BUSINESSWEEK ONLINE : OCTOBER 30, 2000 ISSUE
INTERNATIONAL -- SPECIAL REPORT Europe: It's Time to Start Worrying (int'l edition) A host of problems could clobber growth in the euro zone Just a month or so ago, the European recovery looked rock solid. Consumer confidence was surging, domestic demand was booming, and the rapidly strengthening economy seemed on track for a job-creating bout of brisk, noninflationary growth. Even the surge in oil prices and the anemia of the euro did little to dampen the enthusiasm. Don't worry, most pundits said, Europe is strong. Believe in the boom. Well, it's time to start worrying. Economists are scrambling to revise heady growth forecasts downward. The euro zone economy will be lucky to expand by 3% next year, they say--well below the 3.5% they had previously expected. Sure, that's still growth--but it's just barely enough to generate the new jobs that France, Germany, and Italy desperately need. Europe needs several years of above-average performance--and that prospect is disappearing. Meanwhile, corporate executives are lining up to issue profit warnings. Valeo, the French auto-parts supplier, and Anglo-Dutch steelmaker Corus Steel are just two of the latest companies to say that slower-than-expected economic growth means that earnings will fall short of expectations. ''A lot of people feel jittery,'' says Julian Callow, an economist at Credit Suisse First Boston in London. OIL SHOCK. What happened? A lot of problems just refused to go away, while new ones cropped up. Rocketing oil prices, which briefly rose to a 10-year peak of over $36 a barrel on Oct. 12, are sucking billions of dollars out of Europe at precisely the moment when economists predicted that domestic demand would take over from booming exports as the main driver of growth. Those rosy forecasts were based on the assumption that oil would stay around $25 a barrel. According to Deutsche Bank, this year's price rise means that Europe's total oil bill for 2000 will be around $115 billion--$40 billion more than expected. ''Rising oil prices are like a tax,'' explains CSFB's Callow. ''They take purchasing power out of the economy.'' The result: Gross domestic product growth falls by 40 basis points if oil prices hover at $35 a barrel. And inflation rises by 80 basis points. Consumer confidence has plunged in France, Italy, Spain, and Germany. Since those countries together account for over 70% of the euro zone economy, that's ugly news. ''Consumers are now uncomfortable with the future,'' says Gerard Mestrallet, CEO of French water-and-energy giant Suez Lyonnaise des Eaux. One sign of consumers' growing wariness: New-car registrations in Europe were down 5.7% in September, compared with the same month in 1999. Another: Retailers across the Continent, from Germany's Karstadt to Spain's El Corte Ingles, report that consumers are reluctant to part with their cash. The situation certainly looks scary. Unless oil prices plunge in the coming months, to well below $30 a barrel--which most oil-watchers say is unlikely given the continuing crisis in the Middle East--consumer confidence won't recover in the short term. That's why Andrea Gavosto, chief economist for Italian carmaker Fiat, expects consumer demand to be ''pretty close to zero'' in the second half of next year. If so, ''it would be the third time in a decade that Europe has started off on a positive economic cycle only to see it end abruptly 12 to 15 months later,'' he says. As if that's not bad enough, higher-than-forecast gasoline and heating-oil costs are fueling inflation. Euro zone consumer prices jumped by an annualized 2.8% in September. That's a full half-percent up from August's figure and way ahead of the 2% level the European Central Bank says is consistent with price stability. Meanwhile, the weakness of the euro, which plunged to a new low of 83.3 cents to the dollar on Oct. 18, is adding fuel to the inflationary fire by raising the cost of imported raw materials and energy even further. ''I'm very concerned about the euro,'' says Leif Ostling, CEO of Swedish truck manufacturer Scania. PAY DEMANDS? To make matters worse, core inflation--after food and energy prices are stripped out--is now ticking steadily upward as well. It rose from 1.5% in August to 1.6% last month. ''The big worry is that that could rekindle inflationary expectations and persuade unions to demand higher pay increases next year,'' warns Carlo Monticelli, co-head of European economics at Deutsche Bank. Together, these shifts increase pressure on the ECB to hike interest rates--which have already risen from 2.5% to 4.75% over the past year--for the eighth time in succession sometime in the next few months. That's just about the last thing industrialists want to see happen, since they are already being squeezed by the ECB's tighter monetary policy. ''It is not good news for the European economy,'' warns Ernest-Antoine Seilliere, head of Medef, the French industry federation. And the important IFO index of German business confidence has been trending downward since June. Just as unnerving, many investors now realize that telecom and high-tech companies are grossly overleveraged and overvalued. Investors are rushing to sell tech and telecom stocks, pushing down stock exchange indexes across the Continent. The Nemax 50 index of Germany's tech-rich Neuer Markt has fallen by more than 30% since the beginning of September. Some of Europe's biggest and most aggressive companies have seen their share prices take a pounding. Deutsche Telekom's stock has lost more than two-thirds of its value since March. And the spreads on tech and telecom bonds have widened by almost 50 basis points since the beginning of the year. They now stand at 120 basis points above German government bonds. Investors are so averse to buying their paper, however, that few new bonds are being issued. It's an environment in which Deutsche Telekom executives say they have to focus on digesting existing acquisitions rather than making new ones. IPO FREEZE. The stock market rout means that shares are far less attractive than they were just a few weeks ago as an acquisition currency. Take Martin Varsavsky's Jazztel, which sold its Internet portal Ya.com to T-Online for cash and 10.6 million shares of T-Online stock on Sept. 4. It will have to sit on its hands and hope before cashing in because T-Online shares have lost a quarter of their value since then. Meanwhile, one initial public offering after another is being withdrawn because of poor market conditions. French online broker Direct Finance and Austrian tech company AI Informatics are just two of the many that have canceled IPOs slated for later this month. There is some good news on the horizon. Tax cuts next year should partially offset the impact of higher interest rates and rising oil prices. Companies such as Fiat are trying to boost productivity to counter the higher costs. And despite all the gloom, some business folk are remarkably sanguine. Take Jean-Philippe Dauvin, chief economist for STMicroelectronics, the Franco-Italian semiconductor manufacturer. ''I don't see any kind of trouble on the horizon,'' says Dauvin. ''The market is too sensitive. It's overreacting. Let's try to enjoy the new growth for a while.'' That would be nice. But the truth is that Europe's ''new growth'' will be far lower than most pundits predicted. That means that it will be far harder than expected to push joblessness--still 9% for the euro zone as a whole--down to the 4%-to-5% level currently seen in the Anglo-Saxon world. And it means that European companies will be less able and willing to make the investments in high tech that are needed before a U.S.-style New Economy can be created. To enjoy this kind of growth, you need nerves of steel. By David Fairlamb in Frankfurt, Gail Edmondson in Rome, Andy Robinson in Madrid, Stephen Baker in Paris, with bureau reports _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Prosperity under Siege (int'l edition) The Big Squeeze in America (int'l edition) CHART: Triple Trouble Asia's Liquidity Drought (int'l edition) CHART: Risky Asia Europe: It's Time to Start Worrying (int'l edition) CHART: The Biggest Blow: Oil INTERACT E-Mail to Business Week Online

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