The Italian economy continued to contract sharply in the third quarter of 2008 as exports fell sharply – declining at the fastest rate in three years – under the impact of a global slump which weighed down on foreign demand for Italian products, and pushed the Italian economy into its worst recession since at least 1975. Sales of Italian goods abroad fell 1.6 percent from the previous quarter, their biggest decline since 2005.

Pressure is of course on the government to offer a fiscal reponse to the problem, but given Italy’s outstanding debt issues and the fact that a large part of the problem is long term structural and not cyclical it is hard to see much of note happening, and indeed Finance Minister Giulio Tremonti’s statement this week that additional stimulus packages were pretty pointless could be read as more of an admission of impotence than anything else. What’smore the Italian government announced this week that its budget deficit for 2008 will be 52.9 billion euros, somewhat above the government’s earlier estimate which forecast a gap of 45.2 billion euros. It is not clear yet how this deficit overrun will actually affect the final % of GDP number for the deficit, since we still do not have an accurate 2008 GDP number for Italy yet. In any event speculation is rife about the future of the Italian bond spread and the danger of a credit rating downgrade. The Italian government went to market this week and sold 6.949 billion euros of five-, 20- and 30-year bonds. The 10-year Italian BTP/Bund spread was trading at around 144 basis points after Thursdays auctions compared with 141 basis points the day before. Continue reading →

Bloomberg are reporting (via Der Standard) that Austrian banks have the biggest exposure to Forex lending in Eastern Europe. This is hardly breaking news, and I have had working notes for a post on this lying around for months (here, please excuse the mess, I will append some of this to this post if time permits at the weekend). The issue is simply finding the time to do everything. Basically I would say that all this business about not devaluing currencies (and hence imposing wage cuts) in Eastern Europe is to do with this issue (also highly exposed are the Swedish banks, and Italy’s Unicredit). Der Standard cite an as yet unpublished International Monetary Fund report to the effect that Austrian banks have loans outstanding in Eastern Europe equal to about 70 percent of the country’s gross domestic product, a higher percentage exposure than any other country.

If you are in the business of liking scary quotes, you could try this one (which comes from the king of scary quotes and dreaded anthropologist’s grandson – Ambrose Evans Pritchard – but that doesn’t make it any less scary:

“This is the biggest currency crisis the world has ever seen,” said Neil Mellor, a strategist at Bank of New York Mellon. Experts fear the mayhem may soon trigger a chain reaction within the eurozone itself. The risk is a surge in capital flight from Austria – the country, as it happens, that set off the global banking collapse of May 1931 when Credit-Anstalt went down – and from a string of Club Med countries that rely on foreign funding to cover huge current account deficits.

The more sobre version would be this one from Paul Krugman that I keep using:

“There is a burgeoning economic crisis in the European periphery,” Krugman said on the ABC network Dec. 14. “The money has dried up. That’s the new center, the center of this crisis has moved from the U.S. housing market to the European periphery.”

Either way, the economic meltdown in parts of Europe’s Eastern and Southern periphery is now in the process of working its way back up the pipes and to the core, to Germany in terms of the collapse in GDP growth and exports, and to Austria in terms of stress on the banking system.

Germany’s economy may have contracted the most in more than two decades in the final quarter of 2008 as the global financial crisis hurt exports and damped spending, the Federal Statistics Office said. The economy probably shrank between 1.5 percent and 2 percent in the fourth quarter from the third, Norbert Raeth, an economist at the statistics office, said at a press conference in Frankfurt today. A 2 percent drop would be the worst quarterly contraction since German reunification in 1990 and the most for West Germany since the first quarter of 1987.
Bloomberg

And while I am here, Izabella Kaminska has a timely piece on forex lending exposure in Poland over FT Alphaville. The situation in Poland is important, since the country is widely regarded as the strongest and least vulnerable of the EU10 economies (see Christoph Rosenberg, for example). So basically, I would say that rather than being just one more “meltdown” in Eastern Europe, if Poland crumbles this will be the last domino to fall, bringing all the rest down in its train – craaaash (I wrote a longish piece on Poland back in October, here). The Leu and the Forint will need to correct to levels which bring back export competitiveness, and behind them will come the pegs in the Baltics and Bulgaria, bring with them all the west european banks who funded the lending.

