Bill Jamieson Not there yet

COMMENT

BILLJAMIESON | Executive Editor of The Scotsman

Not there yet

How unresolved problems dog the eurozone.

Two questions spring to the fore in conferences and seminars on the global economic outlook. Both are critical to the export hopes of UK companies selling into continental Europe: when will the eurozone start to see growth rates now enjoyed in other Western economies? And when will we see more monetary stimulus from the European Central Bank?

Both questions assume that the single currency has survived its time of trial, that its problems are largely over and that, with judicious ECB monetary policy and structural reform in the peripheral economies, the eurozone recovery will build momentum before too long. It is certainly true that core Europe has seen a notable upturn compared to the position two years ago. Economic activity has been rising for four successive quarters. The consensus view is that further progress will be made and markets are now focusing on the potential for significant outperformance in the periphery. But big doubts remain, and they can be traced to an uncertainty that the single currency – or more accurately the fiscal and monetary regime required to maintain global market confidence in it – has indeed dispelled those existential fears of three years ago. Is the price of the single currency’s revival a slow and faltering recovery as the ECB seeks to maintain pressure on member states to bear down on excessive levels of public debt? And if today’s muted recovery stalls or goes into reverse, might the regime surrounding the euro itself come under further political and financial strain? To the extent that this will prove to be the case – or be seen to be so by the eurozone’s restless and frustrated voters, can we really be sure that ‘the euro crisis’ really is a thing of the past?

Latest forecasts by the International Monetary Fund give no assurance of growth momentum. It expects Germany to grow by 1.9 per cent this year and for the eurozone to manage 1.1 per cent expansion – an improvement, but hardly one at a pace that will feed hopes of a big fall in current levels of unemployment. Meanwhile, recent business surveys suggest downside risks to overall eurozone growth in the third quarter, feeding concerns that the initial and strongest phase of improvements may lie behind. Geopolitical concerns in the aftermath of the shooting down of the Malaysian airliner over eastern Ukraine and a disruption to trade between Russia and the EU add to worries.

Is the price of the single currency’s revival a slow and faltering recovery as the ECB seeks to maintain pressure on member states to bear down on excessive levels of public debt?

Wearying of austerity

Public debt sustainability across the eurozone is still far from guaranteed, despite unprecedented fiscal austerity in the recent past. As Citi group economist Giada Giani points out, public debt ratios are still rising in all euro area countries, except Germany and probably Ireland. Better real GDP growth and improved budget balances make further improvement more likely today than at the height of the crisis. “However,” Citi notes, “these factors alone are not likely to be enough to set debtto-GDP ratios on clear downward trends in some countries without further fiscal efforts and/or growth-enhancing reforms. Cyclical improvements in the budgetary positions may be more limited than generally thought.”

All this might seem arcane, but with debt to GDP levels in many eurozone countries unlikely to peak for two or three years, the support of Europe’s political leaders for continuing austerity programmes is already wearing thin. And voters are wearying of tight lending and spending regimes that are thwarting falls in unemployment and an improvement in living standards.

The risks to stability in the eurozone’s financial arrangements may become especially high if the recovery pace does slacken – and this in turn may make the fragile settlement around the euro less securely underpinned than many believe. However, the commitment of the eurozone’s leaders to the euro remains very strong, even though it has required member governments to impose serious burdens on their populations. But there is a limit to public acquiescence in this, just as we are seeing limits to public support for the EU overall. Its continuation in its current form cannot be taken for granted. The UK Government wants to renegotiate the terms of its EU membership. German chancellor Angela Merkel is pursuing a foreign policy agenda distinct from the US and that of the rest of the EU. And in France, the most popular party currently is the one that seeks to assert France’s national interests against the EU.

Given these divergent pressures it may be that support for the euro project is limited to measures likely to ensure its survival – and little more.

So, the fragility of the eurozone’s recovery and its vulnerability to shocks require action. The prospect of a muted domestic demand recovery, and worries about a large output gap, have strengthened expectations that the European Central Bank will resort to additional policy stimulus through its own version of quantitative easing towards the end of the year.

That the single currency area finds itself so out of step with developments in the other direction in the US and UK is a measure of how the eurozone’s unresolved problems continue to shape current actions. n