European Update: Progress and Problems

-   Implementation risk around the 26–27 October EU agreement has dominated markets in recent weeks.

-    Political change in both Greece and Italy, and pending change in Spain, is a positive, but much work remains to be done across these nations to stabilise the sovereign debt markets.

-    With the EU economy continuing to weaken, the required fiscal austerity is likely to add to the risk of recession, further weighing on global markets.

-    For Italy and possibly Spain, market developments are heading towards the need to access funds from the EU authorities and/or the IMF. However, given their size, this is likely to be in the form of some-type of hybrid model, with some funding from the markets and some funding from the EU/IMF.

-    The ‘big bang’ policy development could be large scale bond purchases by the ECB, to drive bond yields back down to sustainable levels. This would likely be seen as a positive by markets.

-    Both the ECB leadership and Germany, however, remain strongly opposed to such a move. But this option could become more palatable to the ECB if the EU sovereign debt crisis continues to spiral downwards, weakening the EU economy further.

After the 26-27 October 2011 agreement by the European (EU) leaders to implement a comprehensive package of measures to help stabilise the sovereign debt situation, we described these developments as a “step in the right direction”.

It is far too early to say that the EU sovereign debt/banking crisis has been solved. Further details on the implementation of the various agreements need to be worked through and as is usually the case, there remains a high risk that a number of countries may not be able or willing to fully implement what they have agreed to do.”

And so this risk has proven to be.

Political developments have dominated in both Greece and Italy since late October and the markets have taken a very dim view of the inability of the previous political leadership to implement what was promised.

New leadership in both Greece and Italy has been seen as a positive development by markets – and so it is. However, much work remains to be done to stabilise the situation in the EU, while a continuation of the economic slowdown seems inevitable, with a building risk of recession.