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Eurozone Needs Reforms to Prevent Next Crisis

Deep differences remain between Berlin, Paris, and other eurozone members about whether a shared budget is necessary and what it should be used for if created
GDP growth in 2017 surged to its fastest pace in a decade at 2.5%, but institutional failings that caused and perpetuated the crisis remain unresolved.GDP growth in 2017 surged to its fastest pace in a decade at 2.5%, but institutional failings that caused and perpetuated the crisis remain unresolved.

The euro single currency area must shore itself up with reforms or face renewed threats of breakup when a new economic crisis strikes, a top European Central Bank official warned Friday.

“Even a small downturn could create large economic and social costs. It could, once again, test the cohesiveness of the currency union,” ECB board member Benoit Coeure told a conference in Ljubljana, Slovenia, AFP reported.

GDP growth in 2017 surged to its fastest pace in a decade at 2.5%, statistics agency Eurostat said this week. But “institutional failings that caused and perpetuated the crisis remain unresolved,” Coeure warned. “These are deep-rooted issues that cannot be resolved by a few years of above-trend growth.”

The French central banker outlined three “lines of defense” that policymakers should fortify to brace the eurozone against future shocks.

Financial and service industry markets should be more closely integrated across Europe to better absorb potential blows without calling on taxpayer funds, he said, while incentives for national governments to reform their economies while the sun is shining must be rethought.

Secondly, governments must create “fiscal space”—reducing spending to build up a financial buffer for bad times—while the European Stability Mechanism, cobbled together during the crisis to lend to stricken states, should have a broader mandate and be turned into a formal Brussels institution, Coeure continued.

Lastly, the eurozone “needs a fiscal instrument that can help it cope with large shocks without having to rely excessively on the ECB,” he added.

 Deep Differences Remain

President Emmanuel Macron of France has made creating a eurozone budget controlled by a common finance minister a key plank of his drive to reform the bloc.

And conservative German Chancellor Angela Merkel has sounded cautiously open to such plans as coalition talks come to a head with the center-left Social Democratic Party.

But there remain deep differences between Berlin, Paris, and other eurozone members about whether a shared budget is necessary or desirable and what it should be used for if created.

Coeure urged at least “visible progress on the first two” of his proposed lines of defense—in part to spare the ECB from the risk of overstepping its legal bounds.

It has set interest rates at historic lows and bought almost €2.3 trillion ($2.87 trillion) of government and corporate bonds, fulfilling central bank President Mario Draghi’s 2012 promise to do “whatever it takes” to safeguard the single currency.

“Although our actions were bold and unparalleled, we acted within our mandate,” Coeure said. “Without further reforms, the next crisis may well force the ECB to test the limits of its mandate.”

 Bond Yields Rise

Eurozone bond yields extended their rise on Friday after US payroll data indicated that annual wage growth in the world’s biggest economy was the strongest since 2009, Reuters reported.

US job growth surged in January and wages increased further, recording their largest annual gain in more than 8-1/2 years and bolstering expectations that inflation will rise this year as the labor market hits full employment.

Germany’s 10-year government bond yield, the benchmark for the eurozone, hit a day’s high of 0.768%, up 4 basis points on the day, before edging back to 0.757% in late trades.

The British 10-year government bond yield jumped to 1.609% after the data, its highest since May 2016, up 7 bps on the day, as March gilt futures extended losses. Meanwhile, the 10-year US Treasury yield rose to 2.854%, its highest in four years.

“There’s definitely a correlation between US and European bonds but it’s also important to remember the two regions have completely different dynamics,” said Mizuho strategist Antoine Bouvet. “We expect that eventually US Treasuries will underperform Bunds, and the spread between the two will widen further.”

The gap between US and German 10-year government bond yields, the “transatlantic spread”, widened a touch after the payroll data to 207 bps from 205 bps before, and is close to some of widest historical levels.

German Bund futures briefly dropped below a cash price of 158.00 for the first time since December 2015, before rising back up to 158.10; still down 51 ticks on the day.

 

 

 

 

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