1. Euro area Update
The Euro area in the debt crisis maelstrom
Nordea Research, 29 November 2011
scaled down our growth forecast for 2013 from
The failure of Euro area politicians to
1.8% in August to just 1.0% now.
agree on a framework, which can quell the
debt crisis, has pushed the Euro area In addition, it should be highlighted that the risk of
towards a recession over the coming an even more negative outlook for 2012 has risen
months. Thus, we have adjusted our significantly. Despite great expectations, the EU
forecast for 2012 growth significantly summit conclusions from October 26 have utterly
down to a decline of 0.2% compared to failed to quell the turmoil in financial markets. The
0.6% growth in August. Similarly, we have summit conclusions aimed to increase the firepower
scaled down our growth forecast for 2013 of the European Financial Stability Facility (EFSF)
from 1.8% in August to just 1.0% now. by leveraging the remaining funds 4-5 times to
somewhere between EUR 1000 and 1400 bn. At the
Our new macroeconomic forecast is
moment, there are no signs that either of the two
based on an assumption, that a workable
leveraging instruments; offering first loss bond
solution to quell the debt crisis is found
insurance on new issues of government bonds or
before the end of the year. If Euro area
creating SPV’s focusing on purchasing government
leaders fail to agree on such measures,
bonds in secondary markets, can actually work.
the risk of a far more serious recession
grows dramatically. We expect a mild winter recession
5.0 5.0
% Euro Area GDP, y/y %
The main channel for propagating the risk
of a recession continues to be the banking 2.5 2.5
sector, but a tightening of fiscal policy will 0.0 0.0
also subtract nearly 1%-point from GDP
growth in 2012 and 2013. -2.5 -2.5
Finally, the sharply deteriorating outlook -5.0 -5.0
for the Euro area points to a further easing GDP, annualized, q/q
-7.5 -7.5
of monetary policy by the ECB. We now
expect the next 25bp rate cut in -10.0 -10.0
December, bringing the refi-rate to the 02 03 04 05 06 07 08 09 10 11 12 13
same level seen during the great
recession 2 years ago. In addition, we In this situation, many observers and market
expect the ECB to offer a host of new participants point to large scale bond purchases by
liquidity measures aimed at loosening the ECB as the only realistic option to quell the
funding conditions for Euro area banks. crisis. This is clearly anathema to the ECBs
This might well push EONIA rates to 30- governing council, as the new president Mario
35 bps, as was the case between July Draghi and several other members have argued that
2009 and July 2010. it is not the ECB’s remit to act as lender of last
resort to Euro area governments.
The Euro area is headed for a recession Euro leaders can avoid a deep recession
In our latest Economic Outlook from the end of Our new macroeconomic forecast is based on an
August we pointed to a significant risk of a mild assumption, that a workable solution to quell the
recession in the Euro area. In particular we saw a debt crisis is found before the end of the year. We
continuation of the sovereign debt crisis as a key have previously pointed to the option of turning the
trigger for such a recession. This risk scenario is EFSF into a bank, which could refinance its bond
now rapidly becoming reality. Consequently we purchases at the ECB as a solution which might
have adjusted our forecast for 2012 growth work. This solution has so far been flatly rejected
significantly down to a decline of 0.2% compared by the German government and the ECB, but we
to 0.6% growth in August. Similarly, we have

2. still think this solution may come back in vogue Outlook for business investments is bleak
when (if?) the current leveraging strategy for the 30 15
y/y Machinery y/y
investments, r.a.
EFSF fails. 20 10
Levels of financial stress at record highs 10 5
325 Bp Bp 325
0 0
300 300
275 275 -10 -5
250 250
Itraxx senior -20 New orders -10
225 financials, 5y bid 225
manufacturing,
200 200 -30 advanced 3 months, l.a. -15
175 175
150 150 -40 -20
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
125 125
100 100 Source: Nordea Markets and Reuters EcoWin
75 75
50 50
In spite of the supervisory requirements, we
Aug Nov Feb May Nov Feb May Aug Nov Feb May Aug actually think that the completion of the
08 09 10 11
Source: Nordea Markets and Reuters Ecowin recapitalisation process in Q2 next year could be a
turning point for the Euro area. Growth in business
If Euro area leaders fail to agree on robust measures,
investments and private consumption are usually
which can quell the debt crisis, the risk of a far
dependent on the credit impulse, which we have
more serious recession grows dramatically. The
defined as the second derivative of the outstanding
main channel for propagating the risk of a recession
stock of credit to non-financial enterprises and
continues to be the banking sector, where we
households. As such, the fact that loans to
already see signs of financial stress which in some
households and non-financial companies would
respects are comparable to the period immediately
stop falling once the EU banks have met the new
after the collapse of Lehman Brothers. This could
capital requirements could spur new growth private
easily trigger a far more dramatic decline in
consumption and investments.
inventories and business fixed investment than we
expect in our baseline scenario. The credit impulse is key to turns in the cycle
5 % y/y BN EUR 200
Euro area
4 150
Credit crisis likely to weigh on investments Real GDP, l.a.
