Credibility, Competence and Confidence
When policymakers are lacking in the first two the third is likely to be in short supply. This is particularly notable in reference to the Eurozone and its steadily deteriorating economy – most acutely felt by the ’sin states’ of the Mediterranean. With Europe’s leaders now finally in admission of the debt fuelled malaises, the emphasis has turned to crisis and resolution management, and the markets are feeling uneasy. As the economic data releases worsen by the week investors increasingly look to the European institutions, most commonly the European Central Bank, to provide the financial stimulus to drive an economic recovery.
As the crisis shifts to the business end of the cycle it is clear that a solution for the Spanish and Italian sovereigns is barely making progress as borrowing costs teeter at unsustainable levels. Last week the European Central bank pitched in with a seemingly with a last ditch attempt to contain the crisis by cutting its benchmark interest rate to 0.75% and lowering its deposit rate to 0%. With the ECB quickly running out of options, its President Mario Draghi, once again re-iterated that the ultimate remedy must be driven by Eurozone governments in the form of structural reforms and progression towards and economic and political union.
This is a daunting prospect for investors who are sceptical of Euro area governments’ ability to implement the necessary reforms as well as their appetite for closer integration – particularly in the richer north. This view is vindicated by developments in Greece and Italy where the former has fallen behind its austerity programme, particularly planned state asset sales, and the latter’s technocrat government struggling to win support for unpopular but crucial reforms. There is now a growing disconnect between the European political class and the electorate, for example in Germany, where the constitutional court is currently considering challenges against the ESM bailout fund treaty that is being supported by the government. Any further divergence has the potential to derail the whole Euro project as the Eurozone’s core economies refuse to fund the troubled peripheral economies via the various bailout mechanisms.
Markets have pinned their hopes on policymakers to deliver the strategy to solve the crisis but are growing increasingly unconvinced by the continuous stream of summits, meetings and conferences. A familiar pattern is emerging where an initial bounce is observed on the release of some carefully worded rhetoric on supposed bailout agreements but, on careful inspection of the detail, gains are erased on doubts that the plan goes far enough or on the likelihood of its successful implementation. This is demonstrated by recent moves in Spanish and Italian borrowing costs which have jumped up and down on various announcements, with each piece of spiel having a less positive impact than the previous.
Amidst such painstakingly slow progress investors could be forgiven for having little confidence in the Eurozone economy. As the effects of austerity continue to weigh on growth coupled with falling private investment and bulging public debt levels, the common currency area is likely to reach a tipping point sooner rather than later. Such a moment could involve an instant collapse in peripheral government bonds potentially triggering a funding crisis and bank runs prompting a collapse of the single currency area if the political will to expose taxpayers to contain it is not strong enough. If this does happen don’t necessarily expect that the politicians will be able or have the will to ride to the rescue.