After a tumultuous year in 2008 full of gloom and doom alongside several attempts from the European Central Bank (ECB) and national European governments to stall the economic degradation that hit the economy since the second quarter of last year; before falling officially into a recession in the third quarter on the back of the Credit Crisis that resulted from the total failure of the U.S. sub-prime mortgages. The agony continued into 2009 that passed through different phases starting with a massive contraction in the first 3 months of the year and ending with vivid signs of recovery that appeared clearly since the third quarter. Thus, the year could be divided into separate quarters each of them different from the other in terms of economic problems, achievements, and plans so here we start... Chapter one: First Quarter "Looming Recession"

Following the contraction of 1.8% recorded in the fourth quarter of 2008, the pace of contraction expanded in the first quarter of the year to 2.5%, marking the sharpest drop since compiling data for the first time in 1995, while on the year the contraction widened sharply to 4.9% from 1.7% a year earlier.       

Looking into details, the severity of the contraction sparked as a consequence of the decline in consumer spending which plummeted 0.5% from 0.4% drop in the last quarter of 2008. Confidence in the economy retreated after the fall in recession that aroused skepticism over the government and the ECB's abilities to bailout the sinking economy.       

On the other hand, consumers' spending was adversely impacted by the high unemployment rate which climbed in March to 8.9%, the highest since November 2005. Companies shed employees to cut expenses in order to lower their losses amid the tremendous decline in domestic and global demand. Hence, government spending slipped in the first quarter to 0.2% from 0.4% in the last quarter last year as yields from sales tax plunged.        

Also, investors' confidence slumped which discouraged any company to open new projects; controversially, they began reducing production and inventories as well as canceling any future expansionary plans. For instance, BASF SE, the world's largest chemical company, announced 68% drop in the first-quarter returns and announced 2,000 job cuts. Gross fixed capital formation fell 4.1% in the first quarter, giving a clear picture to the diminishing confidence.       

Consequently, the escalating jobless rate weighed on the euro zone's growth and inflation. Consumer Price Index slipped to 0.6% in March from 1.2% in February and 1.1% in January. Following inflation's peak around 4.0% in January 2008, boosted by the incline in energy and commodity prices, inflation started to decelerate as a result to the slowdown in economic activities and elevating unemployment levels.       

The decline in inflation reflects the sharp fall in global commodity prices, especially when oil fell to a low of $36.00 a barrel in January, while remained below $50.00 a barrel in March. On the flip side, the global economy has weakened substantially impacted by the financial market turmoil, causing a severe fall in world trade volumes. Exports from the 16-nation economy plunged 8.8%, while imports slid 7.6%, resulting in a trade deficit in the first 3 months of the year.        

The decline in global demand negatively affected large economies that rely heavily on their sales overseas such as Germanyin spite of the euro's drop in January and February to 1.2050 levels before rebounding in March after reaching a high of 1.3737.        

Despite the decrease in commodity prices, consumer's disposable income and purchasing power remained vulnerable due to the noticeable weakness in the economy's sectors.

With regard to services, the leading sector in the euro zone, it showed contraction in the first quarter reaching 40.9 in March. Still, the banking sector was suffering as the financial crisis already wiped capital and set banks to hoard cash to restructure their balance sheets which are ailing with diluted investments. Banks were unable to lend due to the high restrictions on lending and decline in investors' confidence.

The manufacturing sector, on the other hand, contracted vastly in January reaching 34.4 as export demand collapsed and companies scaled back production. Although output rose in February and March to 33.5 and 33.9 respectively, it remained below the 50 level reflecting the contraction in the sector. The slump was led by the largest economies in the euro area as March's factory production reached 32.4, 34.6, and 36.5 in Germany , Italy , and France respectively.       

Relative to the housing sector that caused the bubble to burst, demand on houses slipped due to the decline in household's income and restrictions on lending which yielded in large number of supplied houses and therefore prices plummeted more.       

The problem was very obvious in Spain which was described as the catalyst for the euro zone's growth, as the housing sector depreciated rapidly where their housing boom had turned into a doom. The failure in the housing sector widely metastasized all over the Spanish framework, construction companies began to terminate thousands of workers as they no longer have any work to do; unemployment surged to 16.6% in March, recording the highest level in the euro zone.       

As a result to the collapse in the economies' major sectors, European stocks sagged closing in the red territories most of the time. The downbeat earnings from companies and grim outlook for the economy eroded risk appetite and emboldened investors to buy refuges and safe-haven assets.       

