As Summer Ends Markets Focus on ECB and Spain

Mario Draghi ECB

Europeans are bracing themselves for a severe case of post-holiday blues.


As the warm summer months draw to an end, the region’s sovereign debt crisis appears to be coming to a head.


Greek Prime Minister Antonis Samaras has initiated a charm offensive in an attempt to convince European leaders to give the debt-stricken country more time to carry out reforms, though Germany and France have already sent a strong signal that there will be no leeway for Greece.


Meanwhile, Spain, the euro-zone’s fourth largest economy, appears headed towards insolvency and Italy, the third largest economy in the 17-nation bloc, is threatening to follow.


The silver lining to the latest escalation in the long-running crisis, analysts say, is that the European Central Bank (ECB) might finally be prepared to take decisive action after a seemingly endless series of incremental solutions that have succeeded in putting out one fire only for another to appear.


“The crisis and the solution may come more quickly than people think,” Credit Suisse global equity strategist Andrew Garthwaite and his team wrote in a recent report entitled Spain: The Crisis We Have Been Waiting For?


ECB president Mario Draghi raised expectations that major policy moves could be on the horizon when comments he made during a recent investor conference in London were perceived by the market as a hint that the central bank could resort to a targeted government bond-buying program.


“Within our mandate, the ECB is ready to do whatever it takes to preserve the Euro,” Draghi said. “And believe me, it will be enough.”


Key events scheduled to take place on September 12 could determine the course for the next stage of the crisis.


Germany’s constitutional court is due to rule on a challenge to the new European Stability Mechanism (ESM). The ESM is designed to be more flexible and effective than the existing European Financial Stability Facility (EFSF), which is running out of money.


That same day 12.5 million Dutch will go to the polls for the country’s national elections. Voters, frustrated by the huge bail-outs for struggling European economies and tough austerity measures in their own country, could elect a government that opposes the cuts necessary to reach European Union deficit targets.


Such a result would make resolving the euro-zone crisis more difficult.


Even if Germany’s court declares the ESM constitutional, the new fund will only have €500 billion to lend. Though that is more than the current facilities, it is still small compared to the combined €1.3 trillion that Spain and Italy are expected to expend up to the end of 2015.


There are proposals to increase the firepower of the EFSF and ESM, one being what’s known as the Allianz plan which would boost leverage to EUR2.5 trillion by allowing the agencies to insure bonds issued by peripheral euro-zone governments.


So What About Spain…?


Spain contrasts with Greece in that it is easier politically for the European Union to offer Madrid support. Unlike Greece, Spain has followed the EU wish list of deficit reduction, labor market deregulation and bank restructuring. It has also made regional spending more centralized.


Spain is expected to opt for an assistance program overseen by the “Troika” program of the ECB, European Commission and the International Monetary Fund. The country is effectively already in an IMF program, according to the Credit Suisse report on Spain, because it is complying with external demands for reform. Opting for the Troika program would not require many additional conditions or oversight, but it would mean Madrid could access EFSF money — of which about €140 billion has yet to be used.


A question mark still hangs over Greece. There is a 10% chance it will leave the euro-zone by year-end — or establish a parallel currency, according to the Credit Suisse report.


Leaving the euro-zone would mean leaving the EU and losing crucial EU aid, the report said. “The rest of Europe would, we think, make life very difficult for a country outside the EU in order to discourage other peripheral euro-area members from following Greece’s lead.”


D’Arcy Doran writes about business, culture and current affairs. He has written for TIME, Monocle, The Independent, The Financial Times and other international media.


Photo: European Parliament – Flickr