The eurozone has some fundamental issues that will lead to the single currency project unravelling in time, warns WH Ireland’s Mike Ingram.
The monetary and political union has faced significant headwinds over the past decade. The eurozone debt crisis following the global financial crisis had left Europe trailing the US in its economic recovery.
Greece has weighed on the bloc; the nation has only just wound up its bailout programme, but its problems are far from over. Italy’s new, populist coalition Government, is threatening to exit the euro and has clashed with the European Union over its Budget plans. And there’s the small matter of Brexit, and the looming March deadline.
Ingram, chief market strategist at WH Ireland, is calling time on the eurozone, saying it is fundamentally “dead” – although it could take decades for the curtains to finally come down.
The high degree of fiscal union needed to make it work is unlikely to materialise, Ingram warns, although he concedes: “It could easily carry on for another 10 or 20 years.”
Adding: “From Germany’s perspective, they will not want the eurozone to disband until all the bills are paid in countries like Italy, which is, frankly, never going to happen.”
One Size Fits None
In a union between such diverse and wide-ranging economies and markets, it’s almost impossible to find a happy medium, says Ingram. He describes the European Central Bank’s one-size-fits-all monetary policy as “one-size-fits-no-one”.
“Effectively it’s too loose in Northern Europe and too tight in Southern Europe, which keeps Italy in a perpetual state of quasi-depression, and is why they’ve got the Government they’ve now got,” he explains.
That could be made worse by the new-look European Central Bank, after current President Mario Draghi’s term ends in November 2019. The famously dovish Italian is likely to end his tenure having never raised interest rates, and the market will be watching who his successor will be.
“It’s difficult to foresee a more dovish ECB than the one we’ve got under Draghi,” says Ingram. “If we get someone like Sabine Lautenschläger, the former vice President of Germany’s Bundesbank, we’ll probably get more hawkish policy coming through. That’s only going to exacerbate tensions.”
But David Zahn, head of European fixed income at Franklin Templeton, doesn’t think there will be a dramatic change of direction from the central bank, regardless of who replaces Draghi. “But we would expect the new incumbent to want to stamp their mark on the role,” he says.
“We’d expect eurozone monetary policy to remain accommodative in the face of reasonable growth and low inflation across the region. However, the degree of accommodation may alter.”
Italy Threatens the Union
The largest threat to the continuation of the single currency is currently Italy. Its recent general election saw a shift to populist candidates, forcing a coalition between the far-right League and anti-establishment Five-Star Movement.
Their initial Budget plans were met with scepticism from the European Union, which demands countries keep their budget deficit below 3% of GDP and their public debt under 60% of GDP.
At the end of last year, Italy’s budget deficit was 2.4% of GDP but its public debt was more than three times the allowed level at around 132%. The new government’s spending plans and tax cuts could see both those figures ramp up significantly.
The problem is that Italy’s government has been given a democratic mandate to deliver this extra spending, says Ingram. But Brussels, who are largely unaccountable and non-elected, are saying they cannot fulfil voters’ wishes.
Asset manager Robeco believes Italy’s issues will subside, saying in its 2019 outlook that budget discussions will be off the table next year. Robeco expects market forces, such as rising government bond yields, to force Italy into compromise.
Geoffroy Lenoir, head of euro sovereign rates at Aviva Investors, agrees: “Investor sentiment will ultimately have more sway in influencing the Italian government than Brussels.”
Should yields continue to surge towards, or through, 4% – a level not seen since late 2011 – the political mood would change. “In that scenario, the economy would enter a vicious tailspin as higher borrowing costs force up the deficit and the country’s debt burden,” Lenoir explains.
We should find out more on Tuesday, which is the deadline for Italy to submit a revised budget.
Merkel’s Replacement Could Be Less Pro-Europe
As well as a change at the top of the ECB, Germany will soon have a new Chancellor, as Angela Merkel has stood down as leader of the Christian Democratic Union party.
While Merkel has insisted she will see out her term as Chancellor, which ends in 2021, many, including Zahn, believe that will not be possible and that she will leave before then.
And the changing of this guard could have big implications for the eurozone. Merkel’s time in charge has seen Germany at the forefront of European integration, as well as supporting immigration. Zahn notes that recent opinion polls and regional election results suggest those views are not resonating with German voters.
Therefore, he says, “we suspect any successor could be less enthusiastic about further European integration than Merkel has been”, though he does not believe they will be anti-Europe.
Still, he adds: “For many years, Merkel has been seen as the de facto leader in Europe, offering clear direction. With her position weakened and no one figurehead leader offering clear leadership, it might become harder to achieve agreement across the bloc.
“France’s President Emmanuel Macron is working on establishing himself in a pan-European leadership role, but he’s not there yet.”
