Euro zone: Contagion Fears

Consensus Forecasts

The euro has tumbled over the past two months, as a radical EU response to another economic crisis in the region raised doubts about the future of the currency. A last minute deal was secured between Brussels and Nicosia to starve off a collapse of the Cypriot economy and keep it in the euro zone. However, investors have been shaken by concerns that the haircuts imposed on bank deposits and subsequent capital controls will set a precedent for future bailouts. In addition, Cyprus faces a Greek-style recession, which threatens to worsen the debt situation. Bond yields in Spain and Italy have inched higher due to the spread of financial uncertainty and capital flight from euro zone banks in general. A political deadlock in the latter underlines the surge in anti-austerity sentiment, fuelling pessimism about the ability of political leaders to accept German-centred reforms. Significant unease now surrounds prospects for a banking union, which is seen as crucial for the survival of the euro. A series of negative indicators for Q1 (notably in the periphery) has put pressure on the European Central Bank to cut interest rates, held at 0.75% last week. However, monetary loosening would only provide temporary support and will not remedy economic imbalances in the region. Latest forecasts suggest that only a few northern euro zone countries will avoid contraction in 2013, while the growth outlook for 2014 is dim.

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