By Andrew Smith, Chief Economist KPMG in the UK
The recent resignation of two members of Portugal’s ruling coalition and the subsequent, if temporary, spike in the country’s sovereign bond yields provided a timely reminder that the eurozone crisis has not gone away.
This latest instalment (the cost of Portuguese government borrowing rose briefly above 8%) was familiar in many ways after similar episodes in the past, but the crucial difference this time was the absence of contagion. Bond yields did not shoot up in the rest of the periphery. Instead, investors seemed content to take on trust ECB assurances last year that it will do ‘whatever it takes’ to keep the monetary union together. How long this intention will remain untested by the markets, and whether the Bank will pass any test when it comes, remains to be seen.
But this relative calm belies Europe’s chronic macroeconomic problems. While there has been some progress in reducing government deficits and rebalancing trade in the periphery, these achievements have come at a cost – the general economic situation remains dire. Unemployment continues to rise (in Greece and Spain the rate exceeds 25%), inflation has fallen to uncomfortably low levels and few countries will escape from recession this year. In response, the European Commission has softened its austerity drive marginally, but the consensus forecast of a 0.5% decline in GDP remains grim.
For the eurozone to hold together against this background a number of structural problems must be addressed: the loss of competitiveness in the periphery and its consequent lack of growth; high sovereign and private debt levels; the fragility of the banking system; and the associated disparities in credit availability and pricing.
Such challenges will only finally be resolved if the current monetary union is converted into something more closely resembling a full banking, fiscal and political union. There have been tentative steps, but there remains a long way to go. Truth be told, there is already a fiscal union of sorts, as bailouts are effectively inter-state transfers from the rich to the poor (albeit with punitive conditions attached). This ad hoc approach to bailouts will likely continue at least until the German elections in September, but a more formalised fiscal transfer system is necessary at some point.
On the banking front, policymakers have agreed on an ‘operational framework’ for the bailout fund to recapitalise troubled banks and a new resolution regime has been proposed but, in the short term at least, little is likely to change. And a political union? Well, nation states are understandably reluctant to cede power to Brussels amidst volatile politics at home.
So where are we? Bar the odd flare-up, market pressures in the eurozone have abated markedly over the past year, but major macroeconomic and political challenges remain. Politicians need to use these periods of relative calm to address the myriad of problems, for while they have proved capable (just) of defusing crises as and when they arise, they seem incapable of taking the steps necessary to avert the next one.