Greece and Italy cause big Eurozone Issues
Global Economics Weekly Brief
`Big Issues` in the Eurozone are still dominating the global economic landscape and hijacked the G20 agenda in Cannes. Political shenanigans over a referendum on austerity measures in Greece threatened to bring down the bailout agreement, while worries about Berlusconi’s ability to deliver debt reduction sent Italian bond yields to new record highs.
The effects of the ongoing uncertainty are being felt all over the world as equity markets sink and policymakers search for ways to stimulate some growth. The incoming president of the European Central Bank, Mario Draghi, opted to reduce rates at his first meeting. In the US, the Fed held fire for now, but left the door open for future monetary stimulus. It looks like political events are dominating sentiment for now – and both are changing day by day. Eurozone under `Big- Pressure`, what will happen in the future? Greece and Italy will bring down the Euro!
The Eurozone debt crisis dominated the G20 agenda - again. Worsening economic and political conditions in Greece and Italy overtook the G20 discussions. The G20 did not commit to more funding of a financial safety net, effectively deciding that Europe should sort out its own problems. But it did agree to keep a beady eye on Italy’s progress on promised reforms. The markets will need to see some progress on this soon though. Italian bond yields reached record, and close to unmanageable, highs. With Greece’s economic and political situation still on a knife edge too, European policymakers will be keeping their fingers, and everything else, crossed for a bit of stability soon. France are not in the clear of their `big--issues!
The UK economy grew strongly this summer, but there's a sting in the tail. The preliminary estimate of UK GDP showed that the economy grew by 0.5%q/q in Q3, a welcome five-fold increase on the 0.1% rise in Q2. But the underlying picture is less rosy. The UK economy is only 0.5% larger than it was in the summer of 2010 and no bigger than it was in 2006. More worryingly, the October reading for the UK's manufacturing Purchasing Managers Index was surprisingly weak. The index fell to 47.7, unambiguously in contraction zone as new orders and employment intentions also fell. The service sector may dominate in the UK economy, but such a weak assessment from manufacturers raises the risk that the economy will shrink in the final quarter of the year. Unemployment still rising with more on the way. The UK must stop letting in people, the island is full!
The UK’s housing market is still in the doldrums. Nationwide reported a 0.3%m/m increase in UK house prices in October which brought the annual change back into positive territory for the first time since March. But the less volatile three monthly change, a better indicator of the underlying trend, fell to -0.6%. Land Registry data confirms that London is still surging ahead, particularly in the most exclusive areas. Things don't look that much better ahead either. Consumers still expect prices to fall, which will keep a lid on demand and may already be affecting activity. Mortgage approvals for house purchase fell for the first time in five months in September. No new time buyers!
Eurozone issues with; More gloom in the Eurozone leads to an interest rates cut. Mario Draghi, the new President of the European Central Bank (ECB), made a splash at his first meeting. Eurozone inflation climbed to 3%y/y in October, but in spite of this he announced a surprise 25bps cut in interest rates to 1.25%. Looser monetary policy was justified by recent economic indicators which suggest a sharp economic slowdown in the euro area and the expectation that inflation pressures will ease as the economy cools. The ECB also warned that its Eurozone growth forecast is likely to be revised down, possibly as far as a mild recession. The Eurozone forecast is in one direction - down!
Steady as she goes at the Fed. The Federal Open Market Committee (FOMC) left interest rates and the quantitative easing programme unchanged at its November meeting. Even though there was a rebound in the economy during Q3, the outlook is still weak, with ‘significant’ downside risks. As a result the FOMC reduced its growth forecasts by 1% for this year and next. It raised its inflation forecast, but is still committed to keep interest rates steady until the second half of 2013. With an eye on the weakening economic climate Chairman Bernanke raised the possibility of additional stimulus via more purchases of mortgage backed securities, depending on how economic conditions unfold. More unemployment on its way - big-time!
US Payrolls fall short of expectations. The US economy added 80,000 jobs in October, less than the 95,000 expected. Unemployment edged down from 9.1% to 9%, but wage growth was anaemic at 1.8% y/y. Revisions to previous data provided some better news with 100,000 jobs added to the figures for August and September. While employment growth is welcome, it’s only at trend level, at best, and far below the rate we would expect from experience of past recoveries.
