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from MacroScope:

Euro zone may struggle with its own Lost Decade

Additional Reporting by Andy Bruce and polling by Rahul Karunakar and Sumanta Dey.

As Europe’s crisis drags on, the prospect of a Japanese-style lost decade of economic malaise is becoming increasingly real, according to a new poll. Half of the bond strategists and economists surveyed by Reuters are now expecting just such an outcome.

Many market participants have dismissed the fall of two-year German bond yields below their Japanese counterparts as being merely a result of a crisis-fueled flight to quality bid. Two-year German yields are now close to zero, offering returns of only 0.02 percent. By contrast, equivalent Japanese bonds are yielding 0.11 percent.

But a significant portion of analysts in a Reuters poll see something more sinister in the rapid narrowing of the premium investors require to hold German debt over Japanese bonds. One half of those polled – 12 out of 24 – said it is likely the euro zone is close to entering a period of prolonged low or no growth and inflation and low interest rates, with the other half saying it was unlikely.

According to Stephen Lewis, chief economist at Monument Securities:

I don't really see an early end to the financial crisis in the euro zone. I think it's very unlikely that Germany and the other countries will see eye to eye in the course of this year. That's going to keep the euro zone economy looking very weak for the next several quarters.

Europe's economy stagnated in the first quarter of 2012 and is expected to shrink 0.4 percent this year, according to another recent Reuters poll. Data on Thursday certainly pointed in that direction, suggesting even wealthier countries like France and Germany are also starting to feel the pinch.

from MacroScope:

Shifting euro zone sands

A telling moment. Before pretty much every showdown EU summit since the debt crisis exploded into life, the leaders of France and Germany have got together beforehand to agree a common strategy. It is a truism that the European motor only works efficiently when its two biggest powers are in accord.

This time, following the election of Francois Hollande as French president, there has been no such meeting. Instead he will talk with Spanish premier Mariano Rajoy in Paris before they head to the Brussels summit. There, Hollande will press for the currency bloc to start issuing joint euro zone bonds and will run into implacable German opposition that will squash the plan for now. But the plates are shifting and German Chancellor Angela Merkel looks somewhat isolated.

On euro bonds, Hollande can call on the support of Italy’s Mario Monti and the European Commission among others. Nonetheless, Angela holds the purse strings so while we will see some modest pro-growth measures agreed (and no doubt trumpeted), there will be no pump-priming that requires extra deficit spending, certainly no mutualising of debt and probably no hint that the likes of Greece and Spain will be given longer to make the cuts demanded of them (though that policy's time could soon come, depending on how the June 17 Greek elections go).

Greek contagion aside, Spain remains the bloc’s biggest headache largely because of the weight of bad debts dragging its banking sector down. One idea is to allow the euro zone’s rescue funds to lend to banks direct, thereby removing the stigma of a government having to ask for aid. But Berlin is not keen on this one either.

Less controversial are plans to boost the capital of the European Investment Bank, use “project bonds” backed by the EU budget to invest in infrastructure and recalibrate some EU structural funds which has been used to help poorer EU members so that it is spent in other areas which might yield a quick growth dividend. None of that can hurt. But peashooters and elephants come to mind.

The golden rule of this crisis is that red lines have and will be crossed, most notably by Germany and the ECB, if the bloc is teetering right on the edge. The first ones to give this time may be on relaxing debt-cutting timeframes and allowing the bailout funds to help banks direct. Euro zone bonds remain a long way off (probably only when all member countries have got their deficits sustainably below 3 percent of GDP) and talk of a bloc-wide bank deposit guarantee fund isn’t anywhere near, though the pace of events could change that. Much hangs on how Greeks vote on June 17.

A demonstration of just how bent out of shape the euro zone is will be provided by today’s German 2-year debt auction. Yielding about 0.07 percent on the secondary market, that means Berlin has set a zero coupon for this sale and will pay no more to borrow this money over two years, yet investors are still expected to snap it up, such is the desperation for something secure. The debt agency says it is not planning to start offering negative coupons.

from Global Investing:

Three snapshots for Tuesday

The euro zone just avoided recession in the first quarter of 2012 but the region's debt crisis sapped the life out of the French and Italian economies and widened a split with paymaster Germany.

