BR- AND GR-EXITS

Brexit takes center-stage

Cameron’s run for a second term, what’s next? After the landslide victory of the British Conservatives for the General Election, the national debate about the UK’s stance towards European Union is likely to be the centrepiece of Cameron’s second term, according (among others) to Gilles Merritt. Especially since European sceptics gained ground within his own majority, to whom he will have to pay more attention than he did under the coalition with Liberal Democrats according to Erik Nielsen from Unicredit. Reflecting on the UK election, Jeremie Cohen-Setton (Bruegel) looks at whether macroeconomic performance influences electoral success. Yet the UK is not in such a good economic shape as John Springford and Simon Tilford from CER remind, with weakened productivity growth, deteriorated infrastructures and housing supply deficiency. EU could crystallise Britons’ resentment.

Is a Brexit scenario really credible? Euro Intelligence bets on Brexit if Conservatives are unable to negotiate an agreement favourable to the UK terms within the European Union by 2016, namely further rebates on the UK’s financial contributions to EU’s budget. Erik Nielsen expresses a similar opinion assuring the Conservatives will successfully campaign for the UK’s exit. On the contrary, FT considers Britons’ renewed faith to Cameron gives him more authority to fight against Euro scepticism within his own majority—except on immigration.

What are the costs and consequences of Brexit? The outcome of the referendum, to be held by 2017, remains uncertain as Wolfgang Münchau reminds—especially as some EU economic or (geo)political initiatives may no longer be prevalent by then. In Project Syndicate, Carl Bildt highlights the economic and political costs of Brexit both for the UK and the EU. Both the Transatlantic trade and investment partnership and the perspectives of a digital Single Market are two key elements of EU’s rationale that could tip the balance in the UK’s referendum.

Alberto Gallo (RBS) looks at the risks of Brexit. Cameron hopes to renegotiate Britain’s membership terms in seven ways, according to his article in the Telegraph, and would campaign to remain inside a reformed EU: (1) controls to stop “vast migrations” from new EU members; (2) restricted access to benefits for EU migrants; (3) an opt-out from an “ever closer union”; (4) safeguards so that the Eurozone cannot impose changes in the single market on non-Eurozone members; (5) greater powers for national parliaments to block EU legislation; (6) less red tape and “excessive interference” from the EU for businesses, and more free trade deals with the Americas and Asia; and (7) no “unnecessary interference” from the European Court of Human Rights.” For Gallo, Cameron’s intention to bring forward the referendum to 2016 reveals that he expects to be able to extract few meaningful concessions from European partners, notably on freedom of movement (FT). For Gallo, Brexit would pose serious risks to the UK economy by endangering its status as Europe’s finance and services hub and weakening its ties to its largest trading partners: 54% of UK trade in 2013 was conducted with EU members. Moreover, the UK is heavily dependent on inflows of overseas capital to finance its 5.5% GDP current account deficit.

Grexit stifling the Eurozone recovery

Recovery in the eurozone. BarCap and Nomura reports that eurozone GDP expanded 0.4% qoq in Q1, a better-than-expected outcome and the largest quarterly increase in GDP since Q2 13—with France and Italy performing better than expected, while Greece is in recession (FT). Positive contributions came from domestic demand, while foreign trade had a negative impact on economic growth. Rather than boosting demand for labour, the rebound in economic activity has benefited productivity. Goldman Sachs (among others) notes that the recovery is broad-based across the Euro area. Martina von Terzi (Unicredit) suggests that easing credit conditions in the periphery will keep supporting steady, above-potential expansion at a pace of approximately 1.5-2% annualized. The EC released a package of Country-Specific Recommendations (CSRs) and its recommendations on the Excessive Deficit Procedure (EDP) and the Macroeconomic Imbalance Procedure (MIP) for all EU countries, as part of the European Semester. The EDP highlights the poor performance of the UK and Finland in terms of fiscal effort, while France and Italy are moving in the right directions.

With unchanged headwinds. Risks associated with Grexit and prolonged deflationary pressures continue to cloud the eurozone recovery. Although the Eurozone crisis left deep scars, the monetary union is not a source of downside risks anymore according to Angel Ubide from Peterson Institute. Nevertheless further consensus is to be reached between Germany’s savings mantra and the rest of Eurozone country members’ appeal for investment stimulus. Healing sustainably Eurozone’s wounds requires a more flexible institutional framework according to Portugal’s Secretary of State for Europe : tackling political fragmentation, furthering the Single Market, better coordinating economic policy-making.

Different views on Grexit. For ECB’s Vice-President Constancio, the “worse-case scenario” (Grexit) will be avoided, and contagion limited. Peter Spiegel (FT) is more pessimistic, and suggests that negotiations for a third programme could jeopardize Greeks’ national union: with stronger demands in terms of reforms in a reduced timespan. Euro Intelligence takes a similar stance, detailing with Macropolis a range of measures that would help Greece achieve primary surplus targets (e.g., a unified VAT rate and extraordinary levies). Clear reform commitment is paramount after the ECB increased further the ELA ceiling by € 2bn while keeping collateral haircuts unchanged. Financing remains a key issue—the government, according to Greek Reporter, seems to prefer relying on unconditional sources of liquidity via Treasury-bills emissions, yet still complies with its obligations (a €750m official order was made to the IMF on May 11). In Project Syndicate, Alexis Tsipras argues that negotiations are deadlocked because of a lack of common vision about Greece’s sustainable path out of the vicious debt circle. According to him, the Troïka’s concern about conditionality attached to new liquidity is pointless as no reforms can be undertaken unless Greece has financial means to unleash its economic potential in areas such as “productive investment, credit provision, innovation, competition […] and social security”.

On the inevitability of austerity measures. Simon Wren-Lewis in Mainly Macro acknowledged Greece’s partial default was not sufficient to lift it out of recession. He therefore calls for more debt write-off before any additional lending—reiterating, like Krugman, the view that austerity measures have been counterproductive. Beyond Greece’s fate, Barry Eichengreen highlights that the Eurozone’s recent economic performance stems from a pause in austerity plans. Whether austerity was needed in 2010 is still a vivid issue among economists: in Long and Variable, Tony Yates points to financial markets agitation to which austerity was seen as the only viable response. Simon Wren-Lewis suggests however that the ECB’s “whatever it takes” pledge would have been enough to calm financial actors. Eric Lonergan follows the same argument, arguing the 2010 turbulent episode was first and foremost a monetary issue.

Deflationary pressures and decline in interest rates. Proposing a historical perspective, Borio and al. demonstrate that deflation may have a two-fold impact on economic growth: (i) negative on output and feed unemployment, but also (ii) positive through lower prices and higher real incomes—and find that there is no strong evidence for either impacts. The perspectives for the Eurozone may not be that gloomy in the context of deflationary pressures. European Commission’s release on unemployment rate seems to confirm this view with a declining trend. The impact on real interest rates matters. Guntram Wolff (Bruegel) refutes that recent drops in interest rates are due to the QE program. The long-term decline in interest rates advanced economies is now amplified by both the fall in inflation and real returns. Downward revisions of long-term growth rates explain the waning of real interest rates.