Euro still requires a government, says Hermes’ Neil Williams
Neil Williams, chief economist of Hermes Global Government & Inflation-Linked Bonds, says the proposed EU Treaty changes to save the euro still look like a political compromise.
Even if credible, the proposals will be no panacea. First, by seeking fiscal deficits significantly below current levels, but offering no obvious growth plan to get there, the changes would address only future crises. Deficits in 2011 will have ranged from near balance (Estonia) to about 10% of GDP (Greece and Ireland). Spain has admitted that its 2011 deficit will be closer to 8% of GDP than their 6% target.
Second, ratifying the proposals by March looks optimistic, especially where there are new administrations or elections (Spain, France), and where the smallest countries (Slovenia) are averse to cutting their growth to help bigger ones (Greece). In which case, S&P’s own March deadline will be tested, probably triggering downgrades for Germany, France and the four other AAA-rated sovereigns, and further undermining the European Financial Stability Facility (EFSF).
Nonetheless, the biggest challenge will be to appeal to Germany’s hawkish principles, and still head off the economic and market tensions now spreading to the core members like Germany and France. We expect the ECB to ultimately capitulate on QE, but not soon enough to stave off the pressures converging to the core. To sanction a sizeable expansion of the ECB’s balance sheet, the Bundesbank and German government will need more evidence of its own economic and financial conditions imploding.
The economic deterioration has started; activity levels are becoming so stunted that recession looks inevitable. Even if a common ‘euro-bond’ follows, ‘haircuts’ on orderly defaults will probably just crimp growth further.