Risks in the eurozone remain despite progress made, Fitch says

Even if eurozone policy makers have recently outlined initiatives to facilitating a greater Economic and Monetary Union and to avoid the high economic and political costs of a eurozone break up, political and execution risk remain high, warned today Fitch Ratings.

In May, the rating agency identified six broad areas that needed to be addressed before market speculation about the eurozone’s viability is likely to abate: European Central Bank funding; banking supervision; a credible financial firewall; structural economic reform; fiscal integration; and political and institutional reform.

“Progress has been made on the first four, and European Commission president Jose Manuel Barroso has made early-stage remarks about the last two,” the firm said.

The ECB announced on 6 September a new, unlimited sovereign bond buying programme, Outright Monetary Transactions, in which it would not be a preferred creditor.

By removing the convertibility risk premium and addressing investor concerns about subordination, this initiative should lower the risk of self-fulfilling liquidity crises, although ECB intervention needs to support market access rather than be a substitute for it, Fitch added.

Moreover, the European Commission’s proposal on September 12 for a “single supervisory mechanism” for eurozone banks could help break the link between weak banking sectors and sovereign creditworthiness. “However, the timetable for initial implementation in early 2013 is tight, and the proposal is likely to be far more ambitious than the agreement eventually reached,” Fitch said.

Structural reform has remained a priority in peripheral countries, improving growth potential.

“There are political risks to further reform, though – in Italy, for example, the prospect of additional reform has arisen ahead of next year’s general election,” the agency warned.

Reform fatigue is also a risk. Greece has been lobbying for an extension of the timeframe for execution of its austerity and reform programme. An agreement on any change to the Greek programme before the next EU summit in October would reduce the risk of a Greek exit or second default.

“On longer-term political reform, Barroso said the Commission would “put forward explicit ideas for Treaty change” to create a “federation of national states.” However, it is highly uncertain how much political momentum there is for full-blown EU treaty revision, so any Commission proposals may look more like a wish-list at this stage,” Fitch added.

The speed and extent of progress on all these policy measures, alongside the success of adjustment programmes and prospects of a return to economic growth, will continue to inform our judgement on the likely resolution of the eurozone crisis.

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