[Skip to Content]

Register to receive the OMFIF Daily Update and trial the OMFIF membership dashboard for a month.

* Required Fields

Member Area Login

Forgotten Password?

Forgotten password

Gruelling test for German diplomacy

Gruelling test for German diplomacy

UK downgrade with European repercussions
End nears for euro phoney war

by David Marsh

Mon 25 Feb 2013

Europe and the world are waiting uneasily for the result of a complex and difficult weekend Italian election.

The most likely outcome is a weak government reluctantly committed to economic reform, shored up by Europe's biggest creditor, Germany, and by the uncomfortable realisation that things could easily get worse.

Cyprus is preparing for a messy bailout next month after its own elections yesterday confirmed that the new president will be centre-right leader Nicos Anastasiades, an ally of Germany's chancellor Angela Merkel.

Merkel is girding herself for another round of French-led attempts to slacken austerity and 'buy time' (with German money) to heal the euro's seemingly never-ending travails.

The UK is digesting the political and economic fall-out of Friday's loss of Britain's vaunted Triple A status from the Moody's credit agency. The Germans will see the downgrade as a warning of what could happen to them. British politicians of all persuasions will blame it on the euro crisis.

Make no mistake about it. The seven-month 'phoney war' on financial markets since European Central Bank president Mario Draghi's famous, unscripted 'do whatever it takes' remarks on saving the euro is starting to come to an end.

Reflecting the diversity of its causes, the intractability of its symptoms and the impossibility of a solution, the euro imbroglio has a touch of the metaphysical. Leading German historian Prof. Michael Stürmer, warning that 'the worst is yet to come', last week in London termed the crisis 'a malaise in search of an expression.'

Whether or not the phoney war turns really brutal depends on the divisions in the Italian parliament after the poll that closes today. And on whether Paris decides to restart a campaign of aggression against German-ordained budgetary cuts now that France has abandoned attempts to meet its budgetary targets this year.

We will probably see a centre-left coalition led by Pierluigi Bersani, the Democrat party front-runner, possibly with the engagement of former prime minister Mario Monti. Strengthening the Bersani ranks with, say, a prominent figure from the Banca d'Italia would buttress a future government's credibility on financial markets.

Yet the parliamentary arithmetic holding such a coalition together would be anything but stable. And it would face virulent, unpredictable opposition from both the anti-establishment Five Star Movement and the centre-right of former prime minister Silvio Berlusconi and his Northern League allies.

Both these parties, likely to win a sizable minority of votes, take an adversarial line on Ms Merkel's austerity policies.

The task for German diplomacy in coming weeks will be gruelling. Berlin has to broker a deal with the Russians to extend funds to Cypriot banks as a condition for getting support from Germany's Social Democrat opposition party.

Simultaneously the Germans will have to gauge the strength of a potential Franco-Italian coalition against German policies. On one crucial point, French president François Hollande will agree with any new Italian prime minister: Berlin will have to give currency bloc members more time (and funding) to get borrowing under control or risk a euro conflagration.

A sign of fraying nerves is when ministers and officials start diverting responsibility for self-made ills. We saw it earlier this month when European economic commissioner Olli Rehn blamed the International Monetary Fund for stirring up a debate about whether budget cuts had worsened the euro downturn. Somewhat improbably, he claimed the IMF 'risked to erode the confidence that we have painstakingly built up over the past years in numerous late-night meetings.'

In similar vein, Arnaud Montebourg, France’s industry minister, uses an interview in the Financial Times today to accuse France's economic critics of peddling 'falsehoods'. He insists that France is 'a lot more open to foreign investors than the US and Germany' and stresses that the UK is in 'even bigger difficulty than France over its budget deficit'.

This echoes the end-2011 gripes of several prominent French economic personalities, including central bank governor Christian Noyer, that the UK's credit rating was being upheld while France's was under threat. Moody's British downgrade compounds the problems of UK chancellor of the exchequer George Osborne. In Paris it will elicit grim smiles.

Tell a friend View this page in PDF format