Euro zone goes Dutch

April 24, 2012

So the euro zone debt crisis morphs again and there is a hint of schadenfreude about the Dutch, who lectured and hectored the Greeks, now falling into the same mire.

The Dutch premier, Mark Rutte, will probably try to cobble together an unholy alliance in parliament in order to meet an April 30 EU deadline for it to present budget plans for the next year. But with elections not until late June at the earliest, there will be an unnerving period of vacuum for the markets and no guarantee that opposition parties will play ball and allow a budget to be put together.

Given all that, today’s Dutch bond auction, not normally a cause for alarm or excitement, is thrown into sharp relief. Expect yields to spiral although the small amount on offer means the paper will be sold. Italy is selling zero-coupon and inflation-linked bonds while Spain,  which remains front and centre despite the Netherlands’ travails, will probably see borrowing costs double when it sells up to 2 billion euros of 3- and 6-month treasury bills. Spanish 10-year yields poked above the pivotal 6 percent level again yesterday as the Dutch government collapse rocked markets. The Bank of Spain confirmed on Monday that a new recession has taken hold.

That brings us neatly to one of the building themes – a backlash against rapid, frontloaded austerity. It started with the IMF/G20 over the weekend where the call went out that Europe should not cut so fast that it drives itself deeper into downturn, which would actually make debt much harder to cut since government revenues would shrink. If socialist Francois Hollande wins the French presidency, he will attempt to balance the budget a little slower than Sarkozy (though the difference between the two of them is less marked than the rhetoric suggests), Italy has pushed back its deadline to get the budget deficit to zero and the Dutch could well end up with a new government that rejects austerity given the country is also in recession and looking at the state of opinion polls. Spain, of course, has already binned its original 2012 deficit target in favour of something looser, though still exacting.

So is there a shift afoot? Two things to note here. First, the Spanish example. It has been punished by the bond market since it adjusted its deficit sights, showing no country can loosen policy more than the markets will allow (which is not much). Also on that front, ratings agency Moody’s said last night that the events in the Hague were “credit negative”. It kept the outlook on its AAA rating stable for now but said any signs of fiscal wavering would make it think again. If the Netherlands was stripped of its AAA rating, there would only be four top-rated members of the euro zone left.
Secondly, Berlin has little sympathy for the growth over austerity argument and it is the one that foots the bills although if yesterday’s PMIs were anything to go by even Germany may yet succumb to recession, which could change the terms of the debate there.

Does the success of parties out of the mainstream mean the political class have lost their electorates? If that’s true, then we really are in an unpredictable new world though there has been little or no sign of social unrest yet.

The other theme to ponder is the EU fiscal pact which should not be underplayed since it will in the end commit all euro zone countries to manageable debt levels, after which, who knows, even Berlin might consider the option of common euro zone bonds which would go a long way to draw a line under the crisis.
Ergo, it would be disastrous if that edifice began to crumble before it was even topped out. It only requires 12 of 17 euro zone members to ratify it to come into force which looked like a certainty. But Wilders’ populist Dutch party, which toppled the government, will now campaign against the pact, the Irish will hold a referendum on it before the month is out and Hollande has pledged to renegotiate aspects of it. It will probably be fine but there is greater uncertainty surrounding the compact now.

Despite all this, it is too early to expect the ECB to come riding to the rescue. A number of its policymakers broke cover yesterday. The message: they are looking more to inflation now and banks and governments have to put their own houses in order after the ECB gave them time with its three-year money-creating exercise. It will, of course, act if the crisis drives Europe right back to the brink, but we’re not anywhere near there yet.

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