• Home
  • About
  • Subscribe
  • LATIF
  • Conferences
  • Dashboard
  • Edit My Profile
  • Log In
  • Logout
  • Register
  • Edit this post

Room 151

  • 151 BRIEF

    What's New?

  • Soaring inflation and pay pressures to add £3.6bn to council budgets

    June 28, 2022

  • Underfunded social care reforms could ‘exacerbate workforce pressures’

    June 27, 2022

  • Nottingham City Council leader labels proposed intervention as “disappointing”

    June 27, 2022

  • Government preparing to intervene in Nottingham City Council

    June 23, 2022

  • Low earners at Surrey County Council receive 7.85% pay increase

    June 23, 2022

  • UK Infrastructure Bank launches plan to deploy £22bn of investment

    June 23, 2022

  • Treasury
  • Technical
  • Funding
  • Resources
  • LGPS
  • Development
  • 151 News
  • Blogs
    • David Green
    • Agent 151
    • Dan Bates
    • Richard Harbord
    • Stephen Sheen
    • James Bevan
    • Steve Bishop
    • Cllr John Clancy
    • David Crum
    • Graham Liddell
    • Ian O’Donnell
    • Jackie Shute
  • Interviews
  • Briefs

Are we heading for another Euroland crisis?

0
  • by James Bevan
  • in Blogs · James Bevan
  • — 2 Oct, 2012

Part 1 

Despite the gloomy news on Euroland surveys, European crises tend to start when global growth decelerates, not bottoms, and we expect global PMIs to edge up in coming months – and we also expect that if Spanish bond yields rise, Spain will sign the Memorandum of Understanding (MoU). Furthermore, if European tensions mount again, we can believe that Germany will speed up the approval of the use of the ESM for the direct recapitalisation of banks (or at least put a framework in place that means that they are willing to do this in 2014, in way that allows investors to regard the FROB  (Fondo de Reestructuración Ordenada Bancaria or Fund for Orderly Bank Restructuring, a banking bailout and reconstruction program initiated by the Spanish government in June 2009) balance sheet expansion as being only temporary.

One key part of the puzzle is the prospect that the ECB has turned fundamentally more dovish (with the periphery probably outvoting the core) and that its triple target of reducing convertibility risk, improving the monetary transmission mechanism and maintaining price stability may well result in more aggressive action. Reducing the convertibility risk may even mean taking three-year bond yields in Spain and Italy down to 1% to 2%.

There is execution risk, but the Outright Monetary Transactions (OMT, see http://ftalphaville.ft.com/blog/2012/09/06/1148831/omt/ for background) look sustainable for the next 18 months because there is a stick (the actuality of high 10-year bond yields) and a carrot (very low T-bills) and the yield curve in effect acts as an enforcement mechanism.

Politics is of course important, with tough decisions for Spain on the MoU, and in the case of Finland and Germany, national parliaments activating the ESM, and providing cover for the ECB. There have been positive developments, with Mrs Merkel’s popularity at a three-year high and she supports the Draghi plan, while the opposition SPD are in favour of Eurobonds. Meanwhile, most of the Euroland periphery are implementing policies that are close to being consistent with an IMF programme and the IMF has explicitly said this for Ireland, Spain and Portugal. In this regard, it is apparent that despite the news headlines, the political pain threshold of the periphery is much higher than we had thought: 67% of Greeks still support the euro despite GDP, by the end of this year, forecast by the IMF to be down 26% from its peak, Latvia has stayed pegged to the euro despite a 21% fall in GDP and Ireland has so far seen a 10.4% decline in GDP. We can add that the Dutch election suggest that euro scepticism is less pervasive than many fear.

As for the peripheral economies themselves, the three-month annualized current account balance in the five PIIGS has now turned positive for the first time since the beginning of the crisis, and this matters not only because it shows that the periphery is regaining competitiveness (although the bulk of the improvement is down to sharply falling imports), but also because income from a current account surplus can, to some extent, offset the impact of modest capital flight.

Against this backcloth, a Greek exit looks unlikely (less than 20% probability) at least for now – and that means until after the German elections (likely in September 2013), after the OMT is started, after a banking union has been established (one that includes a deposit guarantee, resolution and regulatory regime), and after Greece has been seen, once again, not to implement the Troika proposals.

As a key issue, when all is said and done, Greece’s exit from the euro would look unhelpful for both Greece and broader Europe for the next year at least, but withdrawal over the longer term may happen and may be manageable.

Part 2

Although the Euro project may be ‘safe’ for now, major challenges to the Euro do clearly lie ahead, reflecting the problem that the underlying economies remains deeply imbalanced and an important part of the endgame may materialise in 18 months’ time, when the ECB has accumulated, under its OMT programme and its repos with the peripheral European banking system, very large holdings of peripheral European bonds.

At that point, peripheral European politicians may likely consider the option of not fulfilling the politically painful reform conditions attached to the OMT.

The ECB maintains that, in this case, it would stop any purchases or even sell existing holdings back into the market.

However, we can wonder whether this is a credible stance to adopt, given that this approach would involve the risk of large capital losses in the case of a default or an exit from the euro by the country in question.

