Events over the past two weeks in Europe have been extraordinary. The latest escalation in the sovereign debt crisis has led us to reassess our economic forecasts.…
Azad Zangana, European Economist di Schroders
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We believe that the outlook for the eurozone economy is now significantly more negative and that politicians have missed their opportunity to prevent a European credit crunch.
Following yesterday’s events in Italy, the banking system in Europe is now likely to experience a serious shock from the fall-out of the country’s bond market collapse. We expect debt-rating agencies to downgrade Italian debt significantly in the coming months. The downgrades combined with the falling value of Italian government debt will increase pressure on non-Italian banks to reduce their exposure, which could exacerbate the situation in the Italian bond market.
Many eurozone banks are already on life support – unable to raise funds in capital markets and heavily reliant on liquidity from the European Central Bank. However, this will not be enough to stop banks from deleveraging, and reducing lending to the real economy. As a result, we are now forecasting a serious recession in the eurozone in 2012, which is also likely to result in recessions in the wider European region, including the UK.
The downward spiral came after an initial note of optimism. First there was hope that Europe had finally grasped the urgency of the crisis, but the 27 October accord was overshadowed by Greek Prime Minister George Papandreou calling for a referendum on the Greek package. Since then, Papandreou has won a vote of confidence, but lost the support of his people. He announced his resignation to make way for a coalition government.
Yesterday, Italy’s Prime Minister Silvio Berlusconi was forced to resign after losing his majority in a crucial vote to pass next year’s budget. So two eurozone leaders have pledged to resign in less than a week, following the same fate of the other peripheral European leaders: Ireland’s Brian Cowen, Portugal’s José Sócrates, and Spain’s José Luis Rodríguez Zapatero.
The fall-out in financial markets has been troubling. European bourses are down between 2 and 4%, with shares in banks being hit particularly hard. Alarmingly, the yield on the 10-year Italian government bond rose above 7.4% and, in the process, triggered an increase in the risk margin charged by clearing house LCH Clearnet – effectively raising the cost of trading the bonds. As of yesterday, the yield on the Italian 10-year government bond had risen some 130bps since the start of the month, representing a capital loss of just over 9%!
Important Information:
The views and opinions contained herein are those of Azad Zangana, European economist, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. For professional investors and advisers only. This document is not suitable for retail clients. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Schroders has expressed its own views and opinions in this document and these may change. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA, which is authorised and regulated by the Financial Services Authority. For your security, communications may be taped or monitored.
Source: ETFWorld – Schroders
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