Europe too catches Asia flu

Taken together, the latest indicators have prompted some sharp downward revisions in expectations for lower growth expectations for second and third quarter in the European economy.

J P Morgan now reckons that the Euro zone – made up of the 11 countries due to join the single currency in January – won’t in aggregate record any GDP growthin the second quarter. That is revised down from its earlier estimate of 1.5 per cent growth.

"There had already been strong signs of a slowdown in the second quarter, but we are forecasting a further deceleration in the third quarter," said Elga Bartsch, economist at Morgan Stanley Dean Witter in London. "Business surveys have seen downward revisions in output plans for quite a while… Overall, manufacturers in Europe are getting less optimistic," she added.

The most disturbing news has unquestionably come out of Germany, Europe’s largest economy. Figures released on Thursday showed industrial output falling 1.9 per cent in June. That followed Wednesday’s surprise announcement that June industrial orders declined by 1.1 per cent.

In Italy, production fell 2.1 per cent in June, reversing almost all of the 2.5 per cent gain in May.

Germany’s economics ministry tended to play down the production slump, saying that the result would more than likely be revised upwards in the coming months. Indeed,analysts cautioned that there might be unusual factors working behind the scenes — such as early holiday schedules for certain industries — which exacerbated the weakness.

Still, taken at face value and put in the context of the manufacturing weakness seen across much of the industrialised world, economists remain on guard for more signs of faltering European growth. "The risk factor for Europe right now is that the slowdown in the UK and prospective slowdown in the US will be a second leg of weakness that will hit European industry," added Kasman.

Until now, many had assumed that Germany’s expansion, led by a revival in home-grown demand, would continue unabated and leave the economy mostly insulated from the contractionary forces seen elsewhere. To some extent, that is still the dominant view.

A report by the Organisation for Economic Cooperation and Development offered a relatively rosy outlook for the Germany economy, with growth seen at 2.7 per cent this year and 2.9 per cent in 1999.

But withGerman industry now under pressure, the outlook has become less certain. Ultimately, analysts say Germany’s third quarter GDP performance hinges on the extent to which internal demand can offset the negative forces in manufacturing. While it has been argued that much of Europe could escape Asia’s crisis largely unscathed, such expectations were based largely on the absence of substantial trading links between the two regions.

The twist to the latest figures is of a secondary nature: namely, weakness from Asia transmitted to the US and the UK and then back to continental Europe. This is potentially a much more potent threat, putting Europe in the middle of contractionary forces arising from both east and West.