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The euro has a future, says Newton’s Paul Brain


Paul Brain, manager of the Newton International Bond Fund, believes the euro will survive the Eurozone crisis, but could be further sizeable bumps in the road.

A fiscal turnaround now seems more feasible and indeed evident; the Irish government has made significant moves to slash its spending and increase tax receipts, while Portugal and Spain have also announced a series of austerity measures.

However, any fiscal turnaround relies on reasonably positive growth across the Eurozone, and in particular, strong growth in the core of the region to offset the weakness on the periphery.

The European Central Bank has also stepped up its purchase of peripheral Eurozone government bonds and extended liquidity programmes, suggesting willingness on the part of the core Eurozone nations to keep the single currency bloc together.

Brain says: “There is also much further scope for the ECB to step up its liquidity push; thus far, it has bought the equivalent of two per cent of Eurozone GDP of peripheral bonds. To put this into perspective, the Swiss central bank used the equivalent of 40 per cent of Swiss GDP to weaken the Swiss franc earlier this year.

“Meanwhile, the region still boasts positive economic growth, fiscal action has been taken, and the ECB seems willing to provide liquidity – this should be sufficient to keep the Eurozone intact. The single currency bloc also seems to share many of the characteristics of Japan over the past decade, with contrasting areas of strong and weak growth, low inflation, low interest rates and a festering banking system. However, this should be positive for the region’s bond markets,” he adds.

In recent times, with the winding down of the ECB’s short-term lending programme, Ireland has been forced to tap into the European Financial Stability Fund, funded by the IMF and EU. Brain says the EFSF is structurally flawed; whatever it lends to struggling member states, it then has to issue bonds to cover that shortfall.

“However, if, for example, Spain and Portugal follow Ireland’s lead, they would be ceasing to contribute to the fund, therefore reducing the number of contributing countries, and there would suddenly be a risk of the whole thing failing as a much greater financial burden falls on those not making use of the facility.

“This also brings the issue of the euro’s future into the public domain and starts to pose political questions, weakening governments. For example, the discussion on Irish corporation tax that accompanied its EFSF loan has heightened concerns in Ireland,” he adds.

“Meanwhile, the spotlight looks set to fall on Portugal and Spain in the New Year, with Portugal expected to issue bonds in early 2011.” Brain continues, “The pressure will undoubtedly mount on Portugal, and it would come as no surprise if they too were forced to use the EFSF. However, we would expect a line to be drawn in the sand after Portugal, as contributors such as Italy, which are likely to face similar pressure, are simply too big to be bailed out,” he says.

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