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Euro-Zone Economic Contraction Deepens

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Concerns over the future of the euro deepened Thursday on more evidence of policy inertia and a fresh spate of dire economic data that showed some of the remaining supports for business activity in the 17-country euro zone splintering away.

The euro zone’s economic contraction deepened in May with business activity falling at its st Preview deepest rate in nearly three years, an influential survey of purchasing managers showed Thursday. The data came alongside a sharp reversal in Germany’s Ifo measure of business sentiment this month. A French business survey also delivered a poor result. Collectively, the economic vital signs pointed to a rising risk of the euro-zone economy remaining mired in slump for much of this year.

“The euro area might have side-stepped technical recession in the first quarter, but the indicators for the second quarter are looking increasingly ugly,” said James Ashley, senior European economist for RBC bank.

JP Morgan economist Greg Fuzesi said the figures were a “big disappointment,” and the numbers prompted a cut in the bank’s forecasts for the euro-zone economy this year. The bank’s economists now expect output to shrink at an annualized rate of 1.2% in the second quarter, a deeper contraction than the 0.8% drop previously anticipated, with a full-year forecast for 2012 of gross domestic product shrinking by 0.4%.

A summit of European leaders Wednesday night failed to deliver new policies to boost economic growth and contain the Greek debt crisis. Instead, markets were treated to growing talk that euro-zone governments were preparing contingency plans to limit the damage from a Greek exit from the euro zone. Policy makers warn that a Greek exit could leave the country financially crippled with far-reaching effects elsewhere in the currency bloc.

A lack of clear strategy among European leaders to prevent a downward economic spiral has focused attention on the European Central Bank, which is the euro-zone authority best equipped to provide fast relief for the economic system in the form of interest-rate cuts and, if needed, unlimited supplies of additional cash in the form of long-term credit arrangements with banks.

he yield on two-year German bonds, a haven bet to guard against a break with some countries returning to national currencies, is close dipping below zero, a rare occurrence in the global capital markets. That would mean that investors would rather incur a small capital loss in exchange for safety and liquidity. The German two-year bonds are now trading at below 0.1% on the plus side.

The euro sank below $1.2516 against the dollar Thursday morning, its lowest since July 6, 2010, and lost ground against the pound and the yen.

The next major signpost for the euro-zone currency project are Greece’s June 17 elections, which in effect is a referendum for Greek voters to choose whether they want to remain in the euro. The May 6 elections failed to deliver a governing majority after fringe parties benefited greatly from popular resistance to continued fiscal austerity.

Citigroup economists now estimate that Greece would be likely to leave the euro zone next January, when its new currency will immediately fall by 60% against the euro, unleashing a massive yet manageable wave of contagion across Europe. Read More in The Wall Street Journal

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Written by Theophyle

May 24, 2012 at 7:58 pm

Posted in WSJ

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