VZCZCXRO4842
OO RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHFT #2299/01 2060810
ZNR UUUUU ZZH
O 240810Z JUL 08
FM AMCONSUL FRANKFURT
TO RUEHC/SECSTATE WASHDC IMMEDIATE 7418
INFO RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RUCNMEM/EU MEMBER STATES  IMMEDIATE
RUCNFRG/FRG COLLECTIVE IMMEDIATE

UNCLAS SECTION 01 OF 02 FRANKFURT 002299 
 
DEPARTMENT FOR EUR/AGS 
TREASURY FOR LUKAS KOHLER/OFFICE FOR EUROPE AND EURASIA 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EU GM
 
SUBJECT: Frankfurt Financial Experts Express Pessimism on 
Macro-Outlook to OCC 
 
Ref: Frankfurt 1581, Frankfurt 1001, Berlin 0112 
 
ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED.  NOT FOR INTERNET 
DISTRIBUTION 
 
¶1.  Summary:  With commodity prices soaring, the euro at an all time 
high, and financial turmoil in the U.S. in the headlines, worries of 
a recession and further shocks to the financial system remain high 
in Germany and Europe.  Frankfurt-based financial and macroeconomic 
experts agree that growth will decline in 2008 and 2009 and 
profitability will be low in the financial sector.  Despite the 
turmoil, they see little reason to fear a wider banking crisis or an 
economic shock that would stoke a deep recession.  End Summary. 
 
Macroeconomic Growth Prospects Low 
---------------------------------- 
 
¶2.  In a July 21-22 visit to Frankfurt, Arthur McMahon, Director for 
Economic Outlook and Bank Conditions at the Office of the 
Comptroller of the Currency (OCC), and Geralynn Batista, an OCC 
economist, spoke with senior economists and financial sector experts 
at the European Central Bank (ECB), Deutsche Bank and Citibank on 
current risks to the European banking sector and macroeconomic 
trends.  All sides agreed that current macroeconomic growth 
prospects in the euro zone were likely to trend downwards due to the 
rise in euro zone interest rates, the strong euro and rising 
commodity prices.  Several interlocutors argued that the current 
prospects debunked the myth of "decoupling", whereby Europe's 
decreasing dependence on the U.S. market would supposedly help it 
avoid a downturn. 
 
¶3.  A Citibank economist predicted euro zone growth for 2008 of 1.8% 
and 0.9% for 2009 and 1.8% and 0.6% in Germany, figures below those 
of the ECB which he felt were too optimistic but would eventually be 
revised down.  He predicted a sharper drop in exports, a source of 
current German economic strength, which would set in as demand fell 
off in the U.S. and elsewhere.  He also drew a corollary between 
rate rises by the Bundesbank (Germany's central bank) in 1973, 1981 
and 1992, which each time led to a recession, and the current rate 
rise by the ECB.  Nevertheless he argued that the ECB would rather 
"take the hit upfront" than set off a larger crisis in the long term 
by not fighting inflation. 
 
¶4.  A macroeconomic analyst at the ECB highlighted the problem of 
rising food and oil prices, which negatively affects euro zone 
consumption and investment.  He saw food prices stable in the near 
term, but doubted oil prices would drop significantly as the 
increased demand in the developing world would not go away.  Senior 
economists at Deutsche Bank, however, pointed out that all previous 
attempts to predict oil prices had failed, but there were signs of 
decreasing demand in the developing world.  All sides felt that 
despite some wage increases, Europe had avoided a wage-price spiral 
that would set off inflation. 
 
Credit Crunch Unlikely, but Earnings Low 
---------------------------------------- 
 
¶5.  On the European banking system, experts saw no sign of an 
impending credit crunch or big surprises from the banks.  An ECB 
financial stability expert said that of the twenty largest, and 
therefore systemically relevant, European banks only five or six had 
so far had serious write-downs due to the financial turmoil.  He 
expressed surprise that leverage ratios were not decreasing in 
European banks, but speculated that banks were most likely moving to 
higher quality assets.  The flight to quality would inevitably mean 
diminished returns in the near term. 
 
¶6.  All sides pointed out that the 14% rise in corporate lending 
since the beginning of the financial turmoil in August 2007 should 
allay any fears of a drying up of credit.  The Citibank economist, 
however, ascribed this trend to a lag effect and said the volume 
would go down in the coming quarter.  Many credit lines negotiated 
before August 2007 are still open to corporations and actively drawn 
on.  However, as these lines expire, new ones will be negotiated 
with less favorable rates leading to a decrease in volume.  With 
equity prices also low, corporations will have few attractive 
sources of raising capital. 
 
¶7.  The Deutsche Bank economist expressed some pessimism on earnings 
in the financial sector in the coming months.  With so much debt 
already on the firms' balance sheet, a negative credit cycle of 
decreased lending was inevitable.  Earnings capacity is also 
diminished by lower demand for services, such as equity issuances. 
Firms like Deutsche Bank, which is still doing well on its business 
in the Asia-Pacific region, can count on good earnings, but others 
will need to search for new business models.  He worried about a 
 
FRANKFURT 00002299  002 OF 002 
 
 
regulatory backlash, saying that a rise in capital ratios would have 
a negative impact on balance sheets. 
 
¶8. Comment:  While the mood on the economic outlook among economists 
and financial sector experts has turned decidedly sour, few expect 
great shocks ahead.  But experts have called several false dawns 
over the course of the last year in hopes that the worse was behind 
only to be surprised by further turmoil.  Key indicators such as 
European export figures, euro zone inflation rates and bank 
quarterly reports will be closely watched in the coming quarters to 
judge the health of the European economy.  End Comment. 
 
¶9.  This cable was coordinated with Embassy Berlin and cleared with 
Arthur McMahon and Geralynn Batista at the OCC. 
POWELL