Euro zone compromise no long-term answer

Here, Paul Brain, manager of the Newton Global Dynamic Bond Fund, considers the latest euro zone talks…

“As euro zone leaders meet this week for the EU summit, there is a degree of ‘meeting fatigue' given the history of disappointment over the past 18 months,” Brain said.

“However, this time around there does seem to be evidence of the important parties getting closer together. Indeed, the number of times that French President Nicolas Sarkozy and German Chancellor Angela Merkel have met in recent weeks has risen sharply.

“This can possibly be attributed to the sharp rise in French bond yields and the high profile and 'supposed' failure of the German Bund auction a couple of weeks ago – although the German auction process regularly leads to these failures and the Bundesbank mops ups any unwanted bonds – and a sense that the problems are closer to home than France and Germany had previously dared to recognise. Suddenly, a compromise seems viable.

“What form will this compromise take? The most likely agreement is a euro zone-wide agreement to enshrine fiscal discipline. This would allow the European Central Bank (ECB) to grease the wheels of economic recovery with greater liquidity injections, and would suit Germany as fiscal discipline would help ease the concerns of its electorate. Furthermore, it would confirm the ECB as the only authority with the unlimited resources to sort out the euro zone's problems. A further eurozone interest rate cut was confirmed [today], from 1.25% to 1%, and we now believe that it is now a matter of when, rather than if, the ECB switches on the money printers.

“Such action would most likely prompt a rally for risk assets, although this would probably be fairly short-lived. This is not a long-term answer; commitment to fiscal austerity does not boost the growth or competitiveness of those struggling euro zone states and their economies will remain highly vulnerable to recession in the meantime. The euro zone's struggling banking system will still be with us once the euphoria that will inevitably greet any agreement dies down and while this is certainly a step in the right direction, we do not believe that it is the answer.”