Eurozone to suffer recession in 2012 - report

KUWAIT, Jan 20 (KUNA) -- The European Central Bank (ECB) is expected to continue its tough policy after the latest drop in the rates of interest on the euro, as a result of the uncertainty and looming economic risks that pose a threat to most countries in the euro region, a specialized economic report showed Friday.
The report, issued by Kuwait Finance House's Research Department, pointed out that further drops are expected on the interest rate of the euro, where the ECB is expected to resort to a further shedding of interest rates by 25 points during the first quarter of this year.
It also forecasts that the euro zone will enter total recession this year in light of the current unfavorable conditions that were topped by Standard Poor's downgrading of sovereign debts for European countries.
As widely expected, the European Central Bank (ECB) left its key interest rate on hold at 1.00 percent during its council meeting on 12 January 2012- the first monetary policy decision of the New Year. The Bank also left the rate of the deposit facility unchanged at 0.25 percent, just as the rate on the marginal lending facility remained at 1.75 percent.
The report added that no further non-conventional measures had been announced this time around. We believe that the bank would to see the effectiveness of the previous measures to funding in the banking system before making any moves.
During the last meeting in December 2011, the bank decided to implement several measures, including lowering the banks' reserve ratio to 1.00 percent and relaxing collateral conditions, in order to enhance credit lending and liquidity in the money market.
The report cited recent statements by ECB President Mario Draghi expressing a slightly upbeat view of the euro-zone economy. Business activity was seen stabilizing, with lead indicators had stopped falling of late.
"Financial conditions have improved recently, on the back of the significant liquidity injection through the ECB's three-year longer term refinancing operations (LTROs) in December last year. This 'LTRO' offering was perceived by the ECB to have had a 'substantial' positive effect on easing credit conditions and boosting confidence in the financial system. News showed that there were a net increase in liquidity of around EUR 200bln distributed among the over 500 participated banks. The ECB's decision to offer banks unlimited three-year loans and the central bank's purchase of sovereign bonds helped balloon the central bank's balance sheet to a record EUR2.73tln in December 2011.
"Markit's Eurozone PMI Manufacturing and Services Indices rose for the second month running in December 2011, providing encouraging signs that the widely-watched indicator may have bottomed out.
"The economy also received a boost from a weaker euro. The euro's 10 percent drop against the dollar since late October 2011, giving advantage to trade activities. For instance, German's merchandise exports rose by 8.3 percent y-o-y to EUR94.9bln in November 2011, accelerating from 3.8 percent growth in October 2011. Shipments to the EU rose by 8.4 percent year on year to EUR56bln, with sales to non-EU countries up 8.2 percent to EUR38.9bln.
"Meanwhile, borrowing costs have also eased. Ten-year bond yields fell sharply, down to 5.17 percent in Spain and 6.64 percent in Italy, taking borrowing costs down below the 7 percent level that is widely considered to be unsustainably expensive in the long-run for economies such as these with low growth potential. Italy sold EUR9bln of bills on 28 December 2011 at about half the rate of the previous sale in November 2011 and Belgium raised more money than planned at a 3 January 2012 debt sale.
Despite the optimistic view, the ECB kept its options open for additional rate cuts if the economic downturn escalates. Indeed, officials "stand ready to act" amid continued high levels of uncertainty and "substantial" downside risks to activity. Our forecast envisages a 25 bps cut by the end of 1Q12, but the ECB may choose to keep its powder dry if economic data and financial conditions continue to stabilize. Further support is certainly in the pipeline before the end of the quarter with the second 3-year LTRO scheduled on 28 February 2012. The take up is expected to be substantial, especially since by then measures to increase the availability of collateral should have been clarified allowing national central banks to accept additional credit claims.
The report noted that the euro-area looks to enter a recession in 2012 (GDP forecast:-0.4 percent to 1.0 percent) as the sovereign debt crisis has led to tight fiscal policy, bank deleveraging and a significant drop in private sector confidence.
Indeed, debt crisis has intensified as Greece proved unable to follow on fiscal adjustments, and the decision to initiate debt restructuring in July 2011, against the backdrop of a central bank determined not to appear to be financing government deficits, has turned the crisis systemic.
Although there has been a notable improvement in bank funding markets in early month of January 2012, and sovereigns have issued debt at much lower borrowing costs than in December 2011, underlying stresses appear to be only contained rather than resolved.
This is underscored by recent Standard Poor's (SP) sovereign debt downgrades to several European countries along with the announced stall in Greek private sector initiative (PSI) negotiations. France and eight other euro-zone countries suffered ratings downgrades on their sovereign debt on 12 January 2012, sparking renewed global worries over Europe's ability to bail itself out of financial crisis. SP stripped triple-A ratings from France and Austria and downgraded seven others, including Spain, Italy and Portugal. It retained the triple-A rating on Europe's No. 1 economy, Germany. SP, which in December placed 15 of the 17 euro-zone countries on watch for possible downgrades, said it had decided to lower the debt ratings of nine of them because it felt the currency bloc has so far failed to take adequate action.
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