Click here for an interactive map showing which European Union countries are in recession.

The technology sector has been leading the way in the S&P 500 in performance terms so far this year with energy stocks at the bottom of the list. Since the start of this quarter financials have seen the largest reverse in performance.

from Global Investing:

Poland, the lonely inflation targeter

Is the National Bank of Poland (NBP) the last inflation-targeting central bank still standing?

The bank shocked many today with a quarter point rate rise, naming stubbornly high inflation as the reason, and signalling that more tightening is on its way. The NBP has sounded hawkish in recent weeks but few had actually expected it to carry through its threat to raise rates. Economic indicators of late have been far from cheerful -- just hours after the rate rise, data showed Polish car production slumped 30 percent in April from year-ago levels. PMI numbers last week pointed to further deterioration ahead for manufacturing. And sitting as it does on the euro zone's doorstep, Poland will be far more vulnerable than Brazil or Russia to any new setback in Greece. Its action therefore deserves praise, says Benoit Anne, head of emerging markets strategy at Societe Generale.

(Poland's central bank) is one of the last orthodox inflation-targeting central banks in the global emerging market central bank universe. They are taking action because they are seeing inflation creeping up and have decided to be proactive.

The rate rise  is especially notable given many central banks in developing countries appear effectively to have surrendered their inflation-fighting mandate. Nowhere is the push for lower interest rates more pronounced than in Brazil where the government last week announced plans to scrap fixed-rate savings deposits in a move that is seen paving the way for more agressive rate cuts. Clearly there is tolerance here for higher inflation, which will still end 2012 well above target.

But many analysts such as Manik Narain at UBS consider Poland's decision a high-risk one given the growth issues. Narain sees it possibly motivated by the need to signal Poland will not welcome further currency weakness (the zloty like most emerging currencies has shed much of its early-2012 gain) Therefore a prolonged monetary tightening cycle is unlikely, he says. Indeed many reckon the NBP may find itself, like the European Central Bank last year, reversing an ill-considered rate rise. Analysts at Capital Economics write:

If we are right in expecting growth and inflation to slow by more than most expect over the second half of this year then this may well be the NBP’s “ECB moment”. Recall that having hiked rates twice in the first half of 2011, the ECB was forced to start loosening policy once again by November as the economy weakened. In Poland’s case, we think there is a good chance that today’s rate hike will be reversed by the end of the year.

from MacroScope:

Euro election fever

We will return on Monday knowing whether the Greeks have elected a pro-bailout government and probably to find socialist Francois Hollande – the man leading the growth strategy charge – as the new French president. 

An Hollande victory could cause some jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than incumbent Nicolas Sarkozy would. Contrary to some reports, he is not intent on ripping up the EU's fiscal pact and of course the bond market will only allow so much leeway.

The heavyweight Economist magazine may have labelled socialist Hollande “dangerous” but the reality is likely to be that he will rule from the centre and his demands for a dash for growth -- and a change to the ECB's mandate to aid it -- will be tempered. Spain has shown everybody that too much fiscal loosening will be pounced upon by the bond market and while there is a lot of talk about a growth strategy for Europe, what we've heard so far amounts to tinkering.

 While an Hollande victory looks priced in, Greece still has some power to shock the euro zone.

If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to  stick with the austerity terms demanded by its international lenders. However, the threat of contagion, while still alive, has shrunk. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly to be in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is diminished. The caveat to that is, if it has to be cut some slack by the EU and IMF, Portugal and Ireland would presumably demand the same and then the whole austerity edifice starts to look wobbly again.

Despite the much vaunted growth strategy, the focus remains on structural reforms (which will take years to bear fruit) plus reconfiguring of some EU funds and a beefed up European Investment Bank. It will help, or at least can’t hurt, but what’s being discussed so far does not look like anything like a game changer, breaking the spiral of debt-cutting  deepening economic downturns which in turn will make it yet harder to cut debt.

