Is Europe entering an ‘intervention zone’?

Nicola Marinelli, portfolio manager at Glendevon King asset management, argues that the Spanish bail-out and concerns on the newly elected government in Greece are calling for urgent action by eurozone leaders.

Are we entering an ‘intervention zone’? The concerns about whether the recently elected Greek government is merely delaying the eventual crisis, coupled with the banking bail-out of Spain, seem to indicate an urgent need for political and monetary action. Indeed, it is very difficult to see how the market can regain its confidence without such intervention.

So what actions should be taken? Previous intervention measures such as the ECB’s mass liquidity injection provided the markets with some level of stability and prevented a ‘Lehman style’ event from occurring. However, these seem only to have scratched the surface of the problem and the underlying issues remain.

Proposal of temporary measures such as the Eurobond will not solve the issues, either. While the jointly guaranteed Eurobond may help address the sovereign bank-loop by allowing countries like Greece and Spain to access refinancing at low reasonable costs, it would push up the borrowing costs of financially prudent countries such as Germany. Moral hazard will be a key problem without fiscal and political union.

Decisive action that reassures markets that the eurozone will stay intact should be given the highest priority. Thus, the ECB needs to demonstrate its willingness to support countries like Spain in times of crisis and implement measures to increase liquidity to ease the ill effects of the current instability.

Prospects for economic recovery of the eurozone are worsened by austerity measures, suggesting that blaming countries is not the answer. While the Southern European nations have grown more indebted and dependent on welfare, Germany is responsible for setting rules and institutions that are flawed. Playing the blame game is irrelevant.

Instead, the eurozone would benefit from uniting and moving together towards fiscal and potentially political union. However, the move, while necessary, would take a long time so efforts to save the teetering banks of the peripheral eurozone are needed.

It is clear that the European sovereign debt crisis will not end in the short term despite the “positive turning point” of the Greek election result. The eurozone needs to place greater emphasis on stimulating growth as the austerity measures will only serve to ease the debt problem in the short-run. Fortunately, it seems China has already started the process with the People’s Bank of China cutting its key lending and deposit rates by 25bps and it seems the other major central banks should follow suit so while we may be entering an “intervention zone”, the worst possible situation can be averted.

Without the necessary monetary and political action, the collapse of the eurozone would be inevitable; the question would then become a matter of when rather than if.

Markets would continue to be driven by uncertainty and without substantial intervention from the major institutions, the eurozone would further deteriorate, leading to devastating consequences for the world markets. While steps to solve this debt crisis (such as those made at the recent G20 summit) hopefully reflect a move towards further integration, it remains to be seen whether this will provide the necessary decisive action soon enough to save the eurozone in the long-term.

 

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