Political Backlash against Euro Zone Austerity

A political backlash against fiscal austerity left mainstream French and Dutch politicians struggling on Monday to shore up support as a key economic indicator highlighted the eurozone’s slide into deeper recession.

François Hollande’s first round victory in the French presidential elections — which raised fears of renewed wrangling over the euro zone’s economic strategy — and the collapse of the Dutch government, after a clash over fiscal policy, hit financial markets.

The heightened political uncertainty sent European stock markets tumbling and put pressure on French and Dutch sovereign debt, while Germany’s government bonds benefited from inflows from spooked investors.

Economic fundamentals also appeared to deteriorate as purchasing managers’ indices for the 17-country euro zone showed private sector economic activity had contracted unexpectedly sharply this month, dashing official hopes of an early return to growth.

The composite index covering manufacturing and services fell for a third consecutive month to 47.4 points in April, the lowest reading for five months. A figure below 50 indicates a contraction in activity. That pointed to an intensification of a recession which started in the final three months of last year, when the euro zone debt crisis was at its most intense. Economists had expected a modest improvement.

In the Netherlands, one of the eurozone’s most fiscally disciplinarian governments collapsed as Mark Rutte, prime minister, tendered his government’s resignation at a meeting with Queen Beatrix, clearing the way for elections. That sent the euro down to $1.3105 against the dollar, a session low. In France, the Socialist Mr Hollande’s first-round victory was accompanied by a surge in support for the far-right National Front.

Events in France and the Netherlands were “reactions against incumbents’ handling of the crisis plus the poor economic outlook and prospects,” said Erik Nielsen, chief economist at UniCredit. “It takes time to restore growth after these kinds of crises but people are impatient.”

In both countries, smaller parties hostile to deficit-cutting targets agreed by European leaders have gained in the polls. Mr Hollande’s threat to renegotiate the eurozone fiscal compact championed by Germany has also unsettled markets.

In a speech in New York, Jens Weidmann, Bundesbank president, argued that eurozone leaders should stay the course.

“We can only win back confidence if we bring down excessive deficits and boost competitiveness,” he said. “In a such a situation, consolidation might inspire confidence and actually help the economy to grow.”

The Eurofirst 300 index had dropped 2.4 per cent by late afternoon in London, and has lost almost all of the gains seen in the first three months of the year. The spread between the Dutch and German 10-year bond yields spiked to 77 basis points, the highest in three years.

The PMI data indicated conditions in manufacturing were the worst for almost three years, with even German industry faring badly, hit by declining demand from European neighbours. The deterioration will disappoint the European Central Bank, which has forecast a gradual economic recovery this year and shunned calls from the International Monetary Fund for further action to stimulate economic growth. The ECB is instead awaiting the economic effects of more than €1tn in three-year loans injected into the eurozone financial system.

Fiscal austerity measures would reduce eurozone economic growth by one percentage point this year, according to Gilles Moec, European economist at Deutsche Bank. “That alone would not drive the eurozone into economic contraction, but we have a combination of fiscal austerity and a credit crunch. It is a self-inflicted recession — you don’t get the same combination of shocks elsewhere in the world.”

German 10-year Bund yields — which move inversely to prices — plunged to a record low of 1.63 per cent, and widened the difference to France’s comparable borrowing costs to a three-month high of 145 basis points.

Additional reporting by Hugh Carnegy in Paris and Matt Steinglass in Amsterdam