Euro and the Eurozone: 3 YR LTRO not a game-changer, the key remains growth say BofA

Last Updated on Friday, 17 February 2012 12:47 Written by Will Peters Friday, 17 February 2012 12:46

The 3 year Long Term Refinancing Operation (LTRO) has been widely credited with stabilising confidence in the Eurozone, and indeed the LTRO has been cited as being behind this years stock rally.

But, according to Bank of America Merrill Lynch, the 3-year LTRO has bought Euro area governments time rather than being a game changer – "precious time that they can use to tackle their fiscal, competitiveness and financial problems, and strengthen the institutional structure of the euro area," says a note from BofA.

However, immediate risks remain.

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The key risk is a Greek default; Portugal’s task is complex and its competitiveness will take years to improve; Italy and Spain must resume higher trend growth; and Italy has a specific sovereign issuance challenge.

According to BofA the fiscal compact (3yr LTRO) is not a comprehensive solution to euro-area issues as it does not address the fundamental flaw of its construction, which is a lack of economic policy coordination (common budgetary rules is not fiscal coordination).

This approach creates negative spillover from individual countries’ policies; coordination, conversely, could create positive spillover.

Against this backdrop, the missing piece in this jigsaw puzzle is short-term GDP growth.

Analysts say:

"Our projection is for Euro area GDP to contract 0.5% in 2012, which is in line with consensus, with the North posting a small positive growth rate and the South a large negative growth rate.

"Yet negative growth would impede fiscal and credit adjustment, thus delaying the growth recovery in the Euro area and making the process more painful.

"In our view, if there was ex-ante coordination of fiscal adjustment, growth could be boosted in the short run, in turn easing the adjustment."