September will be a perfect storm in the euro crisis
August 3, 2011 4 Comments
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.