3 100
A key factor behind our significant downgrade of 2
50
the economic outlook is a substantial downwards 1
0
adjustment of fixed investments. This is largely 0
-50
based on the fact that the funding crisis for several -1
-100
-2
Euro area banks is likely to lead to a further -3
-150
tightening of credit conditions for non-financial Credit impulse, r.a.
-4 -200
companies. This credit tightening could be further -5 -250
aggravated by the new requirement for the largest -6 -300
99 00 01 02 03 04 05 06 07 08 09 10 11
EU banks to bring their Core Tier1 capital ratios to
Source: Nordea Markets and Reuters Ecowin
9% by the end of June 2012, well ahead of the 2018 Note: The credit impulse is defined as the annual change in the
deadline otherwise envisaged in Basel III. quarterly nominal change in the outstanding stock of loans to
households and non-financial companies.
In the conclusions from the EU summit on October
26, it was specified that banks should seek to raise Fiscal tightening across the board in 2012
the capital themselves and only in the case where Turning to fiscal policy, nearly all the budgets for
this could not be achieved should member states 2012, currently being finalized in Euro area
step in with capital. This process creates a member states, point to a further tightening of fiscal
significant risk that banks will seek to meet the policy. The pressure in financial markets is rapidly
capital requirements by shedding assets, as the low forcing Euro area governments including France
equity valuations makes it quite unattractive for and Italy to accelerate plans for fiscal consolidation.
banks to raise the necessary funds in capital In particular Italy is slated to undertake a
markets. Consequently, the EU summit conclusions substantial tightening of fiscal policy next year, as
called for national supervisory agencies to oversee it has pledged to bring public budgets back to
that the capital requirement was not achieved balance already in 2013 even though the Italian
through deleveraging. economy is already headed for a deep recession.

3. Fiscal tightening to weigh on growth in 2012 Modest depreciation of effective exchange rate
Change in cyclically adjusted primary balance EER-impact for 2012
Share of Euro
area GDP 2011E 2012E 2013E Baseline Risk scenario
Germany 27.0% -0.7 -0.8 -0.5 %-points
France 21.0% -1.3 -1.5 -1.5 Sweden 0.1 0.1
Italy 17.0% -0.9 -2.6 -1.3
Switzerland -0.1 -0.1
Spain 12.0% -3.4 -1.5 -1.3
China -0.9 -2.2
Belgium 3.8% -0.4 -0.5 -0.9
Netherlands 6.4% -1.6 -1.2 -0.8 Japan -1.0 -2.9
Austria 3.1% -0.6 -0.6 -0.3 United Kingdom 0.2 -1.9
Ireland 1.5% -2.6 -1.9 -2.3 United States -2.1 -6.5
Greece 2.6% -3.4 -2.4 -2.0 Sum -3.7 -13.4
Portugal 1.9% -3.3 -1.6 -0.1 Based on the ECB’s Effective Exchange Rate (EER) weights
Euro area (weighted average) -1.3 -1.4 -1.0 and Nordea’s own calculations.
Source: National Stability and Growth Programs, German
Ministry of Finance, The EU Commission and Nordea’s own In a risk scenario, where the Euro area debt crisis
calculations. causes a significant fall in the EURUSD to 1.00
Overall we estimate that this will subtract just with a corresponding depreciation of the EUR vis-
above 1%-point from growth. The degree of fiscal à-vis the CNY and the JPY, the support for Euro
tightening in 2013 is less certain, but with a area exports would be far larger, see table. Overall,
continuation of the debt crisis the drag from fiscal this could lift the Euro area GDP level by nearly
policy is likely to be of similar magnitude. 1%-point in 2012 rising to nearly 1.7% in 2013.
Debt crisis is depressing consumers The ECB might try privatized QE
20 Balance Balance 20
Consumer sentiment The rapid deterioration in the economic outlook
10 Germany 10
France prompted the ECB to cut interest rates by 25bp to
0 0
-10 Spain -10
1.25% at the beginning of November. So far we
-20 -20
have expected the ECB to follow this move by
-30 -30 another cut in the first quarter of 2012, possibly
Italy
-40 -40 already in January. With this update of our
-50
Portugal
-50 economic forecast for the Euro area we now expect
-60 -60 the next rate cut already at the ECB meeting on
Greece
-70 -70 December 8.
