PLANT

European leaders take steps towards ending crisis

The worst of the euro zone’s financial crisis seems to be over.


FRANKFURT, Germany—The worst of Europe’s financial crisis appears to be over.

European leaders have taken steps to ease the panic that has plagued the region for three turbulent years. Financial markets are no longer in a state of emergency over Europe’s high government debts and weak banks, giving politicians in the 17 country euro zone breathing room to fix their remaining problems.

Threats remain in Greece and Spain, and Europe’s economy is forecast to get worse before it gets better. But an imminent breakup of the euro now seems unlikely, analysts say.

“We are probably well beyond the worst,” says Holger Schmieding, chief economist at Berenberg Bank in London. He says occasional flare-ups in financial markets are likely, but “coming waves of turmoil will be less severe.”

Evidence that Europe has turned a corner can be found in countries’ falling borrowing costs, rising stock markets and a slow but steady stabilization of the region’s banking system:

  • The interest rates investors are demanding to lend to struggling countries such as Spain and Italy have plunged, a sign that investors are less fearful about defaults. Spain’s two-year bonds carry an interest rate, or yield, of just under 3%—down from a July 24 peak of 6.6%. Italy’s bond yields have dropped just as sharply.
  • The Stoxx 50 index of leading European shares has surged 26% since June 1, while the euro has risen from $1.26 to $1.29 over the same period.
  • After months of withdrawals, deposits are trickling back into Greek and Spanish banks, signalling that fears of their imminent financial collapse are abating. And US money market mutual funds loaned 16% more to euro zone banks in September. That was the third straight monthly increase in short-term funding to European banks, and follows a 70% reduction since May 2011.

More proof the crisis is easing: gatherings of European financial ministers no longer cause global stock and bond markets to gyrate with every sign of progress or a setback.

As financial-market panic recedes, euro leaders have more time to try to fix the flaws in their currency union. Among the challenges are reducing regulations and other costs for businesses in order to stimulate economic growth, and imposing more centralized authority over budgets to prevent countries from ever again spending beyond their means.

That’s important because a major cause of the crisis was Greece’s overspending during the calm years after the euro’s introduction in 1999, and Italy’s failure to cut the high levels of debt it joined with. Other governments—such as Spain and Ireland—were saddled with debt piled up by banks and real estate developers during boom years.

Much of the credit for easing Europe’s financial crisis goes to the European Central Bank, which has become more aggressive over the past year under the leadership of Mario Draghi.

The ECB said Sept. 6 it was willing to buy unlimited amounts of government bonds issued by countries struggling to pay their debts. The ECB’s pledge instantly lowered borrowing costs for Spain and Italy, which had faced the same kinds of financial pressures that forced Ireland, Greece and Spain to seek bailouts.

The ECB’s actions are reminiscent of the aggressive action by the Federal Reserve in the US in late 2008 and early 2009 after the financial crisis hit. The Fed offered banks cheap loans and started buying bonds to ease long-term borrowing rates and boost the confidence of consumers and businesses.

The Fed didn’t solve the problem of high unemployment. But its actions defused panic in the financial markets and helped restore the health of US banks. The Fed bought time for the economy to begin to heal.

German Chancellor Angela Merkel has also helped ease financial tensions across Europe by speaking more forcefully about the need to hold the euro together.

Merkel’s support is critical because Germany, the eurozone’s largest economy, has the most at stake financially in any bailouts. Merkel has backed the ECB’s bond-buying plan and has made conciliatory statements toward Greece.

That has paved the way for the so-called troika of international lenders—the ECB, the European Union and the International Monetary Fund—to allow Greece more time to meet deficit-reduction targets.

The Greek Parliament took a big step toward securing its next batch of rescue loans from the troika by approving a new round of tax hikes and spending cuts.

Another key breakthrough in the financial crisis came in late June, when leaders took new steps to steady banks and governments by easing up up somewhat on austerity demands; to use bailout funds to buy government bonds and help ailing banks; and to create a single supervisor for all of Europe’s banks.

Some analysts worry that as the financial pressure eases Europe’s leaders could lose their recent momentum.

A breakup of the euro “is still possible,” says Marie Diron, senior economic adviser to Ernst & Young. “I don’t think we have removed the risk altogether.”

Europe’s leaders have big challenges left.

The most pressing is saving Greece. If the country was forced into a default and began printing its own currency, investors would assume other countries might go next and begin pulling their money out of those countries too, or demand higher returns to keep it there.

Berenberg’s Schmieding thinks there’s a 25% chance that Greece will leave the euro in the next six months, if its parliament balks at painful austerity measures and euro members are reluctant to provide more help.

But a Greek departure would cause “only temporary damage.” Other economists think it could break up the euro.

Another hotspot is Spain, the eurozone’s fourth-largest economy. The country’s debts are piling higher as its regional governments struggle and its economy shrinks. The ECB’s offer two months ago to buy unlimited amounts of government bonds is a potential life-saver, but the country’s Prime Minister Mariano Rajoy needs to formally request such aid. Analysts say that if he waits too long Spain’s borrowing costs could rise again to unsustainable levels and reignite broader fears.

Banks are another problem. Weakened by massive losses on the government bonds they bought and real estate loans that aren’t being repaid, banks across the eurozone have been propped up by governments that are themselves struggling financially. Even with the help, these banks have been forced to reduce lending, which has hurt Europe’s economy.

Economic growth is what would ultimately end Europe’s crisis. But robust growth remains far off. The European Union forecast Wednesday that the 17-nation eurozone economy would grow just 0.1% in 2013.

Much depends, they say, on what gets accomplished in that time.

©The Canadian Press