Ukraine’s industrial output continued its rapid decline in December, falling for a fifth consecutive month, led by steel, chemical and machine building. Output tumbled an annual 26.6 percent, following a 28.6 year on year decline in November, and a 19.8% one in October.

December steel production slumped 42.7 percent, chemical output fell 40 percent, and machine building dropped 37.1 percent. The annual contraction rate slowed slightly in December, but this may be a statistical artefact due to what is know as the “low base effect” in December 2007, since output almost certainly fell in December over November, and we can expect it to continue to fall in the coming months (Update Friday: actually my initial guesstimate was wrong. They just published the data on the stats office website, and output was up 3.2% on December over November. This could be a result of increased exports due to the sharp drop in the value of the hryvnia, but it is too early to say at this point. To be followed closely).

For a full analysis of what is happening in Ukraine, see my As The Politicians Battle It Out Ukraine’s Economy Tunnels South In Search Of Australia

This is very reassuring news. I slept a lot better last night after reading it.

The International Monetary Fund said on Wednesday there was no reason to think that Ireland will need IMF financing, after an Irish broadcaster reported that the country may need IMF help if its economic prospects worsened. Irish Prime Minister Brian Cowen, on a visit to Japan, quickly denied the report by broadcaster RTE which was picked up by other media outlets, sending the euro falling more than a cent against the dollar.”The authorities have been clear today. We agree. There is no reason to think that IMF financing will be needed,” an IMF spokesman said in a statement.

Unfortunately, this article in the Financial Times quickly undid all the calming effects of eight hours solid sleep.

Irish credit default swaps, which measure the market’s view of the probability a country will default on its sovereign debt, jumped close to record highs before Dublin’s denial. The government calculates that, if it sticks to the pay deal agreed with unions in September, the deficit will rise from 6.5 per cent of gross domestic product in 2008 to 10.5 per cent this year, and remain at 11-12 per cent up until 2013…….The Irish government, in a submission to the European Commission last week, said it was aiming to bring the deficit to less than 3 per cent in 2013.

And of course Ireland’s is far from being one of the worst case situations here. The rumpus we are witnessing seems to have been caused by a veiled threat – strongly denied – from Brian Cowen that if unions failed to agree to a proposed 5% cut in public sector salaries there would be no alternative to calling in the IMF. Come on everyone, tidy up the living room, daddy will soon be home from work!

Well, there doesn’t seem to much room for doubt at this point does there, the Baltic Economies are in the van of the European economic slowdown for 2009, just as they were leading the charge up in 2007, and all that debate about whether we were going to get a hard landing or a soft one seems now so out of date and and old hat as we watch how Estonia’s economy contracts almost faster than the body of the incredible shrinking man (by an annual 3.5% in the third quarter of 2008), while Latvia’s seems to be rivalling Harry Houdini in the expert art of staged disappearance (dropping as it did by an annual 4.6% in Q3). Even Lithuania’s economy – which like a half drunken man still manages to stagger forward before it finally gets to fall over – is now expected by IMF regional representative Christoph Rosenberg to be set to contract an annual 2% in 2009. As Rosenberg so pointedly says “Latvia had the highest growth rate in the EU for several years, but it was a bubble.”

Continue reading →

Spain yesterday became the third euro zone country within a week to be warned by rating agency Standard & Poor’s that its credit rating (currently the highest – AAA) is under threat from the deterioration in public finances being produced by the government’s attempt to support the banking system and put a brake on the dramatic decline in the domestic economy. As in the case of Ireland and Greece last Friday, S&P said Spain faces a painful process of rebalancing of its economy and a consequent marked deterioration in its public finances. Continue reading →