-80 -80
05 06 07 08 09 10 11
Source: Nordea Markets and Reuters EcoWin
EONIA rates could return to 30-35bp range
3.0 % % 3.0
Only limited help from exchange rates
2.5 The corridor between the refi-rate and 2.5
The Euro area debt crisis has intensified in step the deposit rate was widened to 75bps
with a sharp slowdown in global growth. We still in May 2009.
2.0 2.0
expect fairly robust growth in the BRIC countries
1.5 1.5
during 2012 and 2013, and this should provide
Main refi-rate
some underlying momentum for export growth. 1.0 1.0
Growth in the most important export markets, the
0.5 0.5
UK and the US is likely to remain very subdued in
2012, however, see our US Update: No recession ECBs deposit rate
0.0 0.0
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct
but slower growth. 09 10 11
Source: Nordea Markets and Reuters Ecowin
Even though demand growth will be fairly modest
in the Euro area’s key export markets, Euro area
exports will also be lent a helping hand from a In addition to a December rate cut, we also expect
depreciation of the EUR vis-à-vis the USD and the the ECB to offer a new range of liquidity measures.
CNY. In our baseline scenario we only expect the We find it most obvious that the ECB will
effective exchange rate of the EUR to depreciate by announce additional LTRO’s at the December
just under 4%-points in 2012 compared to 2011. meeting. In particular we have taken note of
Based on standard multipliers this modest rumours, that the ECB should be contemplating
depreciation should only lift the Euro area GDP LTRO’s with maturities of 2-3 years an alternative
level by 0.3%-points in 2012 rising to 0.5% in 2013. to government guarantees on bank funding, which

4. are currently not very useful in the member states explained by the fact that the 12-month LTRO was
languishing under the sovereign debt crisis. Such a offered with interest rates indexed to the average of
policy would thus aim to prevent a further the refi-rate over the maturity of the operation. If
tightening of credit conditions, and it might also be instead the ECB returned to letting the interest rate
attractive for Euro area banks seeking to fund their be fixed at 1.00% on the forthcoming 13-month
holdings of short term bonds. LTRO, we might see much higher liquidity
withdrawals. In turn this would probably push
Whether such operations will be successful will
EONIA rates down to 30-35 bps, as it was the case
probably depend on the terms offered under such
between July 2009 and July 2010.
operations. As an example, the new 12 month Long
Term Refinancing Operation (LTRO), launched on Anders Matzen, Chief Analyst
October 27 only attracted bids of EUR 56.9 bn, far anders.matzen@nordea.com + 45 33 33 33 18
below the levels seen at the 12-month LTRO’s
offered in 2009 even though money markets are
currently under severe pressure. This might be
Euro area: Macroeconomic indicators (% annual real changes unless otherwise noted)
2008 (EURbn) 2009 2010 2011E 2012E 2013E
Private consumption 5,169 -1.2 0.9 0.4 0.2 0.9
Government consumption 1,901 2.6 0.4 0.4 0.0 0.0
Fixed investments 1,981 -11.9 -0.9 2.4 -1.0 1.6
Stockbuilding* 62 -0.9 0.9 0.5 -0.2 -0.2
Exports 3,877 -12.8 10.1 5.1 0.5 3.5
Imports 3,788 -11.6 9.2 4.5 0.2 3.1
Net exports* 89 -0.7 0.5 0.3 0.1 0.2
GDP -4.2 1.8 1.6 -0.2 1.0
Nominal GDP, EUR bn 9,243 8,938 9,168 9,445 9,580 9,834
Unemployment rate, % 9.7 10.1 10.0 10.5 10.5
Industrial production, % y/y -3.5 4.7 2.0 -1.0 1.5
Consumer prices, % y/y 0.3 1.6 2.7 1.8 1.6
- core inflation** 1.3 0.9 1.6 1.6 1.2
Hourly earnings, % y/y 1.4 1.5 1.6 2.1 1.6
Current account, bn EUR -27.9 -45.7 -55.0 -50.0 -50.0
Current account, % of GDP -0.3 -0.5 -0.6 -0.5 -0.5
General government budget balance, % of GDP -6.3 -6.2 -4.1 -3.5 -2.7
General government gross debt, % of GDP 79.1 84.7 86.3 88.6 89.0
*Growth contribution as % of GDP.
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