The Eurozone is the worst affected in the current economic crisis and the Euro will have to reflect the weakness. The Euro, which had gained over 13% against the USD in the last one year, is set to give up all the gains in the coming months as Eurozone woes worsen. The Euro which is currently trading at levels of USD 1.40 will fall all the way back to USD 1.25 on the back of weakening Eurozone fundamentals.
The Euro has no support. The debt woes in countries such as Greece, Ireland, Portugal, Spain and Italy have no immediate solution at present. Bond yields of these countries have shot in the recent past even as German bond yields have fallen to record lows on risk aversion.
The rising cost of debt in the indebted Eurozone countries coupled with high interest rates and lack of investor support is hurting these economies. All the indebted countries in the Eurozone are adopting austerity measures in order to bring down the fiscal imbalance and to fulfil terms of bailout by the European Financial Stability Fund (EFSF). The EFSF was set up with a corpus of Eur 440 billion to lend to indebted nations. The adoption of the austerity measures is further pushing the indebted countries into deeper trouble as growth falls off and tax collection comes down due to falling GDP growth. The second quarter of 2011 saw the Eurozone GDP growth come in at 0.2% against a growth of 0.8% in the first quarter. France GDP growth was flat in the second quarter while German GDP growth came in at 0.1%. These two economies grew by 0.9% and 1.3% in the first quarter of 2011 respectively. The continuing debt woes are likely to push the Eurozone into negative growth territory in the second half of 2011.
The fact that the biggest economies in the Eurozone Germany and France are facing headwinds themselves is preventing a firm action to bail out the indebted nations. Germany is facing voter unrest on using German funds to bail out other Eurozone countries while France is facing high debt coupled with weak economic growth. France debt to GDP at over 80% is worrying the markets, as it fears a rating downgrade from its current AAA status.
The ECB on the other hand is making halfhearted attempts to keep markets calm by buying bonds of indebted countries. However, there is a lack of decisive action on ECB’s part due to its position as a politically independent central bank. The ECB has actually raised rates by 50bps this year as Eurozone inflation was running higher than target levels of 2% and below. There are now calls for the ECB to cut rates, as August inflation has remained unchanged month on month at 2.5%.
Equity markets in Europe have tanked over the last three month. The Euro Stoxx 50 index, which covers leading blue chip companies across 12 countries in the Eurozone, has fallen by 20% in the last three months. The German benchmark index the Dax has fallen by 20% in the month of August. The worry of European banks exposure to Eurozone government debt has hit German and Eurozone indices hard. The lawsuits filed by the US government against banks for a total of USD 196 billion including leading European banks on misrepresentation of the nature of the mortgages sold before the 2008 credit crisis struck is also taking its toll on the banks in Europe.
There is no respite for the problems in the Eurozone. The US markets at least have a Fed meeting in the third week of September to look forward to in the hope that the Fed will use all its tools to take the US economy out of the woods. The Eurozone has no such hope with the ECB reluctant to take a firm hand in sovereign debt issues.