In recent years, the euro area has typically followed the US business cycle quite closely.
However, in 2012 we expect the eurozone sovereign debt crisis to lead to a contraction while the US should perform slightly better than in 2011.
Can such an unusually large growth differential be sustained?
It seems unlikely. We would expect the gap to close in 2013 and probably from both directions. The regions are too closely integrated for their business cycles to permanently diverge. There are trade ties, with around 15% of exports imported by the other.
But perhaps more important are the financial links. Many US-listed companies have subsidiaries within Europe and in aggregate derive around one-fifth of their earnings from Europe. Similarly, European banks have a significant presence in the US and there is already some evidence of these banks tightening lending standards.
US banks also have direct exposure to European private and sovereign debt. This makes the stock markets highly correlated, which in turn amplifies changes in the real economy. We see two main factors supporting divergence in the near term.
Firstly, some of this difference probably reflects different stages in the inventory cycle. The US cut inventories in the third quarter and currently appears to be in a rebuilding phase, while we believe that the eurozone sovereign debt crisis has probably led to some unwanted inventory accumulation, with companies now attempting to work these excess stocks down by cutting production.
For now, the new orders in the manufacturing purchasing managers’ indices support our contrasting growth forecasts.
The other factor driving the divergence has been fiscal policy. Market pressure has forced many European countries to adopt severe fiscal tightening this year. The US fiscal deficit is significantly larger than the eurozone aggregate, yet the US has continually delayed the necessary fiscal tightening.
At the end of 2012, the Bush tax cuts will expire and automatic spending cuts will come into force. This means the US will see a strong fiscal contraction unless Congress passes legislation to avoid this. By contrast, the rate of fiscal tightening in the euro area is not likely to be any more severe than in 2012, unless there is a full-scale crisis and that will undermine the US and global economy.
As a result, any differences between the two growth paths this year can be expected to fade as we move into 2013.