Market focus will switch back to fundamentals after Greek deal
By Christophe Donay, Chief Strategist, Pictet Wealth Management
The deal agreed between eurozone leaders in Brussels this morning provides a basis for a third bailout package for Greece and for Greece to stay in the eurozone. An eventual new bailout agreement will have to be voted through by 10 national parliaments, including that of Greece. However, European leaders will have negotiated on the basis of what will be politically acceptable at home, so the risk of a veto looks limited.
For Greece, the €86bn package will allow it to meet its financial commitments for the next three years. But the conditions are extremely tough, including spending cuts, tax rises, pension reform, and the creation of a trust fund for privatisation receipts. The Greek economy faces a painful slowdown in the short term. The most immediate concern will be to avoid a banking collapse—the ECB will likely help by maintaining Emergency Liquidity Assistance (ELA) at €89bn.
Rigor versus solidarity, and the continued risk of eurozone break-up
The agreement on Greece has not resolved the eurozone’s fundamental problems. The roots of the Greek crisis are to be found in our concept of the Great Divergence—the diverging trajectories of public-sector debt and economic growth. Greece has been overwhelmed by the Great Divergence, but many euro-zone countries, including Italy and periphery countries, are also struggling with it.
Moreover, the Greek crisis has shown that there are two camps in the eurozone: the ‘rigorists’, led by Germany, and the ‘solidarists’, led by France. The Franco-German motor that has traditionally driven the European project is therefore at odds on this key issue. This schizophrenia in the eurozone will continue to create tensions over fiscal and crisis management.
It remains an open question whether the eurozone can fix its structural challenges. Over the long term, we attach a 45% probability to the eurozone resolving its problems through ‘deepening’: the creation of a fiscal union. There is only a 10% chance of the eurozone muddling through in its current form, and this scenario would depend on the ECB monetizing eurozone sovereign debt. We see a 45% possibility of the eurozone eventually breaking up under the impact of mounting sovereign debt, weak economic growth and a lack of political unity.