The domino effect in Europe's debt crisis
Eurozone Issues Continue...
Protests in Rome over the austerity cuts, the latest in a series of protests across Europe.
The sovereign debt crisis continues to unfold in Europe, with every country appearing to get sucked in.
In October European leaders reached another deal to try to stop the contagion. But which countries are most at risk and why?
Three nations in the eurozone - the 17 nations that use the euro - have been recipients of bailouts as attempts to solve the crisis keep stalling.
Italy became the latest to feel the domino effect of the markets when its debt rating was lowered, the latest in a series of downgrades.
Greece, Spain, the Irish Republic and even Cyprus have also had their ratings cut this year. The future of the euro is being questioned in a way it never has since 1999.
Which countries have fallen, and which are feared to be next?
The problem: Greece's huge debts, about 340bn euros (£297bn; $478bn).
In late 2009, after months of speculation and sovereign debt crises in Iceland and the Middle East, Greece finally admitted its debts were the highest in the country's modern history.
The best credit rating that can be given to a borrower's debts, indicating that the risk of borrowing defaulting is miniscule.
Since then, a 110bn-euro bailout was passed by the eurozone last year and a second bailout of roughly the same size was agreed earlier this year - but not yet passed.
Most observers remain highly sceptical of Greece's ability to ever repay its huge mountain of debt. Talk persists of an unprecedented default or of Greece leaving the eurozone.
Because of the interconnectedness of the European economy, this would cause huge losses for French and German banks.
Thus, though Greece has been bailed out, fears of it running out of money continue to plague investors.
International credit markets remain wary of Greece because of its sovereign debt rating.
Ratings: Greece is now considered to be "junk" by the ratings agencies, meaning it has a very high chance of defaulting. S&P has cut its debt seven times since 2009, from A to CC, the third-lowest rung on its rating scale.
The problem: Italy has the highest total debt in the eurozone, amid stagnant growth.
CREDIT RATINGS EXPLAINED
A ratings agency is a private-sector firm that assigns credit ratings for issuers of debt, ranking its likelihood of paying back the money.
This affects the interest rate.
Ratings are divided into investment grade and sub-investment grade, and borrowers choose according to the level of risk they are willing to accept.
A credit downgrade can make it more expensive for a government to borrow money.
Of the agencies, Standard & Poor's is the oldest, started in 1860 to rate the finances of US railroads.
What is a ratings agency?
In the summer, the country was charged record levels to borrow, which prompted renewed calls to pass spending cuts.
The alternative, selling more debt, was unsustainable at rates that reached 6%.
Rome laid out 60bn euros of austerity measures and aims to balance its budget by 2013, but markets have been concerned over its growing debt load in relation to GDP - the second-highest behind Greece in the eurozone.
If Italy was to be bailed out, few think that the eurozone (or Germany in particular) could actually afford it.
But Italy has the advantage of having most of its debt owed to its own people rather than external investors. This buys it more breathing room than, say, Greece.
Ratings: Italy was last triple-A in 1995. Since then, its rating has been fairly stable near the top of the investment grade rankings.
The problem: The housing boom turned to bust, leaving the country's banks loaded with bad debt and the highest unemployment rate in the eurozone.
Spain has also seen record borrowing costs recently, forcing its government to adopt numerous austerity measures to get its finances under control.
Spain, like Italy, is considered too expensive a proposition for the eurozone to realistically bail out.
This is why the eurozone has tried to help lower its cost of borrowing, rather than give it loans as it did to its neighbour, Portugal.
Ratings: Last at the highest rating in 1992, the Iberian nation has been cut twice since 2009.
The problem: The country's banks bear a heavy exposure to Greek debt.
Europe economy essentials
What is a rating agency?
Q&A: Greek debt crisis
How recession took shape
What is a bond?
How euro crisis unfolded
What now for euro project?
