An improved economic outlook amid a battle with the coronavirus brings Europe closer to a new threat
As investors prepare for a surge in the European economy, they are also preparing for the inevitable consequences in the form of an emergency funding halt by the European Central Bank. That fact will put the region’s most heavily indebted countries face market forces they can’t handle, Bloomberg wrote.
Citigroup, one of the biggest international financial conglomerates, is already preparing to cut its bond purchases as early as June.
Due to the drastic measures taken by the ECB over the past year, the cost of borrowing in the euro zone has never been so risk abstracted. Most EU countries are emerging from the worst recession since at least the Second World War. Nevertheless, an investor in Italian ten-year bonds can only count on an interest rate of around 0.75%. Greek bonds, considered a junk asset by all three major rating agencies, have an interest rate of less than 1%.
“You can only get temporary credit risk relief in European sovereigns in case of an emergency”, – said Eric Lonergan, finance manager at M&G. – “The problem is that when you come out of an emergency, you go back to market forces in the bond market, and some of these indicators look very, very bad. Ironically, Europe is vulnerable to recovery.”
Although ECB president Christine Lagarde said this week that it would be “premature” to talk about easing support, the debate on what to do and when is coming. Some policymakers are already pushing for a reduction in the third-quarter emergency purchasing programme, an unnamed source told Bloomberg in a commentary.
Despite Lagarde’s encouraging words, without emergency support, attention will return to the debt of Greece, Italy and Spain, which has increased further in 2020 due to necessary health-care costs.
For now, EU member states are preparing to spend money from the recovery fund, as repayments will start around the middle of the year. Italian Prime Minister Mario Draghi, the former ECB president credited with saving the euro during the last debt crisis, plans to restructure the Italian economy with more than 200 billion euros.
But while this stimulus would aid economic recovery, the question is whether it would trigger enough sustained growth to substantially reduce Italy’s debt, which currently stands at around 160% of economic output.
The ECB once again faces a difficult choice: Determining monetary policy for countries with very different economic situations, inflation, unemployment and debt. If policy tightens, peripheral countries will lose out, making it difficult to finance their huge deficits.