Just when the situation in Europe started to turn, markets provided a wakeup call that Europe might not be fixed. The European Central Bank (ECB) provided a gloomy economic outlook, Italy’s Silvio Berlusconi is back, and economic data worsens.
Last week’s column explored the dangers a high euro poses for Europe’s export industry. After ECB President Mario Draghi’s gloomy comments on the European economy given at the Feb. 7 meeting, this worry might soon go away.
Last week, the euro dropped 2 percent to close at $1.3369. It registered the largest drop since July 2012 through Thursday, when Draghi spoke, before rebounding a bit on Friday, Feb. 8.
Making matters worse, Draghi left rates on hold and provided no further accommodation in terms of unconventional monetary stimulus. He commented that economic risk remains skewed to the downside and sees further weakness in the beginning of 2013. For most of 2012, Europe and the European banks were helped by the ECB’s injection of liquidity or the promise thereof. In the beginning of 2012, the ECB gave out $1.3 billion in cheap loans, to be repaid in three years’ time.
Instead of giving out more, some banks actually chose to repay a portion of the loans early. At the end of January and the beginning of February, European banks returned 146 billion euros ($195 billion) to the ECB, thus tightening liquidity.
In addition, Draghi’s promise to buy an unlimited amount of sovereign debt if necessary from last September also hasn’t been enacted. This is because he can only start buying once a government asks for help, which so far hasn’t happened. As a consequence, stocks lost even more than the euro, with the EURO STOXX index dropping 2.9 percent to 2,630.
Berlusconi Gaining in the Polls
Italy by far underperformed, with the Milan stock exchange losing 4 percent. Apart from the developing scandal surrounding the world’s oldest bank Banco Monte Paschi di Siena, the boogeyman for last week was former Prime Minister Silvio Berlusconi.
Many people smiled when he announced his comeback in the fall of 2012. Berlusconi had resigned among a fledging bond crisis in late 2011 and many people thought he was gone for good.
Now his party is only trailing the favored contender Luigi Bersani by 4 percent according to a recent poll by Italian TV station Sky Italia. Berlusconi represents a risk as he is most likely going to jeopardize the current European consensus for austerity. This was made clear by Berlusconi’s promise to give cash back to voters and abandon a property tax instituted by the current government headed by Mario Monti. Apart from that he is known to be a political “enfant terrible,” not likely yielding to the European Union’s wishes.
But even if he doesn’t win the general election in Italy on Feb. 24–25, his renewed popularity might lead to enough votes to produce a hung Parliament. These situations in Europe always produce uncertainty, like it was the case with Greece last year, and that is something the market doesn’t like.
The Week Ahead
Economic data in Europe has not inspired confidence recently. In fact, industrial production levels in France are now at a level last seen in 1997. Next week’s release for December 2012 will most likely not budge the downward trend. Citigroup economists are penciling in a 1.8 percent decline over the year.
Even the highly rated German economy is showing signs of weakness. Its industrial production declined to 2007 levels and Germany will release Q4 2012 advance GDP estimates. Citigroup believes there will be a decline of 0.5 percent over the previous quarter.
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