Euro area: the increasingly widespread destabilisation of the European political picture has prompted the European Commission to opt for a very soft interpretation of fiscal rules, which are starting to seem increasingly anachronistic. Solution in sight for Greece’s debt?……
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Intesa Sanpaolo – Research Department For professional investors and advisers only
The notable difference in recent months between the market’s and the FOMC’s expectations for US rates has narrowed in the past week. The Committee has made a strong flow of statements, confirming the stance taken in March, compatible with at least two hikes in 2016, subject to the evolution of data and risks. The minutes of the April meeting explicitly indicate that there is widespread consensus for a possible rate increase in June. April data were largely supportive: retail sales, industrial output, housing starts, employment, hourly wages, CPI, and consumer confidence were all positive. In the minutes, the Committee indicates that the necessary conditions for a hike soon are a recovery of growth in 2Q, the strengthening of the labour market, and an uptrend of inflation. While none of these elements taken alone is enough to prompt a hike, an evolution of all sectors of activity, compatible with a reacceleration of final demand and with widespread consumer price increases, may do the trick. The market has acknowledged this: the probability of a hike have increased to 59% in July.
With May and June data showing an improvement in the consumption and residential investments, a stabilisation of mining and oil extraction (see page 10), job growth of 100150k per month, and core prices on the rise by between 0.1 and 0.2% m/m, the stage for a summer hike will be set. The FOMC’s next “official” messages in preparation of a summer rate hike will come on 27 May and 6 June (Yellen speeches); assuming the Committee does not act on rates before the UK referendum, 15 June (FOMC) with risks probably being again explicitly defined as balanced, and in mid-July (Monetary Policy Report). In the meantime, data will continue to guide expectations, and the market will have been alerted.
Slow growth, the EU referendum in the United Kingdom, and most importantly the progressive crumbling of moderate government majorities, have prompted this year the European Commission to opt for a very soft interpretation of fiscal rules – possibly in an attempt to avoid further destabilising EU governments. Italy has obtained exceptions worth an impressive 0.85% of GDP, which means that no emergency budgets should be required this year. Spain and Portugal, for the time being, have been spared sanctions for the insufficient correction of excessive deficit. In this case, the postponement could be brief, and just enough to allow Spain to hold its general election on 26 June. The new Spanish government will then have to immediately tackle the issue of the fiscal correction required to cut the deficit back down below 3% in 2017. In Italy as well, the problem has only been pushed back for a few months, until the 2017 budget.
Next year, the stability programme provides for a reduction of the overall deficit to 1.8%, which according to the Commission, however, implies a structural correction well below the 0.5% requirement. Whatever the outcome of the negotiations on the 2017 budget, unfortunately, simply postponing fiscal correction will not solve the problem of debt, unless it is followed by a significant acceleration in growth. The truth of the matter is that, given the current environment of slow growth and low inflation, not even the strict application of fiscal rules can solve the problem of debt, and the Fiscal Compact seems increasingly anachronistic. Despite the support being offered by monetary policy, both courses of action may guarantee at best a slow erosion of the debt/GDP ratio, with the risk of the first recession wiping out years of hard-won progress. No decisive reversal is possible without the central bank becoming even more involved: however, in the euro area the constraints imposed by the Treaty, and ideological obstacles, will probably prevent this from happening. A more structural solution, on the other hand, may be found for Greece’s debt. On 24 May, an important Eurogroup meeting will be held, and will also have to examine restructuring proposals on debt towards official institutions, with the declared objective of guaranteeing that debt servicing is kept at sustainable levels, and that a political deal is reached.
Appendix
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