For instance, DAX Index which began 2008 with 8180 points dropped to 5125 points in January 2009 then slid to the lowest level in the first half of March to 3585 points.       

Actually, the contraction stemmed from the slump in the largest economies in the euro region. In Germany, the largest economy in the euro zone, the contraction reached 3.8%, the biggest drop since data were first compiled in 1970, while the French economy shrank 1.2%. Italian GDP contracted 2.6%, the most since records began in 1980, and Spain 's economy contracted 1.8%.       

In response to the abysmal scenario in the first quarter, the ECB slashed the benchmark interest rate by 50 basis point in January and by another in March to reach 1.50% in March in an attempt from the bank to inject more liquidity in markets to spur spending and thereby stimulating the economy on the one hand and fighting any deflationary threats on the other.       

The bank ensured that the outlook for the economy continues to be surrounded by uncertainty, while they mentioned that inflation expectations over the medium to longer term remain firmly anchored.    

Chapter Two: Second Quarter "Remarkable Improvement"    

Following the sharp contraction in the first quarter, the economy began to show signs of improvement starting from April after the bold interventions and announcements by the ECB and national European countries to halt the economic deterioration.       

ECB members decided to cut the key interest rate by 25 basis points in April and by another in May, while they kept the borrowing cost unchanged in June at the historical low of 1%, slashing 325 basis points since October 2008, while the interest rate on the deposit facility was cut to 0.25%.       

In addition, the ECB in May announced it will purchase euro-denominated covered bonds worth 60 billion pounds issued in the euro zone; in addition, the European Investment Bank will become an eligible counterparty in the Euro-system's monetary policy operations. The ECB also offered to lend banks as much money as they want at the current benchmark.       

Apart from the monetary measures adopted by the bank, national governments also introduced stimulus plans. For instance, Angel Merkel, the German Chancellor, introduced 85.0 billion euros plan by assisting in infrastructure as well as tax cuts. French President Nicolas Sarkozy has set aside more than 28 billion euros.       

These monetary and fiscal measures managed to spur liquidity in markets and revive growth. The cash generated by banks enabled them to foster their lending process to companies and therefore helping firms to pay their debts or buy raw materials for production.       

Hence, PMI manufacturing climbed to 42.6 in June from 36.8 in April, led by the incline in Germany to 40.9 from 35.4, from 42.0 to 42.3 in Italy , and from 40.1 to 45.9 in France ; while PMI services for the euro area edged up to 44.7 in June from 43.8 in April.       

The incline in PMI figures reflects the decline in the pace of contraction witnessed in the second quarter when the economy shrank 0.2% from 2.5% in the first 3 months of the year. The contraction eased when both Germany and France emerged from recession each by 0.3% expansion, while in Italy the contraction mitigated to 0.5% from 2.7%, where the Spanish economy fell 1.1% from 1.9% drop.       

In the second quarter, the progress was led by household spending which increased to 0.1% from -0.5% in the first quarter as consumer confidence rose. Capital formation, government spending, exports, and imports also inclined compared with the first the first quarter.       

However, the remarkable successes was witnessed in European stocks which started inclining since mid-March boosted by hopes that the economy is undertaking quick steps towards recovery. The German DAX index gained near 2000 points or more than 33% from the early period of March till the end of June reaching 4780 levels, while CAC climbed roughly 565 points or around 23% during the same period.       

On the other hand, and despite the improvement, unemployment continued its rise till it reached 9.4% in June, putting more pressure on prices and causing CPI to shift to negative territories for the first time in June when it marked 0.1% decline spurred by the fall in commodity prices and the appreciation in the value of euro which soared to a high of 1.4336 in June.       

All in all, activities were still showing a slowdown as global and European demand remained weak. Budget deficits widened and therefore some economies signaled higher government debt-to-GDPratios.

Chapter Three: Third quarter "Signs of Recovery"       

The notable improvement seen in the second quarter continued strongly in the third quarter where we have seen that Germany expanded in the third quarter by 0.7% and the second quarter expansion was revised higher to 0.4%, jolting the euro zone out of recession by recording 0.4% expansion and providing documentary evidence the economy is recovering from the worst economic recession in more than 70 years.       

Germany was the most influential across the 16 economies as it benefited from the incline in exports as global demand started to recover. Also, the effect of the 85 billion euros stimulus began to show its positive effect on the economy.       

