EU growth falls to four-year low as recession looms

GERMANY and Italy are flirting with recession while eurozone business growth has slumped to a four-year low, leaving the region nakedly exposed to the possible shock of a no-deal Brexit.

The closely watched IHS Markit index of German manufacturing fell to 50.2 in November, close to the “boombust line” that divides growth from contraction. It is the weakest level since the tail-end of the eurozone banking crisis in 2013. Foreign export orders fell to a six-year low.

Germany’s data office, Destastis, confirmed yesterday that the country’s economy contracted by 0.2pc in the third quarter. It blamed falling global demand and disruption in the car industry from new vehicle test standards.

Italy’s economy has also stalled. Peter Praet, the European Central Bank’s chief economist, warned that the country is uncomfortably close to a fresh crisis. Risk spreads on 10-year Italian bonds have been stuck above 300 basis points for nearly two months, tightening the noose on the economy. Italian banks are mostly unable to roll over their bonds, forcing them to curb lending. Mortgage rates are being reset upwards. “No country can sustain such high spreads for a long time,” he said.

Mr Praet told the Handelsblatt that there would be no ECB reprieve for Italian lenders at the next meeting in December. Hopes that the economic slowdown in the third quarter would prove nothing worse than a “soft patch” have been dashed as a blizzard of ominous figures point to further trouble in the fourth quarter.

It is becoming clear that the credit crunch in emerging markets – caused by vanishing dollar liquidity – is doing more damage to Europe than anticipated. So is the slowdown in China.

Phil Smith, from IHS Markit, said Germany had seen a “sustained loss in underlying growth momentum”. The manufacturing sector has been hit by “falling sales in China, Italy, and Turkey”. The composite PMI survey for manufacturing and services across the eurozone dropped to a four-year low.

The abrupt downturn in Germany and Italy has echoes of mid-2008 when the two economies went into recession in the second quarter of that year, leading the rest of the eurozone into crisis.

The reduction in QE has mechanical effects on the growth rate of broad M3 money, and therefore constrains bank lending. M3 was growing at around 5pc a year during the peak QE period when the ECB was buying €80bn of bonds a month. It has been slowing ever since. The rate dropped to 2.1pc in September on a three-month annualised basis.

“On announced policies, M3 will stop growing completely in 2019. Frankly, they are setting themselves up for a catastrophe unless there is a change of course,” said Professor Tim Congdon from the Institute of International Monetary Research.

“The eurozone is in state of monetary civil war. There is a game of chicken going on between Italy and the protestant ethic countries of the North, and Germany in particular,” he said.

Fabio Balboni, from HSBC, said the ECB’S forecast for a growth rebound late this year and into 2019 “look increasingly at odds with reality”. The European Commission’s prediction for 2.1pc growth in 2018 issued just two weeks ago already looks impossible.

The clear risk for the eurozone is that a no-deal Brexit would push the region’s fragile economy over the edge, setting off an unstable chain reaction. This would be hard to counter. The ECB’S policy rate is already minus 0.4pc. The apparatus of fiscal rules makes it almost impossible to respond quickly with radical budget stimulus.

The outcome would be worse if the EU chose to act on any of the threats circulated during the Brexit talks of shutting air links and transport ties, and severing the cross-channel supply chains of European multinationals.

The EU side would have to introduce emergency “continuity measures” as a matter of vital self-interest. If it did not do so the eurozone would risk crashing into a deep recession.

There is no sign yet that EU leaders are fully alert to this risk but the shocking PMI data is a wake-up call. The eurozone is once again on the cusp of trouble. Pressuring Britain into accepting the indefinite writ of the European Court in Brexit talks is a high-risk strategy. What if Parliament says no?