The Telegraph: The eurozone is just one crisis away from a hell of its own

‘I’ve been wondering what that special place in hell looks like,” said Donald Tusk last week, “for those who promoted Brexit”.

Many who did soon expressed anger at such provocative language from the president of the European Council. Tusk’s words were “disgraceful” and “spiteful”, said Commons leader Andrea Leadsom, the first of several cabinet Brexiteers to respond.

The Prime Minister was more measured – and so more cutting. “It is a question for Mr Tusk,” said a statement from Downing Street, “whether he considers the use of that kind of language helpful”.

The best comeback I saw, though, was from Yanis Varoufakis. Tusk’s “special place in hell”, tweeted the former Greek finance minister, “looks probably very similar to that reserved for those who designed a monetary union without a proper banking union and, once the banking crisis hit, cynically transferred the bankers’ gigantic losses onto the shoulders of the weakest taxpayers”.

Yaroufakis shot to prominence while boldly negotiating with Brussels and the International Monetary Fund over the terms of the multi-billion-euro Greek bail-out. Athens had been rescued, of course, in the aftermath of the eurozone crisis of 2011 and 2012, which exposed the deep structural flaws at the heart of monetary union.

That crisis happened after a period of stagnating growth further weakened the already ropy balance sheets of some eurozone governments and countless banks. Bond yields in weaker member states then spiked, compounding their problems amid crippling borrowing costs.

Wealthier members, particularly Germany, came under huge pressure to provide support, with all the related political tensions, to stop the single currency falling apart. Are we on the brink of another crisis, then, as the eurozone stalls once more?

Last week, the European Commission warned eurozone growth will slow to 1.3pc this year, down from 1.9pc in 2018. Only in November, Brussels forecast last year’s growth rate would be maintained into 2019. So this is a very abrupt downgrade – and there could be more to come.

The eurozone’s services sector output plunged in January to a five-and-a-half year low, with France reporting a second successive monthly contraction. In Italy, too, now in full recession, the entire economy shrinking for two successive quarters, the service sector just endured a further steep fall in activity.

Investor sentiment across the eurozone is at a four-year low, with Germany’s confidence index down for six consecutive months, at its weakest since August 2012 – amid concerns over export demand. Deutsche Bank says the eurozone’s largest economy is “drifting towards recession” – and, with German industrial production down 3.2pc during the second half of 2018, the sharpest contraction since the Lehman crisis, it’s probably already there.

The IMF expects the UK to grow 1.5pc this year, only marginally faster than the eurozone. There are two fundamental differences, though, between the outlook for the British economy and that of the single currency bloc.

The first is that, while the Bank of England reined in its use of quantitative easing years ago, the eurozone is still heavily reliant on the European Central Bank’s “extraordinary monetary measures”.

Since the 2008 crisis, as eurozone authorities have created virtual money to buy otherwise unwanted government and corporate bonds, the ECB’s balance sheet has expanded fourfold – and is now 30pc bigger than that of the Federal Reserve, despite the eurozone economy being 25pc smaller than the US. The UK base rate is still low, at 0.75pc, but ECB nominal rates are minus 0.4pc – deep in Alice in Wonderland territory.

Wildly expansive monetary policy is hugely unpopular in Germany, where negative rates rile the nation’s army of savers and QE plays on the country’s ingrained neurosis against sudden inflation. As such, Euro-QE was supposed to end last month.

Yet it’s still happening. The ECB bought €3.3bn (£2.9bn) of Italian debt in January, the fine-print shows, and €2.5bn of French securities. This “extra time” QE won’t end soon and is in addition to the explosion over recent years of so-called “Target 2 balances” – secretive credit transfers to weaker eurozone members via the ECB.

This system owes Germany almost €1,000bn, while Italy alone has Target 2 liabilities approaching €500bn – on top of official government debt exceeding 130pc of GDP. The gap between the yield on Italian and German 10-year government bonds – a measure of concern the eurozone could collapse – rose above 330 basis points late last year and is still around 270. A spread of this size, outside a fully blown crisis, is deeply alarming. And it’s only being kept in check by the ECB carrying on with QE, despite claims to the contrary.

The other worrying feature about the eurozone economy is the extraordinarily uneven spread of growth across the region. From the Sixties onward, living standards within nations that went on to establish the single currency were broadly converging. Yet since the euro was formed in 1999, a gap has re-emerged.

Average per capita incomes among “southern” eurozone members are now just 75pc of their “northern” counterparts, down from almost 90pc in the early 2000s – reflecting how the uniform exchange rate has boosted competitive nations, while hammering others. That’s why youth unemployment is over 30pc in Spain and Italy and almost 40pc in Greece but just 5pc in Germany. The UK has regional inequality, yes, but not on this scale – because, as one country, we have a tax and benefit system that facilitates massive regional transfers.

Across the eurozone, bank share prices remain some 80pc below their 2008 peak, reflecting the slew of bad loans still smouldering on their balance sheets. During 2019, the Italian government, at loggerheads with Germany, must roll over €400bn of debt, equivalent to 25pc of GDP. The IMF now warns Italy risks a crisis that could “push global markets into uncharted territory”.

As these Brexit negotiations drag on, it’s worth remembering one fundamental truth. The eurozone is an unsustainable construct – just one bad election, one geopolitical event, one sovereign downgrade, one eurozone bond crisis away from a “hell” of its own. That’s why the UK’s negotiating position is so much stronger than the mainstream narrative suggests.

Click here to read the piece in full.

sign up to our Newsletter