Bank of America sees deeper eurozone crisis before ECB rescue

 


The final trigger is most likely to be a bad debt auctions in Rome, pushing yields beyond the pain threshhold. Italy must raise €48bn (£40bn) in late February. But Greek elections in February are a minefield, and Spain's new government may reveal that the budget deficit is up to 1.5pc of GDP higher than planned. A blizzard of sovereign downgrades loom.

"The Eurozone is like sky-diving without a parachute. We think the ECB will provide a parachute in the end, but not until things get a lot worse," said Athanasios Vamvakidis, the bank's currency chief.

Euroland is already in recession, made worse by €1.5 trillion of bank deleveraging and fiscal tightening of 1.2pc of GDP in 2012, with a further 2pc to 3pc in 2013 as debt-brakes come into force.

"The ECB will have to step in," said Laurence Boone, the bank's Europe economist. She fears the crisis will blow up by Easter or the early summer. "We think the ECB will cut rates to 0.5pc by February, and then start to step up bond purchases as the situation deteriorates. There are ways of doing this within the bank's remit, and the Germans are in a minority."

The ECB can plausibly argue that the "monetary transmission channel" is no longer functioning if rock-bottom rates fail to halt bond turmoil in Italy. This should clear the way for radical action to cap yields.

Ultimately, the bank may play the deflation card, arguing that full-blown quantitative easing is needed to stop inflation (now 3pc) falling too low as commodities slide.

"The ECB is a forward looking bank. Mario Draghi has made it clear he is looking at leading indicators, which was less the Trichet habit."

Bank of America said British gilts should remain a safe-haven as long as the Coalition holds together. "The UK is the only advanced economy with a plan. You may not like the plan, but at least they know what they want to do," said Mr Vamvakidis. "If the risks to the global economy materialise, the plan will not work.

The very tight fiscal policy would make a UK recession worse, while loosening significantly could raise market concerns about UK debt sustainability."

The bank said Britain would not suffer any loss of growth if it withdrew from the EU and negotiated a European Free Trade Area deal. If the UK was forced to rely on World Trade Organisation rules, it might lose 0.2pc in annual growth.