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Europe: Can It Infect The World Economy With Its Ills?

Will Europe’s economic flu infect the rest of the world, even still solid Asia?

It’s the central question now for investors across the globe: does the eurozone crisis have the capacity to slow the world to a point where regions dip into recession or hit stalling speed?

These fears are why the euro has slumped against the US dollar in recent weeks, despite the US economy wobbling its way towards a possible slump.

It seems the markets think Europe’s woes outweigh those considerable ones in America.

A recession in Europe won’t damage the rest of the world economy, even if it is accompanied by a slowdown in the US, which seems to be happening right now.

Asian and emerging economies elsewhere are much stronger and trade more with each other than they did four years ago, before the GFC (see the feature story today).

But what will be damaging is the impact of a financial crisis centred on the euro and the eurozone, especially if Greece continues to be the flashpoint for more speculation (which seems growing around France and its banks, which is a big worry).

In an attempt to ease pressure on Europe’s banks, the Fed, the Bank of England, Bank of Japan, Swiss National Bank and the European Central Bank announced plans for to lend European banks US dollars to tide them over until the end of this year.

It’s an attempt to ease the shortage of US dollars as American investors have reduced their exposure to European banks, especially those in France over fears about their exposure to Greece, Italy and other wobbling economies. 

The move bolstered the euro against a range of currencies.

Wednesday’s update from the Asian Development Bank specifically blamed the growing problems in some developed economies, such as Europe, for the cuts to 2011 and 2012 growth forecasts for the region, including China.

And ahead of the IMF and World Bank meetings in Washington next week, the head of the World Bank Bob Zoellick said yesterday the world has entered a new economic danger zone and Europe, Japan and the US all need to make hard decisions.

"Unless Europe, Japan, and the United States can also face up to responsibilities they will drag down not only themselves, but the global economy," Zoellick said in speech at George Washington University.

That’s a big ask from what we have seen in the past two years.

But we can expect the outlook for Europe, the eurozone and the euro to dominate next week’s talks, especially the updated Global Stability report from the IMF which is likely to warn about the precarious health of European banks.

Here in Australia, the eurozone problems have allowed the Reserve Bank time to wait on interest rates: we probably won’t get a change this year.

It was also why the Reserve Bank of NZ left its key rate steady at 2.5% yesterday.

"There is now a real risk that global economic activity slows sharply," RBNZ Governor Alan Bollard said in a statement yesterday.

"Given the recent intensification in global economic and financial risks, it is prudent to hold the cash rate at 2.5 percent," he added.

The OECD last week warned growth would slow over the rest of this year in some developed economies, especially in Europe, and this week said its composite leading indicators (CLIs) are pointing to a slowdown, in most member countries, especially in Canada, France, Germany, Italy and Britain.

Germany, France and Italy are the heart of the eurozone and the fears over the bailout of Greece and continuing concerns about Italy and Spain are adding to the pressures on the rest of the world economy.

As reported on Monday, Moody’s has cut the credit ratings on two French banks and warned a third: while the market reaction was muted, it won’t be the last intervention by ratings agencies in the expanding story.

France and Germany came out overnight and said that Greece’s future lies in the eurozone.

Greece, in turn, promised to stick to its budget program in an attempt to stop its debt crisis worsening. But no concrete reassurances emerged.

Worried markets like this sort of talk, but want action.

Italy has formally adopted a 54.2 billion euro austerity package this week.

It was the second set of cuts the country has approved, having passed a 48 billion euro package in July.

The measures were a requirement of the ECB support Italy received – it stepped in to the bond market to ease the cost of the nation’s borrowing. But that hasn’t stopped rates rising back over 5%.

Against this background, it’s no wonder that big global and regional share managers are gloomy about Europe.

The monthly survey of big global and regional fund managers from Bank of America/Merrill Lynch has come out with one of its darkest updates for several years.

It shows the big fund managers hold growing fears that a European country could default on its debt and spark a crisis in the global financial system.

And even if authorities can stave off such a default, fund managers believe Europe could still be headed for recession.

The survey found 55% of managers surveyed now believe there will be a European recession in the next 12 months (two or more quarters of negative growth).

That’s up from only 14% forecasting a recession as recently as July . 

“The

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