A deal at a high price

The euro zone leaders finally managed to agree on the outline of a new program for Greece after marathon negotiations in Brussels. Although it is obviously positive that Greece now can stay in the eurozone, the deal comes at a high price – not only for Greece but for Europe as a whole.

The deal is larger, harsher and more controversial than the previous proposals. This is partly because this is a new third program, with €82-86bn of new money rather than a temporary extension of the second program that expired at the end of June. It is tougher not only because of the austerity, but also because it has stronger conditionality, closer oversight and requires more prior action from the Greeks, including parliamentary legislation. This could potentially lead to a political crisis in Athens. But the deal is also controversial in Europe as the negotiations were marked by heated feelings and strong splits within the euro group.

The market reaction has been perhaps surprisingly muted throughout the past few weeks; the euro and equity markets have moved sideways while bond yields have moved up only moderately.

We see three reasons for this. The first is a conviction that there would be a deal in the end. The second reason is a conviction that the spill-over risks to the rest of Europe are limited. Even the neighboring countries in Southeastern Europe are not that exposed to Greece in a real economic sense. A third, and related, reason is that Europe is in a stronger position now compared to 2012. All countries are growing, this is especially true for some of the former program countries in Southern Europe, and the firewalls are credible, including the ECB’s massive bond buying program.

The deal is not signed yet – it will take four weeks to complete the program if everything works out – and many things can still go wrong given the complexity and the amount of decisions that need to be approved in different capitals. But the fact that we have a political agreement should help sentiment going into summer.

 

Marcus Svedberg is chief economist at East Capital

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