Markets, not economy, make Europe's day

FINANCIAL markets have had good cause to celebrate Europe Day, but with the exception of Germany, eurozone economies have little to cheer.

The divergence of European financial asset prices and economies is worrying economists and market strategists, even as the European Union (EU) is forecasting a continuation of the upward momentum in business.

That said, the financial boom has improved animal spirits and Portugal has followed Ireland in saying that it no longer requires further bailouts.

Since the eurozone debt crisis of 2010, European bonds and stocks have staged a remarkable recovery. Greece, still mired in a steep recession and with an unemployment rate of 26.7 per cent, has been the best performer of all. Its stock market has soared 158 per cent since the crisis of 2010 and the yield on 10-year bonds has tumbled from 48.6 per cent to 6.2 per cent.

When bond yields fall, their prices rise, ensuring that yield-hungry European banks and international institutions, especially US fund managers, achieve exceptional gains in both stocks and bonds after the crisis. Italian and Spanish 10-year bond yields have fallen from more than 7 per cent in 2011 to around 3 per cent while their stock markets have since risen by 80 per cent and 74 per cent respectively.

The financial markets' take-off accelerated when European Central Bank (ECB) president Mario Draghi promised in the summer of 2012 that he would spare no effort to protect the euro.

The result was sizeable foreign capital inflows into bonds and stocks that boosted the euro by some 15 per cent from its lows against the US dollar. So much so that Mr Draghi now fears that the euro's appreciation against US, Asian and other currencies could crimp German, French, Italian and other exports, causing a nascent, uneven economic recovery to slip into a deflationary recession. The euro has hit a ceiling on expectations that the ECB and other central banks could intervene in the markets by selling euros, while forecasts of further interest rate cuts are underpinning bond and equity markets.

No doubt bailouts have helped, and Greece which has received 216 billion euros (S$375 billion) so far is entitled to a further 27 billion euros from the European rescue fund and the International Monetary Fund (IMF).

The proviso is that Greece and other bailout nations continue to carry out agreed austerity "reforms", notably major cuts in state spending and higher taxation to cut budget deficits as well as more flexible business and wage policies.

The big question is whether European bond yields can remain relatively low and stock markets high, despite low rates of central banks. According to Credit Agricole, the eurozone's aggregate government budget deficit could fall to 2.7 per cent this year from 3.1 per cent in 2013. But the bank estimates that eurozone member nations will still issue a hefty 947 billion euros of bonds this year.

The bulk of the bonds are replacements of redemptions and new issues are estimated to be 320 billion euros. But the supply of bonds could overwhelm demand if there are fears of a new crisis and eurozone economies defy predictions and deteriorate.

Despite the EU's forecasts that eurozone economic recovery is becoming more broad-based, the region is on a knife's edge. Germany has been leading the recovery, but its gross domestic product (GDP) in constant price terms is only 3.1 per cent above 2008 levels, prior to the global financial crisis. Its exports and productivity have helped boost the eurozone and the rest of Europe, but the strong euro, economic weakness in emerging markets and sanctions against Russia are causing German business people and economists to fret.

France is struggling and flirting with recession, while Italy, Ireland and Greece are still experiencing economic contraction with GDPs well down on the 2008 levels.

Hans-Werner Sinn, president of Germany's Ifo Institute, warned that another Greek or other eurozone crises could occur at an unexpected moment. He said Greece was on the verge of bankruptcy and would have been obliged to declare itself insolvent a long time ago if private credit had not been replaced by low-interest credit from European states. He also believes that the ECB, EU and IMF estimates of Greek growth are ''highly exaggerated''.

The European Commission's spring forecast points to a continuing economic recovery in the EU following its emergence from recession one year ago. Real GDP growth is set to reach 1.6 per cent in the EU and 1.2 per cent in the euro area in 2014, and to improve further in 2015 to 2 per cent and 1.7 per cent respectively.

Despite the rose-tinted spectacles of the financial community, the main worry in Europe, especially the eurozone, is the widening gap between the haves and have-nots. The number of unemployed stood at 25.7 million men and women in the 28-nation EU, of whom 18.9 million were in the eurozone.

Of these, 5.3 million are young people under the age of 25. The EU unemployment rate stands at a staggering 22.8 per cent and is more than 50 per cent in Spain and Greece.

Reflecting the failed economic policies of Europe, these statistics have given impetus to far-right parties ahead of the European elections.