Tumultuous euro zone week

April 30, 2012

A week where every facet of the euro zone debt saga will come from all angles.

The major events are the French presidential run-off and Greek general elections on Sunday, May 6.
In the former case, a likely socialist Francois Hollande victory could cause some market jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and actually 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 Sarkozy would. And, contrary to some reports, he is not intent on ripping up the EU’s new fiscal rules. And of course, the bond market will only allow so much leeway.

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.

Even if fears about a hard Greek default or even euro exit result, the threat of contagion looks far smaller. 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 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 very much diminished.

Netherlands’ fractured political parties have managed to put together a budget deal in time to present it on deadline to Brussels on Monday but Spain remains far more a source of concern. Downgraded again, its borrowing costs have soared since the government loosened its 2012 deficit target in March. Data just out shows the Spanish economy has succumbed to recession again. Madrid will hold a bond auction on Thursday, as will France.

As we’ve been saying for a while, hopes that the ECB cavalry will ride to the rescue are wide of the mark, until and unless the crisis takes a distinct turn for the worse.

The European Central Bank holds its monthly meeting in Barcelona on Thursday. No policy change is expected and Mario Draghi will doubtless re-emphasise that by creating more than a trillion euros of three-year money, the ECB has bought time for governments and banks to put their own houses in order. There will be a strong focus on his latest call – for a “growth compact” – though it seems to focus mainly on structural reforms and some capital spending out of EU funds, i.e. nothing that the ECB has to get involved in.

There is a bandwagon rolling behind the “growth strategy” tallied with calls to ease up a bit on the austerity front. Even Angela Merkel says she does not object. Any change will be marginal. The markets may actually like the idea of a bit of growth – otherwise ever deeper recessions will make debt-cutting near impossible. But one need look no further than at what the bond market has done to Spain since it ripped up its deficit targets to realize that politicians, of whatever hue, are pretty severely constrained.

So this remains largely in the realms of rhetoric given German caution and the fact the markets will punish any government which tries to veer to sharply of track. But we are alive to any initiatives, which are due to be trumpeted at a June EU summit. So far, it looks like the focus remains on structural reforms (which will take years to bear fruit) plus reconfiguring of some EU funds and maybe a beefed up European Investment Bank. None of that looks like a game changer, breaking the spiral of austerity drives deepening economic downturns which in turn will make it yet harder to cut debt.

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