However, European manufacturers, which have been brought back from the brink by government support measures, still need to solve the problem of excess production capacity and take steps to improve operating profitability if they are to keep their investment ratings, said Falk Frey, Moody's senior vice president corporate finance.

"Our concern is that price pressure will accelerate because of oversupply and overcapacity and the negative price effect resulting from the underlying trend toward cheaper, smaller cars, as well as the need to reduce CO2 emissions and tax schemes that favor cars with lower emissions," Frey said.

Overcapacity still an issue

He said the European auto industry would fall short of a 75 percent to 80 percent break-even capacity utilization rate this year. The average rate in 2009 will be below 70 percent in a market where political concerns make job cuts and plant closures virtually impossible, he said.

"In Europe we have seen some capacity reductions. However, there has been new capacity being built up locally in those markets where labor is cheaper -- Eastern Europe -- in expectation of strong demand and also to be imported into (Western) Europe"

"The European industry is facing formidable challenges," Frey said, although he held back from predicting the wave of consolidation that many expect as carmakers look for ways to reduce costs and generate economies of scale.

"We do not anticipate big mergers. Companies are looking more toward cooperation, joint ventures with regard to certain technologies," Frey said.

Consolidation in the supplier sector is more likely, he said, with several big deals -- like Schaeffler's Continental bid -- already done.

Earlier this week France's Faurecia said it would buy into the clean-emissions technology segment with its purchase of Emcon Technologies.

"One issue is trying to get more volumes on single platforms, to save r&d costs and get economies of scale on purchasing and production," Frey said.

World market stabilizing

Moody's expects the world auto market to stabilize next year, rising 2 percent, following an 8 percent fall expected for 2009. But different regions will show large variations.

The European market is expected to fall 9 percent as scrapping incentive schemes fade and signs of economic recovery take time to boost consumer confidence.

"I think the effectiveness (of scrapping schemes) will decline rapidly and don't see a real positive impact in 2010," said Frey.

France, Italy and the UK are expected to fall 5 percent each next year, while Germany, where an extremely generous scrapping scheme ran out in September, will drop 25 percent, Frey said.

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