FYI | Mar 08 2012
By Greg Peel
Oh God, when will it ever end!?
That has perhaps been the catch-cry of global investors over the past two years. If the GFC itself wasn't enough, the ensuing two-year rollercoaster of European-related fear, centred in Greece but emanating out across the eurozone, has been enough to keep nervous stock market investors in particular well away.
We await the outcome of the Greek bond restructure tonight, which should see in excess of the required 75% participation from private sector holders, although that's not yet a given. If not, then the general consensus is not one of renewed disaster, nevertheless and should not threaten Greece's new E130bn bail-out. On the wider scheme of things, the economists at Commonwealth Bank believe its still too early to call an end to the crisis, but they do see “light at the end of the tunnel”.
CBA sees three elements to the European Crisis: the sovereign crisis, the banking crisis, and the recession. Looking individually at these three areas helps to throw light on how each can be resolved, the economists suggest.
The sovereign crisis will be resolved by the “painful road to austerity”, says CBA. It might be hard to believe, but the original Maastricht Treaty which set the rules for the eurozone included various caveats with regard to debt ratios and so forth, for example that no country's budget deficit could exceed 3% of GDP. Had these rules been adhered to, on the one hand, and in any way policed, on the other, then there would not have been a European Crisis. But every single eurozone member breached the 3% rule, including Germany, and in many cases by extraordinary amounts. Greece was obviously the worst offender, and disclosure fraud from the earlier government was an issue, but realistically every official at in the European Commission and EU and so forth was complacently asleep at the wheel.
The original rules will now be upgraded from the nod and a wink “pact” level to mandatory within each individual eurozone member's legislature. The new treaty will come in effect at the beginning of 2013 and make allowances for those members doing their best to move back to within the limits. That's where strict austerity measures come in.
“It will take years to achieve the desired outcome,” says CBA, “but the acute crisis period appears to be passing”.
With regard to those members with bail-out funds in place and as to whether anyone other than Greece will need a second package or anyone else might need a first, CBA notes the three-times leveraged European Financial Stability Fund (EFSF) along with the upcoming European Stability Mechansim (ESM) and contributions from the IMF provide a total of E1.6 trillion, which is more than enough to fund the E1.1 trillion of existing principal and interest payments on the sovereign debt of the PIIGS for the next three years.
With regard to the banking crisis, the ECB is now providing “unlimited liquidity” to European banks at a level of quantitative easing CBA describes as “huge”. If only this had been the initial response back in early 2010, and we did not have to wait until the desperate pleas of the rest of the world (and a change of ECB president) made substantial QE a reality.
European banks have taken up a large chunk of this stimulus on offer via the ECB's Long Term Refinancing Operation (LTRO) which after two rounds has seen banks snatching more than E1 trillion in 1.0% three-year money – a funding source which can prove very profitable for the banks, CBA notes, helping them through liquidity difficulties and ultimately leading them to lend money into the economy.
The banks must also increase their tier one capital ratios to 9% from a previous 4% to meet the new Basel III requirements established post-GFC. (You could look at this as reducing allowable leverage to 11x from 25x.) If they are struggling then they can still approach the EFSF for assistance.
With regard to the European recession which, incidentally, is yet to show up under that old definition chestnut of two consecutive quarters of contraction for the eurozone as a whole (notwithstanding a clear recession in Greece for example) but is simply assumed as inevitable, resolution is also at hand. On the one hand, notes CBA, the initiatives of the ECB will go a long way to curb the depth and extent of the recession. On the other hand, the global economy as a whole is looking relatively firm.
The ECB has cut its cash rate to an historically low 1.0% and the benchmark eurozone two-year bond yield (which exists only as an average of member bond yields) is around a record low 16 basis points. Lending conditions remain tight but should begin to ease as the central bank's stimulus makes its way through the economy, suggests CBA.
The eurozone trade-weighted exchange rate is trading below its ten-year average and as such providing a boost for eurozone exports. (We recall that Germany alone is still the world's biggest exporter.) Meanwhile the global economy is currently growing at just below its historical 3.8% trend CBA notes, the US economy looking a lot better than it did six months ago, and net Asian GDP growth appears to be bottoming at 6%.
All up the eurozone recession is expected to be a mild one, the economists point out, with less than a 1.0% contraction anticipated. This compares to a 5.6% contraction for 2008-09. CBA is forecasting the eurozone to be out of recession and back to growth by the end of 2012.
And then, hopefully, we can all get some sleep.
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