America's economic ills spread to Europe

Image: A customer fills up his petrol tank at a petrol station in Munich
A customer fills up his petrol tank in Munich. Germany and France provided reminders on Tuesday of how vulnerable Europe's economy is as long as soaring food and fuel prices erode confidence and household spending power.Alexandra Beier / Reuters file
/ Source: The Associated Press

It took a few months. But the economic woes touched off by soaring oil prices and the subprime mortgage crisis in the United States are finally engulfing Europe.

While each country has written its own recipe for what appears to be a looming slowdown, they all have one key ingredient in common: "Inflation, inflation, inflation," said economist Gilles Moec of the Bank of America in London.

Pinched by higher prices, consumers aren't spending — reflected in low consumer confidence most of Europe's big economies.

Marie-Charlotte Robin, 23, a communications student who drives every day through Paris for her summer internship, says she has to devote more and more of her budget to gas. Recently, she has spent about 70 euros, or $110, per week at the pump.

"I don't even fill up my whole tank anymore because the price makes me sick to my stomach," said Robin, sitting on a park bench on a street just off the Champs-Elysee during her lunch break.

Inflation could well be the hallmark that defines what might otherwise have been a normal, cyclical slowdown after two or three years of strong growth in Europe. Unusually, it is food and oil prices that have risen without driving up core inflation. But many worry it is just a matter of time before prices for other goods begin rising as well.

"Overall inflation is at 4 percent, twice the target of the European Central Bank," said Marco Annunziata, chief economist of UniCredit Markets and Investment Banking in London. "If you look at core inflation, if you ignore the prices of food and energy, it is less than 2 percent. That shows the prices of everything else except food and energy are quite stable. The question is: How long can it last?"'

A stronger euro buffered Europeans somewhat from higher oil prices, since crude is priced in dollars, and for a while their economy rolled on a faster track. But as oil hits records over $147 per barrel higher gas prices are finally starting to bite, and fears about inflation and trouble in the US — a top export market — are starting to bite.

Kabir Siyar, who owns a mobile phone and electronics business on Hauptwache square, one of Frankfurt, Germany's busiest shopping areas, said business had slowed. "For the past year or year-and-a-half, for things that cost as little as 5 euros, or $7.90, people are asking if they can have it for 3 euros, or $4.75, instead. You never used to see haggling," he said. "People used to just hand over the money, now they're trying to get a better price."

The blueprint for slowdown varies greatly from country to country, creating a complex scenario that is exacerbating worries about how bad it will get — and making harder for the European Central Bank to conduct its one-size-fits-all interest rate policy. The bank's president, Jean-Claude Trichet, has stressed the need to fight inflation, with higher interest rates, if necessary. The bank raised its key rate to 4.25 percent earlier this month despite fears that might weigh on growth.

Spain, Ireland and Britain suffer from a burst housing bubble like the one in the United States. Germany's export motor, running strongly for several years, is suddenly sputtering. Italy, Europe's perennial underperformer, limps along, burdened by chronic structural problems.

Denmark is already in a technical recession — two consecutive quarters of negative growth. And according to many economists, the list of suspects for second-quarter contraction is growing: Spain, Italy, Ireland and possibly France and even Germany.

Gross domestic product in the 15 countries that use the euro currency — which excludes Britain — grew by 2.2 percent on an annual basis in the first quarter of 2008, according to Eurostat. But that may be the last bit of good news for a while.

"The big news is that the euro zone itself may contract in the second quarter," said Barcelona-based economist Edward Hughes.

The crisis has already claimed a casualty in Spain with the collapse of the big construction firm Matinsa-Fadesa under 5 billion euros in debt. The firm suffered the effects of higher interest rates and tighter lending conditions by banks spooked, though not directly impacted, by the U.S. subprime mortgage.

Bad news keeps rolling out of Germany, Europe's biggest economy. Exports were down 3.2 percent in May, the biggest drop in more than three years. The private research firm ZEW reported this week that German investor confidence has plummeted to its lowest level since it launched the index in 1991. And growth appears to have slowed dramatically in the second quarter — to just 0,2 percent of GDP, according to the DIW think tank.

Still, many economists believe that Germany may still escape a big hit, following healthy 1.5 percent first quarter growth.

That may not be enough to improve the picture over all. Bank of America forecasts stagnation in the euro zone for the last three quarters.

But at Barclays Capital, "we haven't penciled in a doomsday scenario in terms of economic growth," said Frankfurt-based economist Thorsten Polleit.

Barclays forecasts a slight 0.1 percent contraction in the second quarter, followed by 0.3 percent growth in each of the third and fourth quarters, Polleit said. For the year, Barclays growth forecast is 1.6 percent in 2008 and 2 percent in 2009.

"Inflation is a societal evil. It starts biting into consumer spending," Polleit said. While that's the picture in Europe and North America, Polleit notes that what is happening is a shift in spending power toward countries exporting commodities.

"It is always the same story. We are happy with rising prices of goods we already own," said Polleit. "We hate rising prices for goods we would like to buy. ... We don't appreciated it if others are getting better off while we are getting less well off."