There was a lot of European economic news today. Not all of it was bad.
The media and investors are celebrating the success of today’s bond auctions by Spain and Italy, the two most critical countries in Europe’s sovereign debt drama. Bond yields fell and stock markets rose, in Italy by 2.7%.
Yet it is a sign of how deep is the pessimism in and about Europe that placing EUR22bn in government debt at lower rates than those recently demanded by the markets generated such a profound sigh of relief.
But relief rallies we have seen before. There are plenty of reasons to be sceptical. In the case of Italy the issues were short term (one year or less), although Spain did manage to place three-year bonds. The rates on benchmark ten-year bonds (and the spreads over German bunds) fell only marginally: in Italy from 6.9% to 6.57%, in Spain from 5.25 to 5.13%. Only when long-term rates fall substantially and lastingly will we have clear evidence that the sovereign debt crisis has been overcome.
Moreover, the context must be borne in mind. The lower yields and ‘successful’ placement come after the massive injection of cash into Europe’s banks by the ECB. Having virtually given the banks almost half a trillion euro just before Christmas, it is hard to see a placement of 22bn in sovereign debt at somewhat reduced rates as a huge success. Moreover, both the Spanish and Italian governments have recently announced severe additional austerity measures. These are certain to depress the economy this year. The latest OECD composite leading indicator, also published today, has been falling for both countries for a year now, in Italy at a precipitous rate. This means that even at the lower interest rates now being demanded (assuming their level can be maintained), fiscal consolidation will make little or no progress, simply because nominal growth will be so weak.
The other main news was the ECB’s decision not to cut interest rates further (from their current 1%), but rather to wait and see what the effects of its pre-Christmas present to the banks will be. ECB president Draghi has made out a ‘tentative’ stabilisation of the situation in the euro area. The key problem remains that the ECB has not taken decisive action directly to stem the sovereign debt crisis. Instead it has offered the banks unlimited cheap money for three years in the hope that some of this will ‘trickle down’ and bolster sovereign debt markets. Nice for the banks that can make money (at some risk) from the high interest rates on government bonds, which is essentially a transfer to them from the taxpayers servicing the public debts. Plus ca change… The three year limit may also explain why the bond issue bought interest-rate relief at relatively short maturities, but failed to make a significant dent in the longer-term rates.
Last but not least, the euro has been sliding gently against the dollar (recently reaching a 16-month low) and other world currencies. This is actually good news to the extent that it will ease the pressure on euro area exporters and those firms facing competition from outside the currency area. However, it is not the way forward. As I have argued before, the euro area needs to exit the crisis by expanding domestic aggregate demand, not by poaching it from the USA and emerging markets that can ill afford to lose it. In any case the ‘good news’ from the bond markets pushed the currency up again.
All in all, yes, today has offered some encouragement. But expect relief rallies to be followed by renewed bouts of fear and panic for as long as the more fundamental issues facing the euro area (the lack of economic growth, sovereign debt burden, and the unresolved competitive imbalances) are not addressed head-on and decisively.