EU watch: At the end of the day it is all about domestic politics…
When push comes to shove in the European Union it is all about domestic politics and EU cooperation becomes harder. The latest Ifo readings coming out of Germany have business expectations over the next 6 months taking a turn for the worse after 6 strong months where sentiment had been improving. Add to that the poor retail sales and PMI numbers and of course, GDP pointing towards recession. The deeper Germany along with the rest of the EZ gets into an economic contraction – the more we expect political fragmentation to pick up. We see a likely scenario where Germany must make the hard choice of lending a helping hand to the peripheral EZ countries or to Herr Müller in Lower Saxony.
We have talked about how heavily indebted EZ countries will find it difficult to rely upon the ECB as the marginal buyer of Italian debt and looking at Germany there isn’t a lot of help to find there either. The easiest choice would be common debt issuance ala the 2020 Covid debt but the famous ‘Schwarze Null’, a German economy in contraction and internal pressures come in the way. Germany has a well-established tradition of frugality and in a scenario where the ECB permits the widening of spreads, thereby increasing pressure on Italy’s public finances – Germany would face a challenge in assuming the role of the lender of last resort. This responsibility would present a significant and burdensome task for Germany, as it goes against its deeply ingrained principles of fiscal prudence.Add to that the official technical recession and a bleak economic outlook where Germany certainly will have their own hands full which will add pressure on the likes of Italy et all.