And those who really count -- Merkel and Draghi at the top of the list -- insist the austerity drive must not be dimmed. The markets would probably respond well to growth measures which did not undermine debt reduction. But that's some trick.

from MacroScope:

“There are human beings involved” in austerity debate

The inventors of democracy and its greatest 18th century champions both go to the polls this weekend. Greek and French voters will try to elect governments they hope will help release their economies from the grips of the euro zone debt crisis.

While exercising their democratic vote, Europeans will also be contemplating another key issue: their basic economic survival.

That is why the debate about austerity versus growth has become so important.

Financial markets see fiscal discipline as crucial to get the euro zone's debt burden back to sustainable levels. They are going into the Greek elections favoring triple-A rated bonds over peripheral counterparts.

The premium investors require to hold French debt over German Bunds has also risen in the run-up to the French vote as Francois Hollande became the favourite to win.

But as economies fall deeper into recession and double-digit unemployment hurts prospects for growth, the view that austerity alone will not solve the euro zone debt crisis, seems to be gradually winning over some investors in the bond market – the heart of the crisis.

Sanjay Joshi, head of fixed income at London and Capital, says:

from Global Investing:

Three snapshots for Wednesday

Euro zone factories sank further into decline last month but manufacturers in Asia upped their tempo to meet growing demand from the United States and China, exposing a widening gulf between Europe and the rest of the world.

Unemployment in the euro zone rose to a 15-year high of 10.9 percent in March - as this chart shows the level of youth unemployment paints a worrying picture:

U.S. private employers hired a far fewer than expected 119,000 people in April, the smallest gain since September 2011, a report showed on Wednesday, adding to concerns that the economy has lost some of its momentum. This chart shows the relationship between the first release of ADP figures and non-farm payrolls which are released on Friday.

from MacroScope:

Europe in recession – an interactive map

Spain has become the latest European country to slip into recession joining the Belgium, Cyprus, The Czech Republic, Denmark, Greece, Italy, The Netherlands, Ireland, Portugal, Slovenia and the United Kingdom.

Click here to view an interactive map.

*Updated to include Romania and Bulgaria

from Global Investing:

Three snapshots for Friday

The U.S. economy expanded at a 2.2 percent annual rate in the first quarter, slightly weaker than expected.  Consumer spending which accounts for about 70 percent of U.S. economic activity, increased at a 2.9 percent rate - contributing two percentage points to the overall growth rate.

Sell in May and go away? Here are the average numbers for the MSCI world equity index:

More awful economic numbers from the euro zone, Spanish unemployment hit 24.4% in Q1 2012 with youth unemployment rising to 52%.

from Breakingviews:

Draghi’s growth babble is no retreat on austerity

By Pierre Briançon

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Is it still possible to mention the word “growth” without becoming a hostage in the French presidential campaign? Mario Draghi, the European Central Bank president, has been hijacked by the French socialist party because he has called for a euro zone “growth compact”. Presidential candidate François Hollande sees it as a sign that his ideas are gaining ground. But Draghi’s statement to the European parliament wasn’t a seismic shift. More important, what he means by growth compact has nothing to do with what Hollande plans to do if elected.

The upcoming conflict within the euro zone is not, thankfully, whether growth is good or not. Everyone agrees it is. There is also unanimity on the need for fiscal discipline. What sets Hollande on a collision course with Germany, the ECB and most of France’s euro zone partners is his belief that growth will come from the rest of the world while France avoids the painful domestic reforms which are underway in most of Europe.

France has the highest hourly labour costs of any major European economy, according to EU statistics, updated this week. They have risen 39 percent in the last decade, twice as fast as in Germany. True, that data doesn’t take into account productivity, which is high in France, but the deterioration in the current account shows the country’s competitiveness has deteriorated.

If Hollande keeps thinking that this is not a problem, or if he thinks it is but feels obliged to lie to the French about it, there’s no way to find common ground with Mario Draghi. Even though the expression “growth compact” may sound new, there’s nothing there that hasn’t been said, over and over, by central bankers: governments must reform, and the longer they wait, the more painful it will be.

Euro bonds, big investment programmes and German stimulus would all help, but they will not spare France the pain of reform. If Hollande the candidate keeps ignoring that reality, Hollande the president will hit the wall head first.