2017 has been a very good year for peripheral euro area countries, with rating upgrades (Italy, Portugal) as the icing on the cake……
Next year, conditions will continue to be favourable for the states that need to bring down their debt/GDP ratios. If major breakthroughs are not made on this front, a perfection of the monetary union will be hard to imagine.
The upgrading of Portugal’s rating by Fitch to BBB from BB+ caps off a year of spectacular improvements in the markets’ assessment of the European periphery. Thanks to the very accommodative monetary conditions guaranteed by the ECB, and to the strengthening of economic expansion, the debt/GDP ratio has started to drop – at a faster pace in Portugal, where the primary surplus is estimated this year at 2.5% of GDP, and real growth has increased to 2.6%, marginally in Spain and Italy. Refinancing conditions for euro area member states will remain favourable in 2018, although the window of opportunity to reduce debt could close in a matter of a few years. The asset purchase programme will be tapered starting in January, and definitively unwound over the following few months September; furthermore, starting in 2019, initial rate hikes and increasing risks of an economic slowdown could make it harder to achieve a significant reduction in debt. This consideration explains in part the mounting frustration at the European level over Italy’s requests for flexibility on its accounts, as the country risks missing out on the opportunity to reduce debt with no evident trade-off in terms of a prospected improvement in potential growth.
This state of affairs is also affecting negotiations on the completion of the monetary union, accentuating a split that has already been evident for some time between those who award a priority to reducing risks (in terms of excessive public debt and the quality of bank balance sheets), and those, on the other hand, in favour of strengthening the institutional structure of the economic and monetary union (European deposit insurance, European fiscal backstop for banking recapitalisation, common fiscal function). The last European Council meeting of 2017 showed that it will be very difficult to change the status quo, unless a compromise proposal emerges combining elements of risk reduction with solidarity measures.
It will be even harder to break out of the status quo in light of developments on the political front. Mistrust towards Italy is amplified by the prospect of potentially inconclusive elections, and of a populist drift which, to varying degrees, is influencing the political agendas of all the Italian political parties. Germany will remain without a government for many months, and a return to the polling stations cannot be entirely ruled out. The Netherlands has a government supported by a very slim majority. In Austria, with the markets turning a blind eye, a scenario has materialised that only a year ago would have been read as a step towards a possible disaggregation of the monetary union: the Popular Party has formed a government coalition with the euro-sceptic right of the FPÖ, which has obtained important cabinets, including the Ministries of the Interior and of Foreign Affairs. In 2000, the government led by the FPÖ clashed with the EU to the point of inducing the Belgian foreign minister to prospect a possible exit of Austria from the Union. However, this time around the FPÖ’s potential for disruption will be greatly watered down by coalition commitments: the new government has explicitly ruled out the possibility of a referendum being called on the euro, and Prim Minister Kurz seems less hostile than the Dutch on the topic of European integration. However, this coalition is unlikely to be able to uphold calls for stronger integration. The markets are at once right and wrong in not showing concern: wrong because the euro area will remain quite fragile; right because serious risks would only materialise in the event of a serious recession, which is a highly unlikely prospect next year.
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