Positive reaction
The reaction to this has been positive. Eurozone shares are up more than 20% from their June low. The euro is up 8% from its July low against the $US. Spanish and Italian bond yields have fallen from their highs of several months ago.
Source: Bloomberg, AMP Capital
And interbank lending spreads have collapsed in Europe, suggesting little problem with banks being able to fund themselves, thanks to the earlier provision of cheap three-year funding by the ECB, again highlighting a key difference with the GFC where interbank lending spreads exploded and late last year where the same looked to be starting to happen.
Source: Bloomberg, AMP Capital
Problems remain immense, but…
To be sure problems remain immense in Europe. Progress will remain likely gradual. The move towards centralised ECB supervision of banks looks like it will take longer than year end to implement. Uncertainty remains as to whether and when Spain will seek assistance. A decision has yet to be made regarding ongoing assistance for Greece. And Europe still has to deal with a recession. Looking at Spain, Greece and the recession in turn:
- Quite clearly Spain would rather not have to sign up to a bailout package – given the blow to national pride and the fear that it will be pushed down the same path as Greece. Rather it seems to be hoping the announcement of more structural reforms and the threat of ECB action will be enough to calm markets. This is possible but not probable.
- Given the depth of Spain’s recession and the resultant pressure on its budget, the more likely outcome is that it will have to seek assistance. The likelihood is that we may have to go through another bout of market worries and upwards pressure in yields to force it to seek help. However, whether Spain does it proactively or reactively the end result is likely to be the same in triggering ECB bond buying.
- Greece remains a problem not least because the move to reduce its public debt to GDP ratio to 120% by 2020 as a result of private investor write-downs announced earlier this year is unlikely to be enough (even if it is achieved) to put Greece on to a fiscal sustainable path. It now looks like the latest troika (EU, IMF and EU) review won’t be released until mid-October. However, it does look as if Greece will be given more time to meet its commitments (as Portugal recently was) with Germany and EU policymakers generally looking like they are unlikely to want to take the risks a Greek exit would pose for the rest of the eurozone – at least not now.
- Finally, while the ECB is on track to deliver on its commitment to keep the euro together and to ensure the benefits of its easy money are more equally spread across the eurozone, it won’t put a quick end to the recession. But it should help put an end to the panic in various bond markets thus allowing the benefit of low interest rates to flow through and preventing the recession this year from turning into a deep recession as was seen in 2008-09 and allowing a return to modest growth next year. The ECB may still have to provide more quantitative easing though.
Source: Bloomberg, AMP Capital
…the worst of the panic may well be over
Numerous problems remain, but our assessment is that with an immense political commitment to the euro being backed up by a progressive move to “more Europe” and not less, and importantly the ECB with its potentially unlimited firepower now starting to swing into action, we may have seen the worst of the panic associated with the eurozone debt crisis.
With the exception of Greece, which may yet leave one day, I see the eurozone hanging together. With economic rationalist reforms being imposed across troubled Europe, depressed European shares (e.g. German shares are trading on a forward PE of 9.8 times) and assets generally are likely to prove to be great value on a 10-year horizon.
Key points:
- The risk of a break-up in the eurozone peaked in May and has been declining since as European leaders have opted for “more Europe” and the ECB has committed to do whatever it takes to ensure the euro is irreversible.
- The eurozone debt crisis is a long way from over, and it will be a long hard slog for Greece, Portugal, Ireland, Spain and Italy, but I suspect that we may have passed the worst of the financial panic associated with it. With the exception of Greece, which may yet leave one day, ultimately I see the eurozone hanging together and becoming stronger, not weaker.
- With economic rationalist reforms being imposed across Europe, depressed European shares and assets are likely to be great value on a 10-year horizon.
Dr Shane Oliver is the Head of Investment Strategy and Chief Economist at AMP Capital Investors. This article should not be seen as investment advice and has been written for general information purposes only.
