Eurozone economy in danger of slumping

Taken as a whole, the Eurozone economy had until recently been relatively robust in the face of the credit crunch. This is about to change. There have already been some worrying data releases this month, particularly in the manufacturing area. Things got worse yesterday, when the European Commission economic sentiment index collapsed. The index saw the second biggest monthly drop since the survey began in 1985 – only October 2001 saw a bigger fall – and economic sentiment is now running at the lowest level since 2003. The survey showed that sentiment falls were widespread across both sectors and countries – Germany was not immune, while the drop in economic sentiment in Italy was bigger even than the fall post 9/11.

Today’s worrying data release was that inflation accelerated from 4.0% to 4.1%, the fastest rate since April 1992. The ECB aims to keep inflation below 2%, so it clearly has a big problem. A few weeks ago the European bond market was pricing in another couple of rate hikes, although the wave of weak economic data this month has meant that rates are now expected to remain on hold. However, as the ECB demonstrated at the beginning of this month, it’s prepared to hike rates, even in the face of a slowing economy. Another such move will serve to inflict even more pain on European companies, and would make me even more nervous about taking on a lot of European credit risk right now.

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