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News Analysis: European economic outlook still unclear

By By Vanessa Liberson, Chong Dahai (Xinhua)

08:25, August 26, 2011

BRUSSELS, Aug. 25 (Xinhua) -- European stock markets have been a real rollercoaster in the past few weeks. Investors and politicians act and react to each other with no satisfying results for either.

MARKET CALMING DOWN? AT LEAST FOR THE MOMENT

After months of turbulence, some degree of peace seems to be coming back to stock markets, at least for the moment.

"Now things are calming down," said Daniel Gros, Director of CEPS, a famous European think-tank on Thursday in Brussels. "These are things that can go up a lot and come down a lot," he said.

It has been a very hot summer for policy makers. European leaders have been dealing with the second bailout package for Greece. Straight after the decisions to expand the EFSF and involve the private sector had been taken at the July 21 summit in Brussels, heads turned towards Italy and Spain.

"Italy did not do its budget well and these things are not linear: small change, small mistakes can have very big effects," remarked Gros.

Italy saw its stock markets precipitate and spreads increase dramatically in July and early August.

SUMMIT MEETING: A WEAK RESPONSE TO PROBLEMS

The latest country to come under the spotlight was France. This spurred French President Nicolas Sarkozy and German Chancellor Angela Merkel to meet in Paris on Aug. 16 to discuss the uncertain future of the euro.

Some analysts saw the two leaders' proposal for a eurozone government with an elected president as a first, timid step towards the type of fiscal consolidation and economic integration needed if the euro is to survive.

Others have deemed the meeting as inconsequential as it did not produce an agreement on creating Eurobonds.

Is the Eurobond, the sharing of debt among the 17 eurozone countries, the only answer to the current debt crisis?

Many have argued that Eurobonds would give the wrong incentive to low rating countries to borrow cheap at the expenses of stronger economies such as Germany.

"Stock markets always have their own psychologies and one should not interpret too much into one month's movement," explained Gros, "but I think the way to interpret it is that basically there is a mismatch between those who want to invest and where they are willing to invest."

In short, investors are reluctant now to take risks and therefore do not lend to those who are more in need to borrow, i.e. countries such as Spain and Italy for the moment.

What is needed then is the restoring of confidence in these markets.

"In this, policy makers in Brussels are completely irrelevant," said Gros. "The only relevant policy makers are in Berlin, Frankfurt and Rome and Madrid."

If the European Union (EU) were to issue the Eurobond, this would be another excuse for the weakest and most affected economies not to do their job and improve their books to restore confidence. In this sense, the Eurobond would end up having the opposite effect to the one desired.

FUTURE STILL UNCERTAIN

Drastic market falls in recent weeks echoed voices of economic falls or double-dip. And markets seem to believe that current work Eurozone governments and Brussels have done is far from enough to rein contagion of crisis.

But further actions may backfire and damage economic growth.

Christine Lagarde, managing director of the International Monetary Fund, also warned that "slamming on the brakes too quickly will hurt the recovery and worsen job prospects."

European leaders may be in a position of dilemma, or get in troubles in search of Goldilocks Economy.

As for Europe at the moment, the key to future stability or turmoil seems lie in Spain and Italy.

"Europe has to wait and see if Zapatero and Berlusconi can deliver, while Brussels for now remains impotent," said Gros.

In the worst case scenario, they will have to be let go, concludes Gros. Everyone in Europe is aware of the costs at which a break up of the euro would come, and no one is willing to pay for it, at least not for now.

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