What has come to be termed as the ‘Great Recession’ seems to have come to an end in the third quarter of 2009, according to the European Commission (EC) in its Quarterly Report on the Euro Area (QREA). The rebound in activity reflects improvements in the external environment, in financial conditions and in confidence. But the outlook remains uncertain as the rebound is underpinned by the massive support provided by governments and central banks worldwide, which eventually will have to be scaled back and depends on the ability of the banking sector to increase the present levels of lending to the economy. The continued, albeit more moderate, increase in unemployment is a source of concern both socially and economically.
The report goes on to argue that to face up to these challenges, it is essential for the euro area to re-energise its structural reform agenda. In one of its sections that looks at public support for reforms, the QREA sees a window of opportunity to lay the foundation for a solid and sustainable recovery. Structural reforms aimed at stimulating research and innovation, competition and human capital should be particularly encouraged as they can have sizeable positive effects on growth and employment. The QREA also looks at how long-term trends in the euro-area banking sector may have become affected by the crisis.
In the third quarter, the euro-area economy expanded by 0.4% quarter-on-quarter, marking the end of the recession, after five consecutive negative quarters. Yet, for 2009 as a whole, gross domestic product (GDP) is expected to have contracted by 4%, according to the autumn forecasts, the biggest fall in output since World War Two.
Benefiting from the improvement in the global economy, exports were the key driver of the rebound in growth in the third quarter. Inventories also contributed positively, reflecting a slower pace of de-stocking. By contrast, household consumption contracted slightly, as a result of the deterioration of the labour market. Investment also continued to contract, but at a much slower pace. Financial conditions have considerably improved and many financial indicators are now at pre-crisis levels. However, money and credit growth to enterprises and households remain subdued on the back of low asset prices and weak demand. Moreover, the improvement in financial indicators has been rather gradual recently and financial conditions are still vulnerable.
Overall, the outlook for the euro-area economy remains uncertain. One major concern is the deterioration of labour markets. In the third quarter, employment in the euro area continued to contract at the pace of 0.5% quarter-on-quarter and unemployment increased to 9.6% of the labour force. Compared to the size of the output loss and notwithstanding country differences the increase in unemployment was, however, smaller than feared.
This is thanks to the measures put in place to mitigate the impact of the crisis on jobs, namely flexible working time arrangements, short-time working schemes and temporary closures.
The QREA analyses public attitudes towards structural reforms and the extent to which the crisis may have affected that perception. The study of annual eurobarometer surveys shows that the crisis has increased people’s awareness of the need for reforms in most euro-area countries. Member States that have been hit more severely have experienced the largest rises. While, ideally, reforms should be carried out in good times, this increased support creates a window of opportunity to address structural impediments to growth and to lay the foundation of a solid and sustainable recovery. At the beginning of 2010, the Commission will come up with new proposals on a new strategy for co-ordinating structural reforms in the EU that will succeed the current Lisbon Strategy. The surveys indicate a strong support for EU involvement in the national reform agenda, with a majority that believe the EU should play a more active role.
The report’s focus section looks at how long-term trends in the euro-area banking sector may be affected by the financial crisis. The analysis suggests that pre-crisis trends relating to size, concentration and integration are likely to persist with banks becoming larger, fewer and more international in the years to come. The EU financial market is also bound to become more integrated as the underlying driving forces remain in place in terms of risk diversification and benefits for consumers and for businesses. But the crisis has also put pressure on the banking sector to restructure because of the new market conditions, financial regulation and supervision reform and the application of EU State aid rules in the cases where banks received government support. Banks’ financing strategies are likely to shift towards a stronger equity component, while their business models are likely to concentrate more on core markets. Overall, the euro-area financial system may ultimately be less dominated by banks with direct market financing via for instance corporate bonds and non-bank financial intermediaries such as private equity firms taking a more important role.
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