Looking ahead, we can muse that at that stage, one of two outcomes is likely.

First, the ECB may relent and support the non-compliant country’s bond market despite the recognised non-compliance. In that case, we might reasonably expect a backlash from the public of the core economies, especially Germany.

Secondly, the ECB may not relent. In that case, it would withdraw OMT support from the country in question and, if necessary, refuse to accept that country’s bonds as collateral for its repo operation. The impact of withdrawing the repo facility could be severe, because the loan to deposit ratios are c150% of GDP in the periphery. Yet, in this case it would have to accept either default within Euroland, or exit from Euroland of the country as two possible consequences, and if it does not adopt one of these approaches, it can be seen to lack a credible threat.

The OMT in effect allows the can to be kicked down the street, and means that crisis can be averted for the next 12 to 18 months – and it need not be that a broad market and financial crisis necessarily rears its head once more at that point, because a Greece exit might be manageable once the OMT, and banking union are set up. That said, the scale of the challenges suggests that a Spanish exit would be unmanageable for the euro, and therefore the problems cannot be ignored.

In terms of where we have got to, our guesstimate would be that roughly 60% of the solution to the crisis in Europe is now in place. That leaves an unhealthy 40% to go.

The critical issue is that policies need to be found to foster growth.  Expansion of the European Central Bank’s balance sheet via the OMT should help significantly in this regard, by both weakening the euro and mutualising debt.

Other measures that might reasonably be seen to be required are more EIB/project bonds, and the 28th June summit had €120bn of these, i.e. 1.2% of GDP.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla

Share

You may also like...

  • Reforming business rates payments for schools 19th Apr, 2021
  • LGPS: Lessons from pooling around the world—there’s good and bad news 25th Oct, 2021
  • Global macro outlook: Virus versus vaccine 22nd Jan, 2021
  • Councils overfunded last year but ‘chronic’ financial pressures remain 20th Jan, 2022

Leave a Reply Cancel reply

You must be logged in to post a comment.

  • 151 BRIEFS – WHAT’s NEW?

    • Underfunded social care reforms could ‘exacerbate workforce pressures’
    • Nottingham City Council leader labels proposed intervention as “disappointing”
    • Government preparing to intervene in Nottingham City Council
    • Low earners at Surrey County Council receive 7.85% pay increase
    • UK Infrastructure Bank launches plan to deploy £22bn of investment
  • Room151’s LGPS Roundtables

    Biodiversity
    Valuations & Risk
    LGPS Women

  • Room151’s LGPS Roundtables

    Biodiversity
    LGPS Women
    Valuations & Risk
  • Latest tweets

    Room151 4 days ago

    Conrad Hall: ‘more sophisticated’ regulation needed for local government: The chair of the CIPFA/LASAAC Code Board has questioned the sophistication of financial regulation in local government and the continuing focus of the Department for Levelling Up,… dlvr.it/SSnPBV pic.twitter.com/G5d7JCWF8c

    Room151 6 days ago

    Slough Council approves plans to restructure finance department: Slough Borough Council has approved plans to restructure its finance department to enhance capacity and capability and to address a “significant weakness” in the function. The local… dlvr.it/SSf8DG pic.twitter.com/l5lmyHmkBg

    Room151 1 week ago

    Job Alert: Various Finance Roles: lnkd.in/eRKRvhJb pic.twitter.com/KkBrjXxAYD

    Room151 1 week ago

    MRP on capital loans: a step in the right direction: David Green says the latest government proposals on Minimum Revenue Provision should be welcomed by local authorities. There are still some unintended consequences, but the suggested approach for… dlvr.it/SSZ7JK pic.twitter.com/M1W9qVgYWN

    Room151 1 week ago

    MRP U-turn welcomed but ‘unintended consequences remain’: Local authority finance directors and treasury advisers have welcomed the government’s revised Minimum Revenue Provision (MRP) proposals, while pointing out that some unintended consequences still… dlvr.it/SSWvY0 pic.twitter.com/sGglpVNFs3

    Room151 1 week ago

    Mike O’Donnell: ‘progress on LGPS asset pooling needs to go further and faster’: The CEO at the London CIV pension pool has called for progress on pooling the assets of the Local Government Pension Scheme (LGPS) to accelerate. Mike O’Donnell told… dlvr.it/SSWvWV pic.twitter.com/rE1NjbMCCq

    Room151 1 week ago

    Mike O’Donnell: ‘progress on LGPS asset pooling needs to go further and faster’:The CEO at the London CIV pension pool has called for progress on pooling the assets of the Local Government Pension Scheme (LGPS) to accelerate. @London_CIV room151.co.uk/local-governme…

    Room151 1 week ago

    JOB ALERT: Watford Borough Council & Three Rivers District Council, various roles:       Technical Accountant Career Grade: We are looking for a motivated team player to join our Finance Department. The post holder will gain experience across these… dlvr.it/SSWN8f

  • Register to become a Room151 user

  • Previous story Where next for the banks?
  • Next story £1 billion allocated to council homes

© Copyright 2022 Room 151. Typegrid Theme by WPBandit.

0 shares