According to the data released in the 3 months ending September, prices remained in negative territories where CPI for July reached -0.7%, the worst drop since records began in 1996, due to the slowdown in economic activities that led many producers to do promotions in an attempt to boost their dwindling sales. However, the decline in prices eased to -0.3% in September as oil prices remained at $70 levels and the economies' major sectors grew.       

Moving to unemployment, it continued its incline at the same pace of the second quarter to 9.8%, the highest in almost 11 years, which showed that the euro zone is still impacted by the economic recession. The highest record was witnessed in Spain where it reached above 19% as the economy could not recover from the collapse of the housing sector.      

GDP in Spain recorded 0.3% contraction on the quarter and 4.1% contraction on the year, while the Italian economy left recession in the third quarter through achieving 0.6% expansion, stopping the contraction that continued for five consecutive quarters. In France, the economy maintained the 0.3% expansion as the second quarter.       

The ECB kept the benchmark interest rate at its historical low at 1% and adopted the 60 billion euros plan starting from July to enhance liquidity and boost prices. Trichet and his team succeeded in emerging the economy from recession and moving prices close to the positive areas.       

Also in this quarter major companies posted earnings that beat estimates, while others saw falling decline in acquired losses. The stock market continued its rise in the three months, whereas the euro appreciated, as the dollar weakened, touching a high of 1.4884 in September.   

Chapter Four: Fourth quarter "Strong Rebound"       

Last but not least, in the fourth quarter the euro area showed strong data that support that the economy would expand more in the fourth quarter, taking into account that the fourth quarter advanced GDP will be released in March.       

The ongoing progress seen day after day led to a nonstop soar in confidence on hopes the economy is on the right track towards full recovery. German IFO business confidence report for the month of December rose to the highest level in 17 months to 94.7 from 93.9 and neared the 100 psychological expansion barrier.

In December, the euro zone's advanced PMI manufacturing rose 51.6 from 51.2, while PMI services climbed to 53.7 from 53.0, and PMI composite jumped to 54.2 from 53.7.

The ECB during the three months ending December kept the borrowing cost unchanged at 1% and on December 16 they indexed the cost of the 12-month funds, ending it as announced earlier in December by Trichet; thereby starting the gradual withdrawal of nonstandard measures as the economy started to improve. Trichet added that stimulus measures will be withdrawn gradually at the appropriate time.

Relative to inflation, CPI shifted to the positive territories for the first time in November since reaching 0.6% in April. The rate rose to 0.5%, higher than October's reading of -0.1% and 0.1% lower than the flash estimate. Trichet mentioned after the December rate decision that price pressures remain subdued and inflation will resume to positive territories in the coming period.       

Energy prices after rising to 10-month high in October and November above $81 a barrel, it retreated to $70 levels in December as the dollar rebounded, thereby eroding demand on all dollar-denominated commodities. On the other hand, the euro fell from the highest in near 16 months versus the dollar in November to 3-month low in December which may help European exports next year.       

Furthermore, Jobless rate inclined but at a slower rate which means that companies are shedding fewer jobs. The rate soared to 9.8% in October from 9.7% in September. There are 134,000 additional lost jobs, making 15.57 million jobless in October. The highest rates were recorded again in Spain at 19.3%, where the lowest were in Netherlands at 3.7% and Austria with 4.7%.       

Equities slowed their rally in the fourth quarter, as it was impacted by the grim Dubai World debt woes which ignited fears and aroused skeptics with regards to the recovery. Nevertheless, confidence was restored gradually when Abu Dhabi said it will give Dubai world $10 billion to pay its instant financial commitments.

In fact, Dubai's debt concerns opened the door for further worries amid concerns over a sovereign debt crisis as governments were suffering with high borrowing rates and swelling deficits.  S&P stated in December that it lowered the debt rating for Greece by on point to BBB+ from A- as the country is suffering from swelling budget deficit. Greece now has the largest budget deficit in the EU and their debt rating was also lowered by Fitch ratings to BBB+ which sparked concerns further.

In response, the Greek government announced that it is ready to do radical changes to lower the deficit and it set a four-year plan to slash the deficit from 12.7% of GDP to 8.7% in 2010 and to reach less than 3%, which is the level set by the EU, by 2013.

Trichet confirmed that Greece is not going into bankruptcy easing fears over their default. Still, the outlook is uncertain and this year that started with the deep bottom of the recession also marked the reversal into recovery which will extending into a consolidation period into 2010...

ecpulse.com