Trends in the Eurozone

In 2015, the currency bloc will have to deal with four major problems: economic stagnation, high unemployment, low inflation and high debt. There will be intense debates about how to address these problems, but the diverging interests of member states and the artificial calm created by the European Central Bank will undermine the European Union's efforts to take coherent measures to deal with its long list of unfinished business.

The debate between countries pushing for more stimulus in the eurozone (such as France and Italy) and countries insisting on further economic reforms (led by Germany) will continue. Paris and Rome will keep pushing for greater EU-wide investment and more investment plans in Germany. However, Germany's domestic constraints will limit its ability to take action. The zero-deficit policy is very popular among German voters, and conservative sectors of the government and the Euroskeptic opposition are pressuring Berlin to avoid making concessions to countries in the eurozone periphery. As a result, Germany is not likely to apply any significant stimulus packages at home or at the European level in 2015.

However, Berlin will likely tolerate eurozone countries that are not honoring their debt and deficit commitments. For example, during the first quarter of the year, France and Italy will apply modest economic reforms aimed at partial economic liberalization to appease the European Union. By the end of the first quarter, the bloc will assess those measures and will decide not to apply sanctions against France and Italy.

This will have two main effects. On one hand, Paris and Rome will slow their economic reform to avoid an escalation of social unrest and to prevent the political divisions within their center-left governments from widening. On the other, these governments will become increasingly ineffective, and social discontent will remain strong. A relaxation of fiscal consolidation measures also will take place in Spain and Portugal, both of which will hold general elections in late 2015. Germany and the European Union will not make any real moves to punish Madrid and Lisbon.

In addition to the "stimulus versus reforms" debate, there will also be a fierce discussion about the European Central Bank's role in fighting deflation and promoting economic growth. In 2014, the bank applied a series of controversial measures, including negative interest rates, cheap loans for banks and asset-purchase programs. In 2015, the institution will have to deal with the difficult question of whether or not to undergo a large-scale purchase of sovereign debt, a move commonly known as quantitative easing.

The introduction of quantitative easing in the form of the European Central Bank directly purchasing sovereign debt from countries in the eurozone periphery will face resistance from the German government, which believes the measure would prevent such countries from applying structural reforms. The Bundesbank and other central banks in the eurozone will oppose the measure as well. As a result, the European Central Bank will delay a decision on quantitative easing for as long as possible while assessing whether ongoing policies are working. The European Central Bank will try other measures (for example, corporate bond purchases) before buying sovereign debt. The European Central Bank could also authorize alternative forms of debt purchases, such as allowing national central banks to do so themselves, letting them assume the risk instead of the European Central Bank. The European Central Bank could also limit triple-A countries' purchases of alternative debt to mitigate German resistance. Even if quantitative easing is introduced at some point this year, Stratfor believes it will do little to resolve Europe's structural shortcomings and the growing political crisis on the continent.

In fact, the eurozone is sleepwalking into a new financial crisis. Soaring sovereign bond yields — a problem that the eurozone's policymakers thought they had consigned to the past — could reawaken the currency bloc in 2015. In December 2014, Standard & Poor's put Italy's sovereign credit rating just one notch above the speculative grade, mostly because of the country's political uncertainty and lack of reforms. In Greece and Spain, popular left-wing parties are campaigning on a promise to renegotiate their countries' sovereign debt. It would take further downgrades of Italy's credit rating or a serious push by Greece or Spain to renegotiate their public debt for the European Central Bank's promise of intervention to be tested and for financial instability to return to the eurozone. Such a scenario would weaken Berlin's resistance to a new round of unorthodox measures.

Finally, the eurozone is also waiting on the European Court of Justice to rule on the legality of the European Central Bank's bond-purchasing program. Although they may introduce a few conditions, the European magistrates are likely to rule that the program is legal, making quantitative easing harder to challenge and more politically acceptable. In any case, quantitative easing would probably not be the silver bullet many think it will be. Such a measure would buy distressed eurozone countries more time, but it would not solve the bloc's underlying problems.

Date: 2016-04-22; view: 601