Last week saw markets being spooked and Germany status as the financial pillar of Europe being called into question. At one point Germany’s borrowing cost rose above that of the UK, this is quite remarkable given the more favorable outlook debt outlook of Germany. The German government bond auction also failed to attract buyers for 35% of its offering.

It therefore appears more likely that the European Central Bank will be allowed to expand its role of lender of last resort to sovereign debt. Germany has been firmly opposed to this until now, but given these developments it may have to re think this. This change would help prevent funding pressures becoming defaults, but it would only be a short-term fix and not solve the underlying economic problems for the country concerned.

A key element of a longer-term solution for the ongoing crisis is Eurozone fiscal integration.  Some progress has been made on this with Chancellor Merkel raising the possibility of rewriting European treaties, which is the start of this process. If this is done it could pave the way for Eurozone governments to collectively issue debt in the form of “Eurobonds”. This is a lengthy process, but there are reports that fiscal integration without any treaty changes may be considered.

The European Central Bank (ECB) cut its policy rate by 25bsi to 1.25% at it November meeting. This decision to cut the interest rate, despite inflation being 1% higher than the ECB’s target of 2%, comes amid increasing signs of economic weakness.  The President of the ECB, Mario Draghi, noted that the Eurozone was heading to a mild recession by the end of the year. Given this the ECB is likely to revise its growth forecast for 2012 down, the markets are expecting and additional 25bps rate cut in December.

Signs that the Eurozone sovereign debt crisis is damaging growth emerged from the purchasing managers index (PMI). The estimate of the combined manufacturing and services PMI for November improved slightly from 46.5 to 47.2, but still remains in contraction. A result of 50.0 and over generally indicates that industry is expanding, and therefore the general economy should be doing the same and a good indication of future GDP. Germany continues to be the better performer with a 4 month high reading of 51.4, which was supported by a rise in business confidence. However, with continued austerity measures across Europe and no clear solution to the crisis in sight, the risks to Eurozone growth remain firmly to the downside. 

About the Author

Rachel Barker

Rachel Barker, an accountant who switched to online banking four years ago and has never looked back.