Eurozone debt crisis 'remains biggest investment risk'

December 2011

The biggest threat to investors remains the eurozone debt crisis, says an expert, following a tumultuous few weeks in which Greece warned it may have to leave the single currency and Italy faced a near-unsustainable cost of borrowing.

The debt crisis threatening to break up the eurozone and send it into a deep recession remains the biggest risk factor for investors during the early stages of 2012, an expert has warned, in a week that saw Greece look increasingly uncertain about its place in the single currency and manufacturing levels drop to their lowest levels since the middle of 2009.

Percival Stanion, head of asset allocation at Barings, said the uncertain outlook for the next 12 months meant outcomes could range from disastrous to safe as the sovereign fallout continues to weigh heavily on the financial world. Although many agree that a double-dip recession across the globe is unlikely to develop, there could be "sudden swings in investor sentiment" due to ongoing economic troubles and potentially "messy consequences".

Primarily, the main threat stemming from the eurozone debt crisis is the impact it will have on the banking sector and general credit availability, Mr Stanion said.

He added: "We expect European leaders to do enough to stave off a collapse of the banking sector, but the fiscal squeeze will continue and recession in Europe and the UK now looks certain." Mr Stanion went on to suggest the potential for France to hit troublesome times during 2012 - despite the much-publicised crashes experienced by the likes of Greece and, potentially, Italy. "France's government does not have the mechanism to buy French sovereign bonds, in effect becoming little more than a local authority at the mercy of the European Central Bank," he remarked. But while Greece's position as one of the 17 member states is in doubt, the core of the single currency is likely to stay together for at least another year, Barings believes - and even if weaker parts drop off, the group will not see any dramatically negative outcomes. Regardless, Mr Stanion concluded, it is likely that the technocratic governments of Italy and Greece will soon be replaced.

His comments also sit alongside figures for December 2011 showing that annual inflation for the euro area is expected to be 2.8 per cent down from three per cent a month prior, the European Union's statistics office Eurostat said. This is still above the two per cent target, but it is forecast to ease as the bloc's debt problems weaken growth. In addition, the European Central Bank (ECB) appears to be keeping interest rates at one per cent for the time being to give the economy a boost. And according to some analysts, the Bank may cut it even further. James Ashley of RBC Capital Markets said he thinks there is room to slash it by another 0.5 per cent, while the majority of a group of economists polled by Reuters also think it will drop below the one per cent mark in the next few months.

Experts are wondering, however, about the potential reasons why commercial banks placed a record amount of cash with the ECB on Tuesday (January 3rd) given that it only pays overnight interest of 0.25 per cent - considerably less than the 0.396 per cent they could achieve in the eurozone interbank market. A total of €453 billion (£375 billion) was placed in the lender's holding area, following last month's surge in withdrawals of some €489 billion - another all-time high and seemingly a response to the Bank's decision to make cheap cash available across the eurozone. But it is widely thought the decision to park money with the ECB was made because institutions are rapidly losing confidence and trust in each other - and this, combined with data showing that emergency overnight borrowing remained at €15 billion, is enough to provoke deep concern in investors.

BCG Partners markets analyst Louise Cooper told the Guardian: "Central banks are having to fund banks themselves because so many credit, wholesale and rates markets are not functioning normally and it is getting worse […] This shows how much fear there is still in the wholesale markets."

In addition, Credit Agricole analyst Orlando Green was quoted by the Wall Street Journal as saying that banks are awaiting "clarity" on efforts the eurozone will make to solve its debt problems and therefore this is why there is more cash at the ECB, while Berenberg Bank's Christian Schulz said such uncertainty means the Bank's deposit capacity will stay "extremely" high for a lot longer. Moreover, recession is strongly suspected by many to be on the horizon for the single currency, given recent statistics showing that manufacturing growth in the eurozone slowed to its weakest point last month in over two years. Markit's purchasing managers' index found that although figures were up from November 2011 and declined at a slower rate than in months prior, they were still highly suggestive of a forthcoming economic downturn.

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