June 10, 2012 / 7:02 PM / 5 years ago


* Obama working to nudge EU leaders into bold action

* Frustration mounts in Washington, fear too little too late

* Sets stage for tense G20 after Greek elections next week

By Stella Dawson

WASHINGTON, June 10 (Reuters) - Rarely have economists spent so much time poring over speeches and scrutinizing body language for hints on the direction of world markets and the economy, but these days politics trumps economics in setting the course of world growth.

Details of Spain’s request for European Union aid to recapitalize its banks and the results of fresh Greek elections next Sunday are foremost on the week’s agenda.

But there is a bigger issue at stake: the resolve of European leaders to act with sufficient boldness to convince financial markets they will fix the flaws in the monetary union.

Washington says this requires laying out a clear roadmap for deeper financial and fiscal integration for Europe, and there is a palpable sense that time is running out.

“With the stakes rising every day, we stand at a crossroads,” International Monetary Fund chief Christine Lagarde said in a speech on Friday calling for urgent action.

Many policymakers are growing increasingly concerned that Germany is not ready to lead Europe toward a deeper union, which would require a greater pooling of financial risk, sharing of debt costs and with it some loss of sovereign powers.

German Chancellor Angela Merkel showed a readiness to move forward last week, saying: “We need more Europe. We don’t only need monetary union, we also need a so-called fiscal union. And most of all we need a political union.”

But U.S. President Barack Obama, whose re-election in November could hinge on whether Europe rescues itself or its woes tip the world economy back into recession, is taking no chances. He used the bully pulpit of a news conference on Friday to apply fresh pressure to European leaders.

“The sooner they act, and the more decisive and concrete their actions, the sooner markets will regain confidence,” Obama said.

Already the economic damage is being felt. The United States reported last week that exports, an engine of its recovery, fell in April for the first time in five months, and investment banks are starting to mark down their global and U.S. growth forecasts.

“It’s political uncertainty. The worst-case scenario in Europe does not have to materialize, just the fear of it is enough to hurt growth,” said Michael Gapen, economist and market strategist at Barclays Capital.

His firm warned that risks to global growth are mounting, so too did Morgan Stanley and UniCredit. Barclays lowered its U.S. GDP forecast for the third and fourth quarters of this year from 3 percent to 2 percent and 2.5 percent, respectively, at a quarter-over-quarter annualized rate.

“Businesses are stalling their investments and the loss of stock market wealth is moderating the positive influence on consumers,” Gapen said.

China cut interest rates last week in a surprise move to counter a slowdown, which is greatly influenced by weak demand from Europe, its biggest trade partner.

Beijing is due to release fresh data early this week on May exports and industrial output, which economists say should show some improvement after a holiday-induced slowing and tighter financial conditions in prior months.

The Reuters forecast is for China’s output to expand by 9.9 percent year on year from 9.3 percent in April and for exports to pick up to 6.8 percent in May from 4.9 percent. Urban investment and loan growth figures, however, could slow, reflecting prior attempts to rein in speculation. Still, economists remain confident China will take all steps needed to deliver 8 percent GDP growth this year.


But so much depends on Europe.

The Obama administration is working overtime before a G20 summit of the world’s leading economies in Los Cabos, Mexico, next week to cajole EU leaders to stop a vicious cycle of half steps and fresh market turmoil.

Pessimism is spreading in Washington that they will deliver.

“Frustration arises from two factors. The speed has not been fast enough from Europe and the scope of the solutions has not gone far enough,” said Domenico Lombardi, a former International Monetary Fund official and now a senior fellow at the Brookings Institution.

“They are trying to put a Band-Aid on top of a gaping wound at the moment, but there has not been an approach to tackle the root cause,” he said.

Spain’s decision on Saturday to seek 100 billion euros ($125 billion) in EU aid to recapitalize its banks, more than twice the minimum recommended by the IMF, will quell immediate concerns.

But heading into Greek elections next Sunday, where the leftist anti-bailout party SYRIZA was leading in the final poll allowed on June 1, Morgan Stanley’s global head of economics Joachim Fels said that all Spain’s action might buy is some calm before the storm.

Spain’s recapitalization “hardly counts as a circuit breaker as it raises the Spanish government’s contingent liabilities,” he told clients.

In other words, lending money to a sovereign government to fix its banks when the country already is deeply in debt only makes its debt profile worse. So if a new bout of market volatility hits, especially if fears of Greece leaving the euro zone are reignited after the election, financing problems for Spain could worsen as well as, possibly, for Italy and even France.

Then major central banks, led by the Federal Reserve and the European Central Bank, which both signalled last week they were keeping their powder dry, likely would jump into the breach.

“It’s all about policy, twenty-four by seven,” said Vincent Reinhart, Morgan Stanley’s U.S. economist.

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