New Hurdles Loom in Euro Crisis

Italy Bond Sales, France Vote Are Among Signal Events for Europe's Economy—and the World's

By BRIAN BLACKSTONE

The Wall Street Journal

… The coming year will be a make-or-break one for the euro zone…

… There's just an almost unending list of things that might go wrong…

… Euro-zone governments will compete for new capital with the region's banks…

… One-seventh of U.S. goods exports is destined for the euro bloc….

… The Chinese economy's expansion is expected to slow to around 8% in 2012 from more than 9% in 2011…

FRANKFURT—The coming year will be a make-or-break one for the euro zone, as a crisis that began two years ago in tiny Greece threatens to engulf larger countries at Europe's core, sending ripples across financial markets and the global economy.

After a brief holiday respite, a series of European government-bond auctions and economic reports will set an early tone this month. Italy must issue around €118 billion ($153 billion) in treasury bills and bonds during the first quarter, beginning in mid-January, and Spain needs to refinance about €60 billion, according to Royal Bank of Scotland estimates. France and the Netherlands also auction bonds this month, gauging the resilience of the bloc's triple-A rated countries.

If the euro bloc passes these refinancing hurdles without too much damage, a closely watched summit of European leaders awaits in March, Greek elections most likely in the early spring, and French presidential elections in April and May—testing whether austerity-weary Southern Europeans are willing to stomach more budget cuts and whether Northern Europeans will keep footing the rescue bill.

Economic reports will shed light on the depth of the downturn in the euro zone, which accounts for about a fifth of world output. Ratings companies lurk in the background, having already put the euro zone on notice for possible downgrades if the crisis rolls on.

"Europe is absolutely my No. 1 concern. It is so far in the lead I can't think of what my No. 2 concern is," says Princeton economist Alan Blinder, a former U.S. Federal Reserve vice chairman.

"There's just an almost unending list of things that might go wrong and start us on a bad track again," he says, adding, "This will not be just a problem for Europe. If there gets to be a real financial crisis in the European banking system, it's going to infect America, it's going to infect Asia, it's going to infect South America, everywhere." Euro-zone governments will compete for new capital with the region's banks, which are not only being relied on to purchase vast amounts of public debt, but also must refinance about €230 billion in their own bonds during the first quarter. The European Central Bank took steps to ease this process in December by making three-year loans available to banks. Banks took advantage of that largess, borrowing €489 billion at the ECB's first three-year offering last month.

"It's going to be hitting the ground running," said Nick Matthews, economist at RBS. "Markets will be looking at the chain reaction" rippling out from key events in the euro zone, he said.

Business survey data in January will determine if stagnation or a mild recession is becoming a major downturn and whether the ECB takes interest rates closer to zero, as other major central banks, including the Federal Reserve, did at the height of the 2008-09 global recession—and where they remain. However, European data held up relatively well at the end of 2011, particularly in Germany, easing concerns of a second steep recession in three years.

The U.S. economy could likely weather a further slowdown, or even a modest contraction in Europe. But a prolonged slump may derail a U.S. recovery that is just starting to translate into a noticeable reduction in unemployment. One-seventh of U.S. goods exports is destined for the euro bloc.

Europe's woes translate directly into problems for Latin America, where emerging powerhouse Brazil has shifted its worries from an overheating economy to a slowdown triggered by the euro-zone turmoil.

In China, which counts the European Union as its top trade partner, export growth had begun to weaken in the past two months and is expected to decline further as Europe heads toward recession. The Chinese economy's expansion is expected to slow to around 8% in 2012 from more than 9% in 2011.

While 8% growth would be spectacular most anywhere else, it can be a problem in China where the system is geared for super-high growth rates befitting a country that has grown on average 10% annually for the past 30 years.

"Anything below this [8% growth] may cause significant layoffs that could risk social unrest," HSBC said in a recent forecast.

That could prompt China to stimulate its economy, but it has less room to do so than it did in 2009 and 2010, because it already has a legacy of nonperforming loans from the earlier round of stimulus, which included heavy bank lending.

On the trade front, Standard Chartered forecasts a decline in net exports will subtract one percentage point from gross domestic product growth in 2012. Exports provide 15% to 20% of China's GDP growth, Standard Chartered estimates, but accounts for as much as 40% of growth in manufacturing output. A slowdown in European growth hits the manufacturing sectors hard because of diminished exports.

That, in turn, will likely spur Beijing to slow the appreciation of the yuan versus the U.S. dollar to less than half the 5% average annual gain it has made since China agreed to let the currency float somewhat against the dollar in June 2010, meaning Europe's economic woes could end up deepening tensions between the U.S. and China.

—Bob Davis and Sudeep Reddy

contributed to this article.

Write to Brian Blackstone at brian.blackstone@dowjones.com