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The Euro problem

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by Peter Switzer

With the Yanks on their Labor Day holiday, it’s time to take the attention away from the possibility of another US recession (which incidentally a majority of fund managers believe it will avoid) to concentrate on the real unknown — Europe’s debt quagmire.

I reckon the Euro-mess is such that the RBA should cut interest rates today, even if it’s only for insurance purposes against what European debt could do to the global economy and stock markets.

Over the week, the German Chancellor Angela Merkel had another bad state poll, which means her CDU party has now lost six of the last six state elections held in Germany. She is a staunch defender of the euro and the union of European powers but Germans are getting tired of playing bankroller for the profligate members of the EU.

So not only are investors worried about countries such as Portugal, Italy, Ireland, Greece and Spain or the PIIGS, but they’re also worried about whether the euro will last.

I know some commentators think it’s only a matter of time before some countries desert the euro but if that happens there could be a domino effect and the banking instability that would follow would be a disaster. That’s why Chancellor Merkel is putting it all on the line to fight the good fight to provide stability in an increasingly unstable Europe.

New concerns

The new worry has become Italy with Bloomberg reporting that stocks were down and bonds fell for the 11^th day in a row. When bond prices fall, it means that the yields on Italian bonds rise and that’s akin to interest rates, which means lenders now want more interest to carry the risk of Italian Government debt.

At the same time, the cost of insurance for both government and bank debt went higher, which adds more economic pressure to an economy already under challenge, not least from Prime Minister Silvio Berlusconi facing prosecution for behaviour unbecoming and because of the fiscal austerity that has been demanded from European monetary authorities.

Euro data

Stocks locally should head south today with the MSCI All-Country World Index dropping two per cent at one stage.

The Stoxx Europe 600 Index was down 4.1 per cent and Bloomberg says this is “the biggest two-day slump since March 2009.”

While German interest rates on bonds are falling, as everyone wants the safety of the country, Greek two-year debt hit 50 per cent!

“Sovereign risk-related events remain the main market drivers,” explained Markus Ernst, a strategist at UniCredit SpA in Munich, via Bloomberg. “The negative market sentiment is unlikely to change for the better in Europe.”

Personally, I cannot understand why European officials sit by and do nothing. Interest rates should be cut immediately and the stronger governments need to take control before a new Lehman Brothers-style calamity results. Fortunately, European banks are better capitalised and less dependent on short-term money but the uncertainty is bound to keep stock markets jumpy for a couple of months.

And to make matters worse, Italy faces a general strike tomorrow because of the proposed 45.5 billion euro austerity plan.

Rate cut today?

Europe is a mess and has the capacity to really rock stock markets over the next two months in particular and given that this mess could get uglier, it’s a good reason to pull our globally high interest rates back today at the Reserve Bank meeting. If the Bank follows the economist polls which say all of the number crunchers expect no change, then it’s clear that the RBA and its board are ignoring Europe’s problems and their capacity to hurt the world’s banking system, economy and stock markets.

I hate to be alarmist and my fears could be excessive but I think it’s time for the Reserve Bank board to move pre-emptively.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Tuesday, September 06, 2011

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