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.
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.
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.
“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:
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
Thanks for comments – Will update with Romania and Bulgaria
Euro zone goes Dutch
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.
Spain: ¿Cómo se dice “contagion”?
It was not a good day for Spain.
The euro zone’s fourth largest economy had to pay dearer to borrow through medium-term bonds, a sign that concerns over the country´s fiscal problems was curbing appetite for its debt. It sold 2.6 billion euros of 2015, 2016 and 2020 paper – at the low end of the target range.
In contrast, Portugal’s 1 billion euros sale of 18-month treasury bills was a successful test of market appetite for the longest-dated debt since it took an international bailout. Appetite for short-dated paper has been especially supported by the one trillion euros of cheap three-year European Central Bank funding injected into the financial system since December.
The problem is that Spain is the latest country to come into the firing line of the euro zone debt crisis. This week’s tough budget was not enough to calm investor nerves and many fear too much austerity could choke an already struggling economy where unemployment rose to a staggering 22.9 percent in the fourth quarter of 2011 – the highest in the European Union. Meanwhile, the government expects Spain’s public debt to jump in 2012 to its highest since at least 1990.
And although Spain has already sold around 46 percent of this year’s planned issuance of long-term debt and therefore is in a favourable funding position compared to its peers, analysts worry it could become the next source of euro zone contagion. In the secondary market, yields on 10-year Spanish government bonds rose to their highest since January at 5.72 percent after the auction.
DZ Bank rate strategist Michael Leister says:
It was only a lukewarm auction. This shows that the LTRO (ECB’s long-term refinancing operation) effect is losing momentum and that Spain is having a much more difficult time.
Europe’s triple threat: bad banks, big debts, slow growth
The financial turmoil still dogging Europe is most often described as a debt crisis. But sovereign debt is only part of the problem, according to new research from Jay Shambaugh, economist at Georgetown’s McDonough School of Business. The other two prongs of what he describes as three coexisting crises are the region’s troubled banks and the prospect of an imminent recession.
These problems are mutually reinforcing, and require a more forceful policy response than the authorities have delivered to date. In particular, Shambaugh advocates using tax policy to lower labor costs, fiscal stimulus from those economies strong enough to afford it, and more aggressive action from the European Central Bank:
It is possible that coordinated shifts in payroll and consumption taxes could aid the painful process of internal devaluation. The EFSF could be used to capitalize banks and to help break the sovereign / bank link. Fiscal support in core countries could help spur growth. Finally, the ECB could provide liquidity to sovereigns and increase nominal GDP growth as well as allow slightly faster inflation to facilitate deleveraging and relative price adjustments across regions.
All these steps, especially if taken together in an attempt to treat the three crises holistically could substantially improve outcomes. At the same time, institutional reforms to create a true financial union and a common risk free asset could help both solve the current problems and reduce the connections of these crises in the future. Of course, politics, ideology, or additional economic shocks could all hinder improvement. The euro area is highly vulnerable and without deft policy may continue in crisis for a considerable amount of time.
A recovery in Europe? Really?
There’s a sense of relief among European policymakers that the worst of the euro zone’s crisis appears to have passed. Olli Rehn, the EU’s top economic officials, talked this week of a “turning of the tide in the coming months”. Mario Draghi, the president of the European Central Bank, speaks of “sizeable progress” and “a reassuring picture”.
At last week’s spring summit, EU leaders couldn’t say it enough: “This meeting is not a crisis meeting … it’s not crisis management,” according to Finnish Prime Minister Jyrki Katainen. All the talk is of how the euro zone’s economy will recover in the second half of this year.
But for the 330 million Europeans who make up the euro zone, the outlook has, if anything, darkened. As euro zone governments deepen their commitment to deficit-cutting, and rising oil prices mean higher-than-expected inflation, households can’t be counted on to drive growth. Not only did housing spending fall 0.4 percent in the October to December period from the third quarter, but unemployment rose to its highest since late 1997 in January.
Joblessness is reaching shameful levels in southern Europe. In Greece, unemployment rose to a new record high of 21 percent in December and to 23 percent in Spain in January. Even in wealthy, northern Europe, the number of people out of work has started to rise in France, the Netherlands and Germany.
Just over half of the euro zone‘s economic output is generated by domestic consumer spending, but demand for goods looks chronically weak and fiscal austerity is aggravating the situation. Euro zone governments, desperate to distinguish themselves from debt-stricken Greece, are completely unwilling to step in and spend. The European Commission, persuaded mainly by Germany that fiscal discipline will lift economic growth, is on their backs to get their deficits within the 3 percent level of GDP by the end of 2013.
“The case against Europe’s growth strategy is that it is all supply and no demand,” said Philip Whyte, a senior research fellow at the Centre for European Reform. “Fiscal policy is being tightened too rapidly. The more certain EU countries do to balance their budgets, the more output contracts,” he said in a recent paper.
So where will growth come from? The ECB’s Draghi said this week he is counting on foreign demand. Emerging Asia and a stronger recovery in the United States might help pull the euro zone out of its slump. But with Germany responsible for almost 40 percent of the euro zone’s exports, a wider tide of prosperity across the currency area looks unlikely.
Being poor is no fun: study
Poor people have shorter life spans and more health problems than the wealthy. Surprising? For growth-obsessed economists, yes actually. A new study from The Organization for Economic Cooperation and Development represents a worthy attempt to move economics away from its traditional tendency to equate growth with well being. Its rankings suggest factors other than the rate of gross domestic product expansion are important in determining quality of life.
But as often happen when economists look for a human angle in their research, they end up stating the glaringly obvious. Take this statement:
Some groups of the population, particularly less educated and low-income people, tend to fare systematically worse in all dimensions of well-being considered in this report. For instance they live shorter lives and report greater health problems; their children obtain worse school results; they participate less in political activities; they can rely on lower social networks in case of needs; they are more exposed to crime and pollution; they tend to be less satisfied with their life as a whole than more educated and higher-income people.
You don’t say? And what about this gem:
Having a job is an essential element of well-being. Good jobs provide earnings, but also shape personal identity and opportunities for social relationships.
OECD economists must be elated then: updating the dense “How’s Life” report each year should keep them employed for the foreseeable future.
