Euroland’s recovery stonewalled by stocks and currency
- Equity markets have slumped to a 5-year low. Whether current levels are anywhere close to fair value depends crucially on the valuation model and on the required risk premium. Further uncertainty caused by corporate malpractice and doubts about future earnings growth could spell the end of investors’ long-time love affair with equities, which could trigger a substantial undershooting.
- Dissatisfaction with corporate America and the performance of the US economy has given the euro a leg-up. Although policymakers publicly display contentment with the euro’s gains, there are worries about potential overshooting.
- In combination with doubts about the US economic momentum in H2, the appreciation to date has already undermined hopes for an export-led recovery in Euroland.
- Coming on top of disappointing export expectations, the equity market slump – which increases the cost of capital and depresses the propensity to invest – will hit investment spending, particularly in the TMT sector (telecoms, media, technology).
- The stronger euro – if it stays at present levels – will increase the real purchasing power of EU households by around ¼ of a percent. This will be more than offset by negative wealth effects which will, in total, shave some 1 to 1 ¼ percentage points off consumption growth during the next three years.
- All in all, the 50% drop in equity prices (EuroStoxx) and the euro’s appreciation will each reduce Euroland growth over the same period by ½ a percentage point, with the bulk of the effect coming in 2002 and 2003.
- The risk is increasing that the new economy’s virtuous cycle of rising share prices and stronger economic growth might shift into reverse resulting in mutual reinforcement on the way down.
- Even if this can be avoided, downward revisions to consensus GDP estimates for this year and next will increase in the coming weeks. In Germany, in particular, it will be difficult to achieve ½% growth in the current year. The consensus is still looking for a 0.9% rise. Similarly, the consensus forecast of 2.7% Euroland growth in 2003 increasingly looks like pie in the sky.
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Euroland’s recovery stonewalled by stocks and currency. For more DB Research analyses see theDeutsche Bank Research website.