Risks to the life of the euro currency seem not to be off the radar anymore. There was a report that the European Financial Stability Facility (EFSF) would include explicit warnings of a Eurozone breakdown as well as the cessation of the euro as a lawful currency in the prospectus for its bailout instruments, known as Euro Sovereign Credit-Linked Certificates. Note that these products are modeled on credit default swaps and expected to be launched in January. As the news threatened investors and hampered markets, a source said that the EFSF will remove the clause on the euro breakup from initial drafts. Such a move highlights that EU officials are becoming more sensitive to the issue and indicates the increasing fragility of the Eurozone.
It seems that officials of late have acknowledged a rising chance of a euro recession and the risks it could post to the global economy. The IMF director sees a gloomy economic outlook, with no country or region being immune to the crisis now deemed to not merely be unfolding but escalating. In order to cope with the problem, the IMF has urged countries, in the Eurozone in particular, to take action to shore up growth. While there’s limited room for interest rate cuts given the current already low level of the policy rate at 1%, the ECB decided to gear up its non-traditional monetary easing by lengthening the duration of the Long Term Refinancing Operation (LTRO) to three years. In addition, the ECB president stated that “we want to make it absolutely clear that in the present conditions where systemic risk is seriously hampering the functioning of the economy, we see no stigma attached to the use of central banking credit provisions: our facilities are there to be used”. While the three-year LTRO will help prevent the economy from a credit crunch, we see that quantitative easing is still needed to pull down market interest rates, which would alleviate overall financial tension and support economic growth. Such unorthodox measures are very important, especially with fiscal hands tied by the budget deficit target of 3% that must be met by 2013. To us, while there’s no doubt about the Eurozone economic recession, we believe that a euro breakup is unlikely. We also see that the crisis this time in the Eurozone will not be as severe as the one in the US in 2008, as the situation was much more complicated due to the more sophisticated nature of problematic securities. Meanwhile, we believe that EU officials will eventually do whatever it takes to save the life of the union, which has been in existence for a decade. Still, the region will continue to struggle with sub-par growth for some time, constituting a drag on the global recovery, at least in the coming year.
