The limits of austerity

April 23, 2013

With debate about the balance between growth and austerity well and truly breaking out into the open, flash euro zone PMIs – which have a strong correlation to future GDP — are likely to show why a bit of fiscal stimulus is sorely needed. Talk of a European Central Bank rate cut is growing, euro zone policymakers at the G20 last week began to ponder loosening up on debt-cutting in an attempt to foster some growth and European Commission President Jose Manuel Barroso added his voice to the debate yesterday, saying the austerity drive had reached its “natural limit”.

Crucially, we haven’t heard similar from Germany but something is afoot, starting with the certainty that the likes of Spain and France will get more time to meet their deficit targets when the Commission makes a ruling next month. Portugal has already been given more leeway and today its finance minister will spell out new spending cuts which are required after the constitutional court threw out Plan A.

It’s a coincidence, but an interesting one, that this debate – frequently voiced in private over many months – has gone public just as THE academic study from 2010 which asserted that as soon as debt exceeds 90 percent of GDP growth is crushed, has been called into question.

France continues to look like the poor cousin of northern Europe. It will also release an annual study of household income and wealth today. Its loss of economic clout is one factor behind the weakening of the French voice in comparison with Germany’s.

One of the saving graces for the likes of Germany has been the ability to export outside the euro zone so a Chinese slowdown would concentrate minds even further. Hey presto, today’s Chinese PMI showed growth in its huge manufacturing sector dipped in April and export orders contracted, a reflection of weakening global demand. Beijing will respond in policy terms if it has to but it is a worry.

Spain will sell a hefty wodge of treasury bills but with the “ECB put” still working its magic, fund-raising on the bond market is proving to pose no problem at all. Italian bonds rallied on Monday after the re-election of president Napolitano, which suggests the country is about to get serious about forming a coalition government. 87-year-old Napolitano will launch rapid fire talks with the main parties today and has implicitly threatened to resign if they don’t play ball. 75-year-old Guiliano Amato is favourite to become prime minister. Anything that delays fresh elections and all the uncertainty that would entail will be well received by bond investors.

German Bund futures have opened flat, waiting for the PMI reports which analysts say may be the final piece of evidence the ECB needs to cut rates to a new record low. European stock futures are pointing upwards but modestly so given signs of weakness in China.

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