OECD highlights eurozone contagion risk
European leaders need to provide “credible and large enough firepower” to halt the sell-off in the eurozone sovereign debt market or they will risk a severe recession, according to the chief economist of the Organisation for Economic Co-operation and Development.
The warning came as the organisation slashed its half-yearly forecasts for growth within the world’s richest countries, and said activity in Europe would grind to a near-halt.
Pier Carlo Padoan said that Europe’s leaders had so far failed to put in place firm plans to address concerns about sovereign debt sustainability, which threaten to destabilise the region’s banking sector and tip it into a severe recession.
“The scenario so far is that Europe’s leaders have been behind the curve”, Mr Padoan said. “We believe this could be very serious.” He said that leaders need to put in place firm plans for fiscal integration.
“Everyone should be clear that the euro is at stake and everyone should do what is needed to avoid the worst,” Mr Padoan said. While declining to single out any member state, Mr Padoan noted that Germany has had very clear benefits in the form of productivity improvements and a large surplus because of its participation in the common currency.
In its economic outlook, the OECD slashed its 2012 forecast for economic growth to 1.6 per cent for its 34 member states from 2.3 per cent six months ago and for Europe alone from 2.0 per cent to 0.2 per cent.
In the report’s introduction, the OECD notes that the global economy has deteriorated significantly since its previous report in May and that the euro area “appears to be in a mild recession”. However, “recent contagion to countries thought to have relatively solid public finances could massively escalate economic disruption if not addressed,” the report notes.
While there is some uncertainty about just how an unspecified “major negative event” might play out, what the OECD characterises as “a large negative event” – perhaps the break-up of the eurozone – “would likely send the OECD area as a whole into a recession, with marked declines in the US and Japan.”
In particular, the eurozone’s rescue fund, the European Financial Stability Facility, will need to be given the financial resources to make it a credible institution with sufficient firepower to stop the contagion from spreading.
“In view of the great uncertainty policymakers now confront, they must be prepared to face the worst,” the OECD said.
However, there is a potentially positive outcome if eurozone leaders do take the necessary steps for stability. This would come in the form of a pick-up in confidence among households and businesses that is likely to translate into a rise in demand and economic activity.
In the UK, growth is expected to contract slightly in the fourth quarter of 2011 and the first quarter of 2012 and is not expected to pick up much until the fourth quarter of 2012.
For the year as a whole, growth is expected to be 0.5 per cent, down from 1.8 per cent forecast in May and for 2013 is expected to be 1.8 per cent. Unemployment is likely to rise to 9 per cent next year and stay there until at least the end of 2013.