Image © ARTENS, Adobe Stock
- Dramatic slowdown in growth will lead to integration
- More integrated Europe positive for bonds and Euro
- Major test to come during European elections in May
The European economy’s rate of growth is slowing down, and this will probably drive the Eurozone to integrate more rapidly at a political and fiscal level, says Hans Redeker, global head of foreign exchange strategy at Morgan Stanley.
A more integrated Eurozone would have significant implications for European bond markets, providing more confidence to lenders, increasing funding flows and supporting the Euro by extension.
The European Commission released their latest set of economic forecasts for the European Union on Thursday, February 07, showing a series of downward revisions.
Eurozone growth for 2019 was revised down to 1.3% from previously 1.9%.
The growth forecasts for Germany was lowered from 1.8% to 1.1%. GDP growth for Italy was lowered to just 0.2% in 2019 from previously 1.2%.
Of the major European economies Italy has entered a technical recession, defined as two consecutive quarters of negative growth, and Germany is at risk of following suit.
One consequence of the slowdown is that proponents of deeper European political and fiscal integration will redouble their efforts to achieve a more integrated Europe.
The rationale is that without fiscal integration the monetary union is left fighting with ‘one hand tied behind its back’ and this places it at a distinct disadvantage.
Before the advent of the Euro countries like Italy could recover from a downturn simply by allowing their currencies to devalue.
The weaker domestic currency would then stimulate both inbound investment from foreign investors hunting for ‘bargain’ assets and by making exports more competitive - but with the single currency, this policy tool is not available.
The second issue is a lack of ‘safe-assets’ in a splintered Europe which makes borrowing for states in crisis more hazardous than it would do.
If the Eurozone were integrated and there was a type of ‘European Treasury bond’ akin to the U.S. Treasury bond it would be cheaper and easier for the region to borrow even if individual member states such as Italy were in difficulty.
As it is Italy must borrow on its own merits without the help of its own currency. This makes the threat of a squeeze from negative economic forces more hazardous.
Redeker says the upshot of the slowdown, however, is likely to be the evolution of another “mechanism” whereby Europe is forecast to face up to integrating at a deeper fiscal and political level in order to ensure the stability of the region.
“This is going to launch another mechanism, which I believe people have not adequately debated in the past, namely the pressure to integrate - you cannot run a currency union without political integration. I think this economic slowdown we are currently seeing is going to force them into the additional step of political integration with significant implications for bond markets too,” says Redeker.
“I think that fiscal integration has already started. The steps have been small so far but I think they are going to accelerate from here. We have a limited amount of time. We do not have safe assets in Europe or less so than we used to have. That is going to limit the European Central Bank (ECB) in its capacity to maneuver in the next economic decline, and it is all about the need to create those safe assets, and I think you can only do that via political integration,” adds Redeker in an interview with Bloomberg News.
Italy, which is in a technical recession, has suffered from a 'double whammy' of higher borrowing costs caused by the market reaction to the new government’s profligate budget and a slowdown in global trade.
Italy traditionally has a strong trade balance due to high trade goods exports and the current slowdown has been caused, in part, by falling demand for European goods in China. Yet, Redeker sees the Chinese economy as solid in the longer-term so the effects will probably only be temporary.
There are also some, such as Carlo Messina the CEO of Italian Bank Intesa Sanpaolo, who recently argued that the Italian government's more generous fiscal policies will drive a rebound in consumer growth by putting more money into the pockets of consumers via tax cuts and more generous welfare benefits.
Messina actually sees the policies driving a rebound in the Italian economy in H2 of 2019.
Political Union or Populist Divorce?
The opposite to deeper union - divorce - is the one major risk factor facing advocates of deeper European integration - and even for the Euro currency - as outlined by Morgan Stanley’s Redeker.
In this respect, the European Union parliamentary elections between May 23-26 are likely to be a major test or ‘make-or-break’ moment for those wishing to accelerate integration.
Considering the forces of nationalism, populism, and revolt which have spread through Europe, a major risk factor for European federalism is that voters support parties with nationalist sympathies, in the up-and-coming elections.
Deeper integration would be expected to be a positive driver for the Euro as it would stabilise European bond markets and make investors more likely to lend to the Eurozone given the wider financial underpinning.
This would increase net inflows and drive up demand and value for the single currency - the opposite, further splintering of member states ties would be expected to have the opposite effect on the single currency.