Europe – the sequel

Greek spreads now mean more to us than tzatziki.

The European Union emerged in the early 1990s as a French-German idea to bind the region after the unexpected collapse of the USSR. 20th century Europe had twice torn itself to shreds and a union seemed like a great way to bury the well-used hatchets. But the great coming together hasn’t worked as planned: Greek spreads now mean more to us than tzatziki.

Germany, disillusioned by its debt-happy neighbours, is no longer reserved about wielding its economic and political clout. Its hard line against the credit binge of the Club Med nations has won out and it is now reshaping the union.

European leaders (sans the Brits) have agreed on a new fiscal pact calling for tighter regional oversight of government spending. This is a good move; the euro crisis didn’t need more can kicking down Stimulus Road. It needed a long-term overhaul of membership rules.

These new structures will force errant borrowers to mend their ways. Then, with the EU’s fiscal future more certain, it’s hoped the European Central Bank will take a kinder view of the basket case countries, and start buying up their bonds. This should force down their yields and reduce the chances of a European implosion.

But we are not out of the woods yet. Expect the cold winds of a recessed Europe to buffet the global economy for another year or two. Down Under, this will translate into investment tentativeness, moths in consumer wallets and another nail in the coffin of Aussie manufacturing.

And how will this affect interest rates? Let me preface my thoughts by quoting John Kenneth Galbraith: “The purpose of economic forecasting is to make astrology look respectable”.

With that in mind, let’s have a crack: I reckon the RBA will move rates down until the middle of next year, settling around 1% less than current levels. The Bank will sit tight for a bit and then slowly nudge rates upward for the rest of the year. So put a lobster on the nose of a .25% rise on Melbourne Cup day 2012. But don’t hold me to it, I’m an Aquarian after all.

Andrew Pegler