Of course, one of the more remarkable aspects of the past week has been the resilience of the euro in the face of the underlying developments of the sovereign debt crisis. This could well be repeated later today when Ireland publishes the results of the latest stress tests on its banking sector, where nationalisation of two more institutions appears likely. But what are worrying are the self-destructive forces that are now at play, which stem from the weak incentives and structures required to reach any lasting or binding agreements at the pan-eurozone level.
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Germany is digging its heels in on the European Stability Mechanism (ESM) but, by doing so, it is putting more of the funding pressure on the periphery after 2013 and increasing the likelihood of bail-outs. Meanwhile, by refusing to call for outside help, Portugal is increasing the likelihood of debt restructuring further down the line. And finally, by raising rates, the ECB is putting greater pressure on those nations currently suffering the most, given that the average maturity of their debt is the shortest within the periphery.
So, if things are this bad, why is the euro not suffering more? For now, it appears to be down to the interest rate story. The ECB’s apparent determination to increase interest rates, likely as early as next month, appears to be one of the more dominant factors. Furthermore, to be fair, some countries have done fairly well in delivering fiscal consolidation, which is one of the reasons why Spain has managed to decouple from Portugal over the past couple of weeks. Nevertheless, there are some strong undercurrents beneath the euro that look set to keep investors on edge in the coming days and weeks.
Simon Smith, Chief Economist
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