Europe is on the cusp of a major market blowout
The political crisis in Spain over Catalan secession is a reminder to investors never to underestimate Europe’s ability to shock global markets
It is the stuff of a central banker’s worst nightmares, when all seems to be going too well and there is the spectre of a dark force lurking in the shadows waiting to pounce. Europe has already had its fill of shock horror during the worst of the post-2008 financial crash, but policymakers could be waking up to a new fright-fest of deadly dangers in the very near future.
European growth may be getting back onto a firmer footing, employment conditions may be improving and stock and credit markets are still partying hard, but that is a smokescreen hiding serious fault-lines that pose material threats to the continent’s future security. Some of these tensions are already bubbling to the surface and Europe’s leaders and vulnerable investors need to pay more than lip service to them.
The political debacle in Spain over the Catalan region suing for future independence is a reminder to investors that they should never underestimate Europe’s capability to shock global markets in a big way. Catalonia may only be a small part of the European Union but it is a microcosm of the bigger problem Europe faces: numerous nations, with diverse cultures and peoples, being forced into a standardised lump.
The dream of European leaders looking for closer integration and stronger unification may be a bold vision for some, but for many others the idea of being shunted into a generic federation is anathema. Catalonia is not an isolated case. Scotland wishing to break away from the UK, and Britain looking to disconnect itself from Europe are symptoms of a multi-faceted Europe seeking to protect identity, culture and diversity.
Spain has gone so far down the road towards granting autonomy to its regions, but acceding to Catalan hopes for complete independence is a step too far for the government in Madrid. It would not only set a precedent for Basque separatists in Northern Spain, but encourage similar movements in other parts of Europe. Demands from the anti-euro Northern Leagues for a separate state in Italy have gone quiet in recent years, but still have the propensity to unsettle markets if grievances start to mount again.
Populist movements in Europe seem to have been keeping their heads beneath the parapet in recent months, in no small part because of the economic recovery and the downward drift in unemployment rates, especially for disaffected young people in the 18-25 age group. The European Central Bank’s provision of ultra-low interest rates seems to have done the trick, keeping consumer confidence high and providing a steady flood of new jobs flowing into the economy. The hope is that it will last.
If keeping the economy well lubricated with easy money and fostering a sense of well-being among consumers are keys to maintaining the peace, then Europe could be heading for crunch-time in the next few months as the ECB mulls the best time to start winding down its policy super-stimulus. With hard-line Germany and the more prosperous northern European nations looking for an early lockdown on easy rates and cheap money, tensions look set to rise again soon.
Germany may be worrying about the inflationary consequences of loose monetary policy ahead, but the weaker economies will want to keep their reflation coffers primed with as much quantitative easing funds for as long as possible. The risks of higher inflation must be weighed up against the consequences of slower growth and the jobless rate popping up again. Keeping social discontent at bay is paramount.
Policymakers will have their work cut out. Slowing down the ECB’s imminent policy taper is plausible, but Spain’s impending Catalan crisis has a long way to run and could turn nasty. Political instability could have dire consequences for European financial markets, and investors should buckle down for a bumpy ride ahead if political pressures mount.
So far, the impact on financial markets has been limited, with the benchmark 10-year Spain-Germany government yield spread widening to 122 basis points from 95 basis in July, well below this year’s 150 basis-point high. The cost of credit default cover for Spain is still low compared to the worst point of the European crisis in 2012 but it’s already starting to surge.
European markets are still enjoying a heady sense of euphoria, which makes them especially prone to a sudden downturn in sentiment. If Spain’s problems boil over, contagion effects will spread far and wide. Investors have had their warning and extreme caution is advised.
David Brown is chief executive of New View Economics