Is euro crumbling? (Video)
In graphics: Eurozone crisis
While France's public finances have not yet been questioned heavily by the market, its banks have seen sharp falls on the stock market.
In September, Moody's downgraded Credit Agricole and Societe Generale after reviewing their exposure to Greek debt.
Credit Agricole and Societe Generale have seen their share prices fall by about two-thirds since February, while BNP has fallen by more than half.
France has also announced plans to cut spending by 45bn euros over the next three years.
Ratings: France was given the top rating by Moody's in 1988, and kept it ever since, despite anaemic growth.
The problem: Most of its neighbours are broke.
Unlike many of its neighbours, Germany enjoyed vigorous economic growth - GDP rose by 3.6% in 2010. Unemployment is lower than before the 2008 crisis.
And the government plans to cut the budget deficit by a record 80bn euros by 2014.
While that growth has slowed, the main problem is that Europe's largest economy is the biggest contributor to the bailout fund used to help stricken nations.
And Germany's banks have a heavy exposure to debt from Greece, Europe's biggest headache.
This means in the event of a Greek default, Germany would probably have to bail out its own banks.
But having taken the lead in bailing out three nations - Greece twice - how many more can the country afford?
Ratings: Following reunification, the country was given the highest possible creditworthiness by S&P in 1992 and Moody's in 1993.
The problem: UK banks have a heavy exposure to Irish debt.
Other than that, the UK has been relatively unscathed, while its eurozone neighbours endure turmoil.
The coalition government has announced the biggest cuts in state spending since World War II.
UK gilts are viewed as one of the safest investments in the world, with the country's borrowing costs falling to recent lows.
But the situation remains precarious. The country's budget deficit was 10.3% last year - this is just behind Greece, greater than Spain's and more than triple that of Germany.
Ratings: In 2009, S&P lowered its outlook on British debt to "negative" from "stable" for the first time since the agency started rating its public finances in 1978. But the triple-A rating has been affirmed since 1993.
The problem: The country's banking system collapsed.
The country's biggest banks were taken under government control in the financial crisis and recapitalised. The cost of doing that has been about 70bn euros.
The Irish received a bailout worth 85bn euros from the eurozone and IMF, then passed the toughest budget in the nation's history.
Since then, the IMF has said the Irish Republic is "showing signs of stabilisation" and there is a sense that the worst has now passed.
Ratings: The Irish Republic held the highest triple-A rating as recently as 2001. S&P has cut it five times since 2009.
The problem: A shrinking economy straining its budget.
The country has been the third to get a bailout, worth 78bn euros. The previous government fell after failing to pass austerity measures, which the subsequent government had passed.
Investors have since moved on to ongoing worries about Greece, Spain and Italy.
Ratings: Portugal has been cut four times since 2009. It was once triple-A, way back in 1993.
We have another global crisis that needs urgent attention by skilled and experienced people who can do the job right!
Storm warning: As the European debt crisis spreads across the continent, the outlook for the single currency has never looked so grim. Financial markets fluctuated violently as fears that Italy, Spain and France now, plus Germany in the future will be dragged into the eurozone debt crisis triggered another day of turmoil for investors.
--- --- ---
`Building An Excellent Business!` is available for immediate purchase by visiting the secure Cavendish eStore online at: http://www.cavendish-mr.org.uk - customers can download this e-book in PDF Acrobat format immediately after purchase.
More Economics and Business Inspiration:
`Accelerate with Impact` -
by Colin Thompson ISBN: 978-1-84549-289-2
Accreditation: UK Registered Learning Provider:10025755
Note: About the Author Colin Thompson
Colin is a former successful Managing Director of Transactional/Print Manufacturing Plants, Print Management/Workflow Solutions companies and other organisations, former Group Chairman of the Academy for Chief Executives and Non-Executive Director, helping companies raise their `bottom-line` and `increase cash flow`. Plus, helping individuals to be successful in business and life in general. Author of several publications, research reports, guides, business and educational models on CD-ROM's/Software and over 400 articles published on business and educational subjects worldwide. International Speaker and Visiting University Professor.
Eurozone Issues Continue with Greece and Italy