November 9, 2012

After 3 bumpy years, Europe turning corner

Threats remain in Greece and Spain, and Europe's economy is forecast to get worse before it gets better. But an imminent breakup of the euro now seems unlikely, analysts say.

David McHugh and Don Melvin / The Associated Press Writers

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click image to enlarge

German Chancellor Angela Merkel, center, speaks with European Central Bank President Mario Draghi, left, and Italian Prime Minister Mario Monti during a round table meeting at a EU Summit in Brussels in June.

AP

Another key breakthrough in the financial crisis came in late June, when leaders meeting in Brussels took new steps to steady banks and governments. They agreed to ease up somewhat on austerity demands; to use bailout funds to buy government bonds and help ailing banks; and to create a single supervisor for all of Europe's banks.

Some analysts worry that as the financial pressure eases Europe's leaders could lose their recent momentum.

A breakup of the euro "is still possible," says Marie Diron, senior economic adviser to Ernst & Young. "I don't think we have removed the risk altogether."

Europe's leaders have big challenges left.

The most pressing is saving Greece. If the country was forced into a default and began printing its own currency, investors would assume other countries might go next and begin pulling their money out of those countries too, or demand higher returns to keep it there. The coming months could severely test Germany's new willingness to help. Despite two bailouts totaling €240 billion ($311.3 billion) since 2010, Greece needs an estimated €30 billion more from the other eurozone countries as its economy shrinks.

Berenberg's Schmieding thinks there's a 25 percent chance that Greece will leave the euro in the next six months, if its parliament balks at painful austerity measures and euro members are reluctant to provide more help. But he thinks a Greek departure would cause "only temporary damage." Other economists think it could break up the euro.

Another hotspot is Spain, the eurozone's fourth-largest economy. The country's debts are piling higher as its regional governments struggle and its economy shrinks. The ECB's offer two months ago to buy unlimited amounts of government bonds is a potential life-saver, but the country's Prime Minister Mariano Rajoy needs to formally request such aid. He has held off, apparently hoping the current market calm will last and he won't suffer the political humiliation of taking a bailout. Analysts say that if he waits too long Spain's borrowing costs could rise again to unsustainable levels and reignite broader fears in financial markets.

Banks are another problem. Weakened by massive losses on the government bonds they bought and real estate loans that aren't being repaid, banks across the eurozone have been propped up by governments that are themselves struggling financially. Even with the help, these banks have been forced to reduce lending, which has hurt Europe's economy.

A banking supervisor for all of Europe could provide some relief, by forcing crippled banks to merge with healthier ones. But it will be the second half of next year, at the earliest, before the supervisor is in place, banking analysts say. European leaders disagree over how much authority to give the supervisor and how to fund it.

Economic growth is what would ultimately end Europe's crisis. But robust growth remains far off. The European Union forecast Wednesday that the 17-nation eurozone economy would grow just 0.1 percent in 2013.

Privately, European officials say the ECB's bond-buying plan has afforded them a crucial window of opportunity — a year, perhaps — to resolve their biggest challenges.

Much depends, they say, on what gets accomplished in that time.

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