A year ago, the crisis in the eurozone had got so bad that European Central Bank president Mario Draghi was forced to declare ‘the ECB is ready to do whatever it takes to preserve the euro’.
One year on, the concerted efforts of the ECB and other European regulators and central banks have indeed managed to put a lid on the crisis, government bond yields have subsided to manageable levels and European equity markets have more than recovered the ground they lost in the first half of 2012.
The MSCI Europe index is up almost 25 per cent in the year to 7 August and this increases to 32 per cent over the two years to this date.
Looking at government bonds, there has been similar improvement, with the yield on 10 year Spanish government debt falling from 6.87 per cent on 8 August 2012 to 4.57 per cent on 7 August this year. Portuguese 10 year government debt is now offering yields of 6.5 per cent but this is a substantial reduction of the 10.2 per cent it hit at the beginning of August 2012.
Schroders European economist Azad Zangana says: “Although investors still demand a significant premium for holding Spanish and Italian debt compared to for example Germany, the sharp fall in borrowing costs has been key to the restoration of investors’ confidence in the ability of the ECB to manage the monetary system.”
But have the problems that plagued Europe really receded in the past year or have they simply been overshadowed by Japan’s latest attempt at economic revival and the positive news from the US?
Allianz Global Investors chief investment officer for Europe Neil Dwane says: “When it comes to the headlines it seems that Europe has taken a back seat to the Japan monetary experiment, the potential tapering of the US asset purchase programme as well as the crises in Syria and the Middle East. Despite this, Europe is hitting the news for more positive reasons; it is making progress, albeit slow progress, on many fronts, and the recovery is coming.”
One of the problems that investors were concerned with last year was political instability in Europe, with Greece, Portugal and Italy all ending up with uneasy coalition governments that many doubted would be able to stick to the austerity plans that they were forced to sign up to.
These concerns are still around but it is perhaps an indication of how different things are now that political problems in Portugal and Italy this summer have had very little effect on investor sentiment towards the eurozone.
In early July, Portuguese foreign minister Paulo Portas resigned in protest at the governments ongoing austerity programme and as a leader of the minority coalition party his action threatened to bring down the government and force new elections.
Similarly, former Italian prime minister Silvio Berlusconi’s conviction for tax fraud also looked likely to force Italy in to a fresh round of elections as he briefly threatened to withdraw his party’s support for the coalition government in protest.
Although both mini-crises were quickly resolved – Portas has since been appointed deputy prime minister and Berlusconi has withdrawn his threat – but the lack of impact in the markets shows how far the panic about Europe’s economic future has receded.
Henderson Global Investors director of European equities Tim Stevenson says there is a growing realisation amongst the public and politicians that there is no real alternative to austerity.
He cites the collapse of support for the Italian protest party led by comedian Beppe Grillo in this year’s local elections as one example that the public is aware of the lack of any alternative. In February’s general election the party attracted 25 per cent of the vote but its support was down to single figures in the local elections last month.
Stevenson says: “There isn’t actually an alternative. People realise that we have done perhaps 8/10ths or 7/10ths of the work and to get out now would be totally wrong.”
The other significant cloud on the horizon is the German general election to be held on 22 September.
Although Angel Merkel and her Christian Democratic Party is comfortably ahead in the polls, the fly in the ointment is the fate of the junior coalition party, the Free Democratic Party. The FDP has seen its support collapse in recent months to just 4 per cent, according to recent opinion polls. Under the German electoral system, any party with less than 5 per cent of the vote is discounted from the election and gets no representatives in to parliament – a result that could force Merkel to form a grand coalition.
But again the markets have seen untroubled by the potential for a political banana skin in Germany.
Perhaps surprisingly, given the growing opposition to Germany having to foot a large part of the cost of the bailout, austerity and the cost of sustaining the eurozone has not been a big feature of the German election campaign. Stevenson describes a recent front page headline in a prominent German newspaper which read “The crisis that everyone is keeping quiet about”.
Dwane points out that it is not just Germany that has been downplaying the issue of austerity.
He says: “The EU has made the decision to soft-pedal on current and future austerity. This has lowered the political tensions ahead of the German elections in September. As a result we can expect the improved chance of less negative, not necessarily good, economic growth. Europe, unlike other headline makers, has seen political calm even within the carefully-balanced coalition in Italy.”
The growing consensus that Europe’s political leaders are heading in the right direction is backed up by the first positive economic data.
Last week’s Markit eurozone Composite Purchasing Managers’ index tipped into positive territory and gave a strong indication that after six months of contraction the eurozone is about to move out of recession.
Zangana says: “The economy is on the right path a year on from Draghi’s promise to do “whatever it takes”, however, more can certainly be done to help boost growth and ease the path of reform including extending the transition period of banks, and not forcing them to reform any faster or further than their international competitors.”
However, Stevenson says while the economic data is encouraging we should not read too much into them: “The latest economic numbers are good to see but we shouldn’t get too carried away.”