This weekend is a big one in the eurozone saga, with both the second round of the French presidential election and Greece’s parliamentary elections.
In both we are likely to see a vote against austerity and, by implication, eurozone bailout plans. It could be make or break.
And yet the markets have been eerily and surprisingly calm, with no repeat of the kind of panic we saw last autumn, either in eurozone sovereign debt markets or currencies. The European Central Bank, which decamped to Barcelona for its regular meeting last week, sat on its hands.
Markets reacted adversely to the first round of the French presidential elections but that passed. What about this time?
The key question, assuming the polls are right and Nicolas Sarkozy is replaced by Francois Hollande as French president is what kind of relationship he strikes up with Angela Merkel, the German chancellor. Will the end of “Merkozy” be followed by a Paris-Berlin stand-off?
I suspect not. Some of Hollande’s pre-election bark, even his tax plans, may be worse than his bite. When he talks about reorientating the eurozone towards growth, he is reviving a familiar argument.
The eurozone, you may remember, was originally governed by a stability and growth pact, though today there is not much of either. The Germans insisted on stability, fiscal discipline, while France pushed for growth as well, to avoid the eurozone turning into an austerity zone.
Despite apparent differences now, it is likely Merkel and Hollande will find a way of working together. It is also likely that there will be enough figleaves for the new French president in growth-friendly measures built around infrastructure measures and job-creation schemes. Hollande wants to rock the euro boat but not make it sink.
A potentially bigger risk comes from Greece. Holger Schmieding, chief economist at Berenberg Bank, sees a 40% chance of a Greek euro exit this year because of what he describes as “austerity fatigue in Greece or donor fatigue in Berlin”.
A Greek exit, should it occur, would eventually be good for Greece and remaining eurozone members, Getting there, however, without triggering a domino effect, and without a hugely damaging impact of the banking system, is the difficult part.
So, as it has been for two years, the eurozone remains the key global economic threat. It is back in proper recession and eurozone unemployment, at 10.9% (22.1% for young people), is at record levels.
My sense is that while we will see a strong vote against austerity this weekend, this is not yet the pivotal moment. Such are the eurozone’s problems, and so far are we from a permanent solution, that those who vote against austerity in the belief that their lives will be immediately transformed are bound to be disappointed.
How does this feed back to Britain? There are two routes. One is that today’s elections will usher in a period of renewed instability in the eurozone which will further undermine Britain’s recovery.
That could happen directly. Already the volume of exports to the rest of the European Union is down 3.3% in the latest three months compared with a year earlier, compared with 1.7% growth over the same period in exports to non-EU countries.
Or it could happen indirectly. The main effects of the eurozone crisis have been in the financial system, adversely affecting the cost and availability of funding.
This effect, pronounced in the second half of last year, was reversed by the European Central Bank’s ¤1 trillion long-term refinancing operation (LTRO), launched in December. There are signs this is wearing off. Many home-owners are receiving news of mortgage rate hikes, even with official interest rates unchanged.
The other effect is on confidence, particularly among businesses that part of the weakness in business investment due to eurozone uncertainty.
That brings me on to the second route from the eurozone to Britain? Is anti-austerity catching, and could it force the coalition to relax or abandon its fiscal strategy?
The government is suffering serious mid-term blues, as shown by Thursday’s council elections and the opinion polls. Austerity is unpopular and Labour leads the polls.
Interestingly, however, if we take our own YouGov polling, voters are not yet ready to trust Labour again with the economy. David Cameron and George Osborne still enjoy a lead of several points over Ed Balls and Ed Miliband on this key question of trust in running the economy.
Only when Labour is decisively ahead on this, as after the Tories’ ERM (exchange rate mechanism) debacle in September 1992 should the coalition get really worried.
In the meantime, ministers need to do better explaining. Most people. I find, are ready to accept that the economy’s weak growth is entirely due to “the cuts”.
Official figures suggest otherwise. We do not yet have the detail for the first quarter, but gross domestic product numbers for the end of 2011 show government spending grew 0.5% in real terms compared with the final three months of 2010, following growth of 0.8% over the course of 2010.
The picture is a bit more complicated because the coalition inherited big cuts in public sector capital spending from its predecessor: it fell 5.1% during 2010 and 6.7% in 2011. Capital spending by government is, however, only a tenth of other spending, so the overall effect of government on the economy is still broadly neutral.
If not the cuts, then what? The big shift has been consumer spending, which grew in 2010 but fell in 2011. Some of that was Vat and national insurance hikes. Mostly it was unexpectedly high inflation.
Exports are contributing to growth, as is business investment, though modestly. One big reason why growth slowed in 2011 compared with 2010 had nothing to to with austerity, confidence or inflation. The economy was boosted initially by firms rebuilding stocks after the recession. This was always going to be temporary.
Even if they do not defend it very well, I think ministers will stick with the fiscal strategy, even if the politics gets more difficult. They will be hoping they are not trying to stick with it through a period of renewed eurozone chaos. Today’s elections will have some say in that.
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
This post originally appeared at David Smith’s EconomicsUK and is posted with permission.