September will be a perfect storm in the euro crisis

The August holidays are about to set in. Given the consistent pressure placed on Italian and Spanish debt over the past few days pushing yields to record highs, we may skip the annual August lull in Europe this year. But even if we don’t and news on the euro crisis grows quieter this month, September promises to be a perfect storm in the euro crisis for a number of reasons.

First, the troika (EU, ECB and IMF) will be descending on Athens in September to assess the Greek government’s progress implementing the terms of the medium-term programme passed in June. It is very likely the troika will have trouble coming up with positive developments to report, in which case Greece’s eligibility for the next tranche of funding from the EFSF may be called into question. This could easily lead to a vote of confidence being called, which the government may well fail. An early election would result in no clear majority for either of the main parties (the ruling socialist Pasok and the opposition New Democracy), and a coalition government would likely emerge. The resultant gridlock in parliament would make further structural reform and austerity measures even more difficult to implement. This is hardly a confidence-inspiring narrative.

Second, national parliaments will just be returning from their summer recesses in September to finally pass the changes agreed at the July EU summit pertaining to the European Financial Stability Facility (EFSF). Members of the ruling coalition in Germany, consisting of the Christian Democratic Union (CDU) and the Free Democratic Party (FDP), have heavily criticised the EU agreement to expand the scope of the EFSF. I expect these changes will nevertheless be passed by the German parliament given that the opposition Social Democratic Party (SPD) is in favour of them. However, Frank-Walter Steinmeier, the leader of the SPD, has said that his party will call for an early election if the CDU/FDP coalition cannot reach a majority on the EFSF reforms on its own. In addition to early Greek elections, therefore, we could be facing early German elections in the autumn as well. This would not necessarily be a bad development for the euro area in the medium-term, as the opposition SPD is much more in favour of bailouts than the current ruling coalition. In the short-term, however, it would likely feed general market uncertainty over the future of the euro area.

In addition to potential political instability in Greece and Germany, we already know that early elections will be held in Spain in November. Consequently the 2012 budget is being delayed until after the elections in the autumn. With the current government focused on the election campaign, it is likely we will see fiscal slippage in the meantime. Furthermore, a number of Spanish cajas are due to raise funds in the markets in September, which is likely to be difficult given the challenging market conditions. This would serve to undermine confidence in the Spanish banking sector, and therefore raise concerns about the cost for the Spanish government of future bank bailouts.

Finally, Italian and Spanish ten year government bond yields have exceeded 6%, climbing higher than they were before the recent EU summit designed to stem contagion of the euro crisis. There is no reason to assume that market pressure on the Italian and Spanish governments will abate. Italian finance minister Giulio Tremonti called for a meeting of the financial stability committee yesterday (comprising representatives from the ministry of economy, the central bank, the market regulator Consob and the insurance agency ISVAP) and prime minister Silvio Berlusconi will address both houses of parliament today about the recent rise in Italy’s borrowing costs. Spanish prime minister Jose Luis Rodriguez Zapatero postponed his summer holiday to address his country’s rising borrowing costs. However, it seems unlikely any significant steps will be taken on the national or the EU level in August to instill confidence in the markets. These high yields are simply unsustainable for both Spain and Italy, and come September (if not before then) something will have to be done to address them or both countries will be forced into bailouts, which the EU and IMF simply cannot afford.

I hope everyone is enjoying their summer holidays this month, because September promises to be a doozy.

4 Responses to September will be a perfect storm in the euro crisis

  1. Pingback: FT Alphaville » Eventually, French Spreads Fail (E.F.S.F.)

  2. Cody says:

    I don’t doubt that at all. Anyone who’s been following European finance knows that the Eurozone is bound to collapse sooner or later. I actually wrote a brief post today which cited Eurozone volatility as a cause for significant drops in the US (in addition to widespread uncertainty about the US’s economic future).

    I’m of the mind that it’s just a matter of time before the euro gets blown over. What really irks me is the Swiss central banking system inflating the franc just to prop up exports. With growing uncertainty over the stability of the dollar and the euro, a (relatively) safe bet could have been found in the franc. I mean, granted, the currency finagling will probably only temporarily weaken the franc, same as Japanese devaluation of the yen, but it’s still annoying that it’s being attempted.

  3. Pingback: The Eurozone is stabilising - Page 113

  4. Luke says:

    If Italy and Spain enter bailout territory (which is a likely scenario in the fall of 2011), this will create such a huge burden on the more prosperous Norh European countries that they too will see their debt to GDP raise close to 100%. Which means they automatically will become “problem countries” (with regard to national debt) as well. The only solution they would have in that case is draconic cut backs in government spending. This in its turn will create two problems: 1) their local economies will tank, and 2) their voters will be fuming because they see their pensions and social safety-net evaporate.
    Both outcomes would therefore not be acceptable to those countries. So the alternative is simple: In the case Spain and Italy enter bailout territory (on top of Greece and Ireland), it is the end of the euro as a single currency. There will be no other solution than to abolish the currency and to give each nation their own curreny back.
    The BIGGEST mistake Northeren European counties then could make is to enter a kind of “New euro” scenario for the more prosperous North part of Europe (sometimes called the “neuro”), which would mean we will get the same dramas all over again within 10 years.

    It is simple: You can NOT unite sovereign countries in a monetary unity without a strong central governing body, and a strong sense of unity within the different peoples. . In the USA this works because Americans FIRST see themselves as American, and then as Texan, New Yorker or whatever. Europe does not have that luxury. The Dutch will never feel a bond with those corrupt Hungarians, and the partying Greek will never feel a bond with those meticulous and efficient Germans. And so on. Europe can therefore not be united in a federation. There is too much nationalism in the independent countries. It was a huge mistake for the EU politicians not to realize this when they went into the “treaty of Maastricht” where the euro as a common currency was born. The result of this political short-sightedness from Brussels is the euro mess we see today.

    The only solution is: To abolish the euro as a single currency. Sure; politicians will see this as a huge defeat which is the reason they keep kicking the can down the road without taking the hard decisions. But the longer they postpone the inevitable, the worse it will get when the final bill presents itself. Because THAT will NOT be a pretty picture….

    In the European blogs, I see a lot of Europeans gloat about the problems we have here in the USA. So much for our atlantic “allies”. Needless to say that as a result of this continuous negative European attitude toward Unce Sam, I cannot deny myself the same emoitions when I look at the mess in Europe. So I say: Who needs enemies when you have “friends” like these. Cheers, Mateys!

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