The risk of contagion from the European debt crisis is on the rise, and the outcome remains far from certain, says TD Economics
In a new report, TD notes that contagion pressures have increased, with fears of a default in Greece spreading to Italy. These rising pressures have, in turn, given way to leadership change in Europe, in both Greece and Italy, which TD says is a positive development “as the incoming politicians should have more scope to push through needed reforms. They are also viewed as technocrats that have backgrounds that hold greater promise for dealing with the fiscal challenges.”
However, it maintains that the outlook remains uncertain, particularly given the risk that the citizens of both countries are resisting fiscal austerity measures and economic reforms.
“The recent developments leave the end game for Europe still unclear,” TD concludes. “A default by Greece is inevitable, but that is old news now. The worry last month was about contagion, and the risks on this front have clearly intensified. European leadership still appears to be lacking.”
TD says the most likely scenario is that Europe “will continue to muddle along in a constant state of financial crisis”. It predicts the final outcome in Europe will be some form of a fiscal union and the launch of Eurobonds.
“If the political system cannot deliver this end game and conditions start to spiral out of control, the [European Central Bank] will step in and act as lender of last resort. This would arrest the financial crisis but also create a new set of economic and financial problems,” it concludes. “We’ve gone from a world of banks too big to fail, to a world of countries too big to fail. The implication is that three of the top financial themes will be volatility, volatility and more volatility.”