“The last thing that the markets need right now is increased political uncertainty at the heart of Europe at a time when the economic outlook is already bleak,” says Capital Economics. Yet that’s exactly what they’re getting. German ten-year bond yields fell to a record low of 1.6% this week as the ruling Dutch coalition collapsed and the Socialist candidate François Hollande won the first round of France’s presidential election. He looks set for victory in the run-off against incumbent Nicolas Sarkozy on 6 May.
Rebellions on the rise
The “austerity backlash” is gathering steam, says Bloomberg.com. Hollande has said he wants to renegotiate the fiscal compact – a set of rules enforcing long-term fiscal discipline – agreed by Germany and France last year. He has also called for an EU-wide push for growth, in contrast to Germany’s emphasis on austerity.
The Netherlands, a “hard-line enforcer” of budgetary discipline in the eurozone, is failing to get its own house in order, says Peter Thal Larsen on Breakingviews. Cuts designed to shrink the budget deficit from 4.6% to the 3% mandated by the fiscal compact have proved too much for the eurosceptic populist Geert Wilders, leader of the Freedom Party; he walked out of talks saying that too much austerity was damaging growth.
The debt trap
The Dutch are cutting spending against the backdrop of a shrinking economy. The trouble is that the periphery’s experience has shown that austerity dampens the economy further. That makes the debt problem worse as revenues fall short and borrowing rises, necessitating more austerity, and so on. Countries end up “chasing their own tails”, as Larry Elliott puts it in The Guardian.
Anger is mounting because austerity isn’t just “forcing people out of jobs… it isn’t even helping to bring down the debt”, says Andrew Sullivan on Dailybeast.com. This month’s eurozone activity survey suggests that the recession that began last autumn is intensifying. So fears of the vicious debt circle, and consequent political turbulence, are hardly likely to dissipate.
In early May, for instance, a Greek election seems set to result in a multi-party coalition with many parties hostile to the spending cuts outlined in the bail-out package.
What next?
If Geert Wilders gains greater influence in impending elections, “Germany might just have lost a key ally in its efforts to achieve a euro based on sound money and budget discipline”, says Mats Persson on Telegraph.co.uk. “Dutch ratification of Merkel’s fiscal treaty and the permanent bail-out fund could be in jeopardy.” Similarly, if France now decides to oppose austerity, it could “tempt some peripheral sovereigns to break ranks”, says Gavan Nolan of market analysts Markit.
This would make Europe’s leadership look less united and coherent than it has for years, “and this at a time when weak leadership is something Europe can ill afford”, says The Times. Markets could also be rattled by an apparently weakening commitment to getting debt under control if austerity is put on the back burner, while further debt downgrades bode ill for confidence too. After all, “ratings agencies have become increasingly sensitive to political will and ability to enforce fiscal discipline”, says Markus Peters on Bondvigilantes.com.
Another possible consequence of mounting resistance to Germany’s austerity drive is that Germany becomes even less willing to bail out countries in trouble. What’s more, one or more southern countries on the periphery could well pull the plug on austerity, triggering a messy default. With political divisions threatening to increase the chances of a messy eurozone break-up, says Capital Economics, the crisis looks set to enter “a new, more dangerous phase”.