Feb. 4 it would build a new car model at its Barcelona plant after reaching an agreement.