The twentieth anniversary of the creation of the ECB has coincided with the re-emergence of financial tensions in the Euro zone. According to Bankia Estudios, this makes clear that “the irreversability of the single currency will require advances the European project as ambitious as those that were necessary to create a central bank and a currency for the whole region”. If not, every time there is a financial crisis, whatever its origin, analysts add, “we again will see calculations of the probabilities that a country will leave the euro, with its subsequent impact on the fragmentation of markets and imposing responsibilities on an ECB which has often been at the limit of its competences.”
A few weeks ago we saw further proof of the inherent fragility of the project of European construction. In a single session 2 year Italian bonds rose more than 200 base points (the largest increase since 1992, during the crisis in the European exchange rate mechanism) in the lastest case of “flash crash” in the markets, while the risk premium climbed to above 300 base points. This impacted on yields in the whole periphery, including in Spain.
“It is true that this mini crisis occurred in a European Monetary Union with much more ammunition than in 2012 (OMT; QE etc). But Italy is not Greece or Portugal. The European Stability Mechanism has neither the firepower nor the governance structure to tackle a real crisis in Italy. The warning ought to be sufficient to secure more ambitious advances at the June Council than those on the table (mini European stablisation fund, sovereign bond-backed securities etc).
The “whatever it takes” worked in a given moment, but the markets will not always be so forgiving; especially when Anglo-Saxon academic institutions and financial agencies are again focusing on Europe.
Without a European asset (Eurobond) to execute monetary policy, the next crisis will be difficult to manage. And this would need a trade-off between mutualization and much clearer fiscal rules, something which seems difficult to achieve in the short term. Recent weeks have made clear that the markets think the European institutional architecture insufficient, even with all the advances of recent years, to tackle a new regional crisis.
Against this background, the increase in inflation in Europe (from 1.2% to 1.9% in May, well above the provisions of 1.5%/1.%) is significant. Most of the increase results from the increase in energy costs. But the underlying inflation has also increased to the highest level in the last 13 months (1.1% against 0.7%). This trend will be consolidated throughout the rest of the year, given the increases in wages in important countries and the reduced unemployment rates in the region (8.5% in April). All this will force a revision of predictions for inflation over the next few months. It will also encourage the ECB to normalise monetary policy towards the end of the year, something which the markets, for now, have not priced in.