Europe Crisis Is Not Over, May Lead to Fiscal Union, UBS Says
Europe’s debt crisis is “far from over” and the most likely outcome is closer fiscal ties among nations as officials seek to strengthen the region against future disasters, UBS AG analysts said.
“Euro area-wide policy measures announced and enacted in the last few months have already created fiscal transfer mechanisms,” UBS analysts Justin Knight and Andrew Rowan in London said in a report today. Proposals for a European Monetary Fund and more formal sanctions for budget-rule breaches “suggest Europe is already at least looking, if not moving, the way of fiscal union.”
The European Union set up a 750 billion-euro ($981 billion) package with the International Monetary Fund designed to combat a debt crisis triggered by Greece’s near default. The facility, which helped calm markets, included pledges by governments across the bloc to accelerate plans to reduce their budget gaps.
EU officials also proposed better coordination of draft national budgets. While this is “one of the key elements” toward fiscal union, opposition from some governments “demonstrates countries still have a long way to go when it comes to renouncing fiscal sovereignty,” Knight and Rowan said.
UBS examined scenarios where investor confidence in European bonds returns and where the 16-nation euro region breaks up. The analysts said the return of confidence is the outcome “in which we have the least confidence.” While the region is unlikely to fracture, the possibility is “not tiny,” they said.
“Fiscal union is the most likely scenario and, in the longer run, the only sustainable endgame,” they said.
Closer union should help narrow the yield spread between German bonds, Europe’s benchmark, and those of peripheral nations Greece, Spain and Portugal, the UBS analysts said.
“The two obvious strategies to employ in those circumstances are to buy the European periphery versus the core and sell German bonds versus interest rate swaps,” Knight and Rowan said. “However, as we expect the sovereign debt crisis to reach a more distressed level, these are not trades for now but for some point after that.”
To contact the reporter on this story: Fergal O’Brien in London at fobrien@bloomberg.net
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