Worse Euro Crisis Needed for Germany to Yield: Tom Keene

July 25 (Bloomberg) -- Europe won’t be able to resolve its debt crisis until the economy worsens, pushing Germany to allow support for Spain and Italy, said Julian Callow, chief international economist at Barclays Plc in London.

“We’re going to see Spain and Italy arguing more and more forcefully to Germany that the current strategy is not working,” Callow said today in a radio interview on “Bloomberg Surveillance” with Tom Keene. “These economies are just sinking here, putting the pressure on Germany.”

German Chancellor Angela Merkel’s ability to offer support to other European nations may be curbed by voter opposition before federal elections in Europe’s largest economy next year, Callow said. A worsening economic outlook would increase pressure for action, he said.

“It only really gets addressed as the economy gets worse and worse, and, moreover, as the pressures build up,” Callow said. “There’s an election in Germany scheduled for September next year and Chancellor Merkel has her eye on that.”

He said German public opinion is “turning quite significantly against” providing more financing.

Europe’s debt crisis intensified this week as Moody’s Investors Service cut the outlooks on the Aaa credit ratings of Germany, the Netherlands and Luxembourg to negative.

Euro Exit

The risk that Greece will leave the euro area and “increasing likelihood” of collective support for countries in debt such as Spain and Italy were among reasons for the change, Moody’s said in a statement on July 23.

Spain’s two-year note yield fell from a euro-era record after European Central Bank council member Ewald Nowotny said there are arguments in favor of giving the European Stability Mechanism, the permanent bailout fund, a banking license. Callow did not predict that the ECB will support Nowotny’s proposal under current conditions.

“The ECB has made it very plain,” Callow said. “Its interpretation of the EU Treaty is that it’s not authorized to be able to lend to this new fund, the ESM.”

Granting a banking license to Europe’s permanent bailout fund would give it access to ECB lending, easing concerns that its 500 billion-euro ($608 billion) cash pot won’t be enough if Spain or Italy requires aid. Callow said that Chancellor Merkel would have to find a way to give an opinion or revise the treaty if the banking license were to come to fruition.

“That, therefore, is going to be some way off,” he said.

To contact the reporters on this story: Caroline Fairchild in New York at cfairchild2@bloomberg.net; Tom Keene in New York at tkeene@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net