No time for complacency

September 17, 2012

After a tumultuous fortnight where the European Central Bank, U.S. Federal Reserve, German judges and Dutch voters combined to markedly lift the mood on financial markets, we’re probably in for a more humdrum few days, although a raft of economic data this week will be important – a critical mass of analysts are saying that after strong rallies, it will require evidence of real economic recovery, rather than crisis-fighting solutions, to keep stocks heading up into the year-end.

A weekend meeting of EU finance ministers reflected the progress made, but also the remaining potential pitfalls. Our team there reported the atmosphere was notably more relaxed and Spain’s announcement that it would unveil fresh economic reforms alongside its 2013 budget at the end of the month sent a strong signal that a request for bond-buying help from Madrid is likely in October. If made, the ECB could then pile into the secondary market to buy Spanish debt  if required and hopefully drag Italian borrowing costs down in tandem with Spain’s.

BUT. The Nicosia meeting also exposed unresolved differences between Germany and others over plans to build a banking union. German Finance Minister Wolfgang Schaeuble said handing bank oversight to the European Central Bank is not in itself sufficient to allow the euro zone’s rescue fund to directly assist banks – another key plank of the euro zone’s arsenal. It sounds like that debate went nowhere.
Having largely been the dog that hasn’t barked so far, public unrest is on the rise with big marches in Portugal and Spain over the weekend against further planned tax hikes and spending cuts.

And, putting further out risks such as Italian elections to one side, it remains to be seen whether euro zone policymakers have learned from previous mistakes when they took their foot off the gas each time the crisis hit a lull. It is noticeable that German officials are already telling anyone who will listen that a Spanish aid programme may well not be necessary given the extent of the country’s borrowing costs since Mario Draghi’s late-July declaration that he would do whatever it takes to save the euro. German Chancellor Angela Merkel’s setpiece news conference today could shed some light here.

Our working hypothesis has been that having put so much effort into shoring up Spain, the euro zone couldn’t conceivably let Greece drop, thereby plunging the whole lot of them back into crisis. That still holds true – Greece must get more time and/or money to meet its bailout targets. But Austrian Finance Minister Maria Fekter muddied the waters on Sunday,  saying Athens would get only “a few more weeks” and no more cash. Fekter has a track record as something of a loose cannon but if she’s right, Greece is doomed, and most importantly for the rest of the euro zone, doomed quickly.

There’s plenty to chew on over the week, notably Spanish, French and German bond auctions, Prime Minister Rajoy holding talks with Catalonia, Spain’s most indebted region, and fresh after elections which kept pro-European parties at the helm, the Netherlands’ 2013 budget plan will be unveiled.

Flash September PMI surveys for the euro zone, Germany and France will serve as a reminder that even if some time has been bought for the euro zone to put its house in order, it is heading firmly for recession with little prospect of a strong recovery thereafter. Germany’s ZEW sentiment index and a slew of British economic data is unlikely to look much prettier.


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