Ukraine Crisis Threatens Fragile Eurozone Economy

Ukraine Crisis Threatens Fragile Eurozone Economy

Russia has voted down a U.N. Security Council resolution, which calls on the world to reject the results of the referendum in Crimea Sunday. The people of Crimea, an autonomous republic in the Ukraine, are set to vote Sunday whether to merge with Russia and break away from Ukraine. As crisis in the Ukraine escalates, it increasingly threatens the Eurozone’s fragile economy.

The European Union led by Germany is threatening to halt Russian travel and assets by Monday. Russia does 10 times as much trade with the E.U. than it does with U.S. Russia says it will counter with its own sanctions. China has said sanctions could trigger an economic chain reaction.

Deep-seated challenges in stimulating economic growth in Europe over medium term remain, says Andrew Balls, deputy chief investment officer and head of European portfolio management at PIMCO. The Newport Beach, Calif.-based investment firm has $1.9 trillion in assets under management. He forecasts the euro zone economy will grow 1% to 1.5% over the next six to 12 months. He sees the inflation rate running at 0.75% to 1.25% over the next year, far below the European Central Bank’s target of 2%.

Business investment and consumer spending should improve as they put off spending during the crisis and may have a lot of pent-up demand. Although it remains difficult to borrow money from banks, Balls expects credit conditions to improve. Germany’s economy should expand 2% while France grows 1% and Spain and Italy 0.5% each. Europe’s economy has emerged from the deepest stage of the sovereign debt crisis but the crisis from Ukraine’s conflict with Russia threatens the Eurozone’s fragile economy.

Although consumer confidence has improved recently, an extremely high unemployment rate of 12% and wage stagnation will hinder consumer spending, says Howard Archer, chief european economist at IHS Global Insight. The eurozone has been growing steadily second the second quarter of 2013, it is not enough to create many jobs and many companies are still reluctant to hire workers because of how difficult and expensive it is to fire them in some countries.

Eurozone employment ticked up 0.1% quarter over quarter in fourth quarter 2013, marking the first rise since second quarter of 2011, according to IHS Global. The latest purchasing managers’s survey suggests employment in the manufacturing and services sector improved in February after flatlining for two months.

The European Central Bank will not likely engage in quantitative stimulus, or bond purchases, because of low inflation. Given the eurozone’s fragility, there’s little to protect it from experiencing deflation. Should inflation fall short of the ECB’s expectations, ECB President Mario Draghi will likely buy government bonds or ease credit to flush money into the financial system, Balls wrote in an economic outlook released March 14.

Rising tension in the Crimea has worried investors around the world. But the global markets should be able to weather the storm, some market watchers say.

“There is no question that the Ukrainian situation is causing short-term (stock market) volatility but the bigger picture looks constructive,” Nicholas Atkeson and Andrew Houghton of San Francisco-based Delta Investment Management wrote in a client newsletter Friday. “Financial markets appear to be betting that the investment environment in the Ukraine will improve, which should be a positive for the rest of the world’s stock markets.”

So far the conflict over Crimea is an incidental event in the midst of a bullish backdrop, Atkeson and Houghton say.

“On the basis stable inflation and interest rate trends, stock price resilience and rising consumer spending power, stocks could be poised for a significant move higher once the near-term uncertainty associated with Ukraine dissipates,” Nicholas Atkeson and Andrew Houghton of San Francisco-based Delta Investment Management wrote in a client newsletter Friday. “U.S. consumer net worth is at a new all-time high at over $80 trillion and personal balance sheets have substantially recovered.”

The crisis in the Ukraine threatens the Eurozone’s fragile economy but some market watchers believe the stock market has already priced in the risk.

By Trang Ho

Sources:
PIMCO
IHS Global Insight (report)
Delta Investment Management (report)
Voice of America
Washington Post
MarketWatch

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