The good, the bad and the euro

Just as the news coming from Athens augured a little better for the future of the eurozone, the word from Madrid plunged the future of the embattled currency back into doubt.

Polls showed that New Democracy, the centre right party that has pledged to continue the bailout programme, was on track to win a majority in the Greek general election on June 17.

Even if this did not resolve the deep issues surrounding Greece’s euro membership , it should give other countries extra time to cope with the massive fallout of a Grexit as predicted to occur at sometime during the next two years. Spain’s deputy Prime Minister, Soraya Saenz de Santamaria, was in no doubt that her country’s growing crisis could well spell the end for the currency and the EU.

“If the EU doesn’t reinforce the eurozone with some sort of mechanism, it’s not about who leaves (the euro), it’s about the EU itself. What is the EU without the euro?”, she told Reuters editor-at-large, Harold Evans, in Madrid.

Ms Saenz made it clear the end could be brought about not so much by markets and speculators as by its citizens, who were making huge sacrifices, paying increased taxes, losing their jobs and suffering cutbacks in state services. The country has cut its budget by more than €45bn this year — but much of this will be eaten up by increased interest payments of €30bn on its debt.

Spain is pushing for the ECB to issue more liquidity, or for the central bank to purchase sovereign debt on secondary markets as well as allowing the bailout funds, the EFSF and the ESM, to lend directly to banks.

Ireland is watching this with interest and John FitzGerald of Dublin’s Economic and Social Research Institute said: “Taking on the risk of a bank failure at European level through the ESM is far preferable to the much greater risk of a sovereign default”.

At their summit last week EU leaders discussed a pan-EU bank resolution fund to deal with failing banks and their effect on other institutions. However, EU leaders move very slowly on such changes while talk of a Greek exit has speeded up its possibility by increasing nervousness among the public and investors who have been steadily withdrawing funds from Greek banks.

Berenberg Bank economist Holger Schmieding told Reuters: “Preventing bank runs in Italy, Spain and Portugal should be the top priority”.

The latest converter to the need for a fund to prevent the vicious cycle of bank debt bringing sovereigns into trouble is Joerg Asmussen, former adviser to Angela Merkel and now ECB policymaker.

Who will take the necessary steps is unclear. Mario Draghi head of the ECB said last week: “We have reached a point in which the process of European integration needs a courageous leap of political imagination in order to survive”.

However Germany’s enthusiasm is difficult to gauge, although there are signs it would be willing to pool its own bank resolution fund with that of other countries, but when is not clear. In the meantime, the divergence between eurozone economies increases with the record low cost of borrowing for Germany contrasting dramatically with the increased costs for the hard-pressed economies.

There is now talk of a bubble starting to form in Germany’s government bond market as its 10-year bond dropped to a record 1.345% yesterday — 74 basis points below the rate of consumer-price inflation.

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