Less than two weeks ago, the leaders of the eurozone were looking forward to sunning themselves on the beach this month after they concluded a deal that was supposed to resolve once and for all the debt crisis on the fringes of the single currency.
On Tuesday, the euphoria was a distant memory as the financial markets threatened two of the big beasts of the monetary union — Italy and Spain.
As bond yields in both countries rose to levels not seen since monetary union was created more than a decade ago, Spanish Prime Minister Jose Luis Rodriguez Zapatero said he was postponing his three-week vacation to monitor economic developments. Italian Minister of Economy and Finance Giulio Tremonti called an emergency meeting to discuss how his country, which has the biggest national debt of any eurozone nation bar Greece, could cope with the speculative attacks.
Traditionally, Europe closes for business this month unless there is a good reason policymakers should be shackled to their desks. This year there is.
When the heads of the 17 eurozone governments met in Brussels on July 21, they agreed not just to bail out Greece for a second time, but to put together a war chest that would enable them to take pre-emptive action in countries seen as vulnerable to attack. The message to the markets was clear — monetary union will be protected come what may, so think twice before turning on Italy and Spain.
However, it did not take long for the financial markets to unpick the Brussels agreement. They quickly discovered that while there was the promise of more money for the European financial stability facility, it would take months for the funds to arrive and then only if national parliaments agreed to pony up the cash. What looked on the surface a once-and-for-all solution was exposed as a naked attempt to buy time.
Events in the US over the past week mean the respite has been short. The threat that even the world’s biggest economy might welsh on its debts has reignited concerns about the weaker members of the single currency. Dismal growth figures from the US have made matters worse, since the chances of countries like Spain and Italy growing their way out of trouble will be impaired if the recovery in the global economy stalls. That now looks much more probable than it did a fortnight ago.
Nick Parsons, head of strategy at National Australia Bank, said: “Europe’s leaders probably thought they had bought themselves three months. I thought they would get six weeks at best. It now doesn’t look as if they will get as long as that.”
“There is a growing sense of crisis enveloping markets in the northern hemisphere. Thus far, asset markets in Asia have been holding up relatively well and currencies have moved in an orderly fashion. With increasing doubts about the forward momentum of the global economy, we will need to watch these Asian markets very closely for any signs of contagion. The month of August has got off to a very nervous start,” he said.
In their different ways, Italy and Spain exemplify the difficulties in making the eurozone work. Deprived of the ability to devalue its currency, Italy has struggled to remain competitive with Germany and growth has been sluggish. Spain, by contrast, had excessively strong growth in all the wrong parts of the economy courtesy of a one-size-fits-all interest rate. Cheap borrowing costs led to soaring asset prices, an unsustainable construction boom and a widening current account deficit.