Towards the end of 2012, Greece finally received some aid and another reduction of debt. European leaders, led by Germany, preferred to avoid the politically sensitive question of writing off loans to Greece. Many see this as inevitable, and Angela Merkel even raised this option in a trial balloon.
However, she prefers pushing this back beyond the German elections in September. It is unclear if this can be pushed so far into the future, but it can certainly be pushed back beyond the first quarter.
* This article is part of the January 2013 monthly forex report. You can download the full report by joining the newsletter in the form below.
The financial situation of Spain has also eased: benchmark 10 year bond yields are back around 5% – high yet bearable levels. The spreads between Spanish and German bonds dropped 182 basis points since June 2012. One of the reasons is the big bazooka: the ECB’s commitment to buy bonds in the secondary markets assuming the country in question asks for and receives a bailout. Spain didn’t ask for a bailout nor saw an improvement in its economy, but still enjoyed relief in the financial markets.
Spain’s unemployment rate already reached 25% and house price falls accelerated in 2012. Was the bazooka the only reason? Another reason is that Spain tapped into its Social Security Reserve Fund for buying bonds. This also helped in pushing yields lower. Spanish issues are therefore on the backburner as well.
Italy, the euro-zone’s third largest economy, is suffering from a high debt-to-GDP ratio and political uncertainty. Nevertheless, the elections are only in late February and are probably overhyped – no big change is expected in policy.
Core issues
With all these problems sidelined for now, why is the euro still under pressure? It’s the core countries. First and foremost, the German locomotive is moving slowly: Germany’s economy has slowed down in Q3, and recent PMIs also show weakness. Germany has an export-oriented economy, and Merkel stated that manufacturing is all-important. Manufacturing PMIs have pointed to the downside.
In addition, consumers are somewhat more worried: retail PMIs in Germany, France and Italy are contracting, and this holiday season was somewhat less festive.
In France, there are also worries about the tax policy: while the French constitutional court has rejected the current top tax rate of 75%, the backlash against this move continues. The French economy hardly moved in 2012, and unemployment reached levels last seen in the 90s.
Many doubt if France is still a core country or belongs to Club Med. It is still Europe’s second largest economy (bigger than the UK) and is still important.
Why are core countries slowing? They are not immune to the struggling economies in the south of Europe, and they are not immune to slowdowns elsewhere. While there is no contagion in the financial markets, there is contagion to the real economies.
For investors that see the euro as a new Deutschmark or a currency representing core countries, the euro seems less attractive at the moment.
The official recession in the euro-zone comes against a steadily growing US and a stabilizing China. On this background, the euro is set to weaken, even if the worst of the European debt crisis is behind us.