What Happened In Europe?(Global Investor)(oil prices and euro exchange rate impact Europe's economic growth)

Byline: Holger Schmieding; Schmieding is chief economist for Europe at Bank of America in London

The eurozone has been hit by two shocks: the surge in oil prices, and the rise in the exchange rate of the euro.

After a flying start into 2008, European economic growth ground to a halt over the spring and summer. Six months ago many observers had hoped that at least the 15 eurozone countries could weather the global storm unleashed by the U.S. mortgage crisis with limited damage. These hopes have now been dashed for good. The eurozone is mired in stagnation. We cannot even rule out a genuine recession. But the U.S. credit crisis is not the major culprit. The oft-touted scare scenario, namely that European banks burned on the U.S. market would deny credit to worthy borrowers at home, has not come true.

Instead, the eurozone has been hit by two other shocks. The surge in oil prices from $73 per barrel in 2007 to a peak of $146 in July 2008 has forced consumers to spend almost the entire gain in their incomes so far this year on higher energy and food bills, leaving them little extra money for other goods and services. In addition, the rise in the exchange rate of the euro from an average of $1.37 last year to a peak of $1.60 this July went beyond what even the eurozone could bear, despite its reform-enhanced resilience.

The eurozone is now faring worse than the United States. Helped by an undervalued exchange rate, the United States enjoys a boom in exports, with annual growth rates of close to 20 percent, whereas the eurozone is now struggling to raise its exports at all. In addition, while oil prices soared to their peak, the U.S. government sent its consumers tax-rebate checks that, by chance rather than design, offset much of the increase in the average energy bill. In the eurozone, higher levels of government debt make such largesse impossible.

Fortunately, the current European malaise need not last beyond the coming winter. The fact that it took two giant external shocks--spiking oil prices and the rising euro--to derail the upswing offers hope for the future. The shocks are unlikely to be repeated. Oil prices are now more likely to settle down than to rise further, barring any catastrophic geopolitical accident. Demand for oil is already declining in many countries (though not in China). Consumer spending in the eurozone usually starts to recover six to nine months after a peak in oil prices. Oil prices have already dropped by about $25 per barrel since mid-July. If they stay below the peak, consumer spending could start to firm again next spring. If oil prices decline further, as they may, the rebound could be pronounced.

The long rise of the euro, which had started at a trough of $.82 in October 2000, seems to be over, thanks partly ...