Greece And The ECB: What Precedent Will Be Set For The Eurozone?

Greece has voted “no” to a referendum on further austerity measures proposed by the ECB. Greek PM Tsipras wanted this result, in order to gain more bargaining power with creditors. The ECB reacted accordingly, and placed steeper haircuts on collateral for emergency funding.   This puts additional pressure on a banking system that is already in deep distress. Today, finance ministers from across Europe are meeting to discuss next steps.

On Monday, European government bond markets reacted as expected, with a flight to quality and a sell-off of riskier assets. The reaction was more subdued outside of Greece, than one would expect, as a Grexit seems more probable. The S&P German Sovereign Bond Index rallied, with yields tightening 3bps, while the S&P Portugal Sovereign Bond Index sold off, with yields widening 10bps. The S&P Spain Sovereign Bond Index widened 10bps, and the S&P Italy Sovereign Bond Index widened 8bps. The Greek Sovereign Bond Index continues its descent, with yields widening 452bps to close at 20.74%.

The performance of these markets indicates that systemic contagion is not a huge concern. What is a concern, however, is the precedent that will be set for other Eurozone countries with struggling economies. If Greek’s hardball tactics end up giving them a degree of debt relief, and/or looser austerity measures, there could be incentive for Portugal, Spain and Italy to change their compliance with austerity measures. This has serious implications for the euro’s stance as a reserve currency.

A growing concern in Europe, is a possible shift in power to anti-austerity political parties outside of Greece. Portuguese Deputy PM Paulo Portas felt the need to comment Monday, saying that his government is committed to austerity plans and intends to stay on track. Portas was responding to Portugal’s socialist leader Antonio Costa, who is calling for Portugal to show more solidarity with Greece. Spain has a very outspoken, rising anti-austerity party called the Podemos. The Podemos, the second largest political party in Spain, is gaining momentum as it appeals to a society that has engaged in years of unpopular austerity measures. Spanish elections are set for late fall, and the ECB’s actions over the next few days will surely be scrutinized.

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