Euro Area Under Threat From Uneven Virus Shock, EU Warns

(Bloomberg) --

Barely a decade after the euro-area sovereign debt crisis threatened to blow up the currency zone, the pandemic has put Europe’s south back in the eye of the storm.

Italy, Spain and Greece all face economic contractions of more than 9% this year, according to the European Commission. Spending on rescue programs will bloat already stretched public finances, widening the gulf between northern and southern countries and straining the bloc.

The risk was underlined by the commission Wednesday as it warned that the EU faces the deepest downturn in its history. The bloc’s executive body was blunt: Without some form of common rescue plan, distortions call into question the stability of the region.

“Such divergence poses a threat to the single market and the euro area -- yet it can be mitigated through decisive, joint European action,” Economy and Financial Affairs Commissioner Paolo Gentiloni said in a statement.

The euro-region economy as a whole is forecast to shrink 7.7% this year, forcing up unemployment and public debt, after governments took drastic steps to contain the spread of the virus.

The dismal numbers, and growing doubts on the bloc’s future, pressured the euro this week. The shared currency dropped for a third day Wednesday to touch $1.0782, its lowest level against the dollar in about two weeks before trading at $1.0812. The euro has lost more than 3.5% against the U.S. currency this year and analysts forecast further weakness.

The continent-wide hit is bad enough, but the greater devastation in the Southern European nations that have less fiscal room to respond is stoking fears that the euro area could fragment.

Political Tensions

The wear and tear is now evident in domestic politics, as embattled leaders try to maintain control amid tensions within ruling coalitions and pressure to get people back to work.

There’s speculation about how long Italian Prime Minister Giuseppe Conte can survive after he was forced to apologize for delays in delivering aid. In Madrid, Pedro Sanchez faces a vote in parliament Wednesday afternoon to extend his emergency powers. While the Spanish premier is likely to prevail, a close result will show that the broad support he enjoyed in the early days of the lockdown has evaporated.

Spain and Italy suffered most from the virus, which overwhelmed their medical systems, infected more than 400,000 people and claimed in excess of 50,000 lives.

Figures published earlier Wednesday showed the extent of the regionwide economic damage from lockdowns that shut businesses including hotels and restaurants. Activity at services companies plunged in April, while sales and employment both dropped.

Greece’s response to the disease was seen as a model as authorities acted quickly to contain the virus and recorded few fatalities -- yet the nation’s dependence on tourism means that it too will take a serious hit from travel restrictions, social rules and fear of infection.

Precarious Finances

The pandemic has underscored the precarious state of Southern Europe’s finances just as those nations were struggling to get them in order. Italy’s debt-to-GDP burden is seen as high as 159% this year, and in Greece it could be closer to 200%.

The European Commission’s forecasts show how rapidly the outlook has deteriorated. Three months ago, it predicted euro-area growth of 1.2% this year, with the caveat that the pandemic was a downside risk. The new projection, which is broadly in line with IMF data, is still subject to a high level of uncertainty.

While countries including Spain, Italy, Germany and Austria have started easing restrictions, parts of their economies including cafes and restaurants will remain shut because of the risk of a renewed surge in infections.

Such a setback could reduce output by another 3 percentage points, according to Maarten Verwey, the commission’s chief economist. The European Central Bank previously said that the economy could shrink by as much as 12% this year, depending on the course of the pandemic.

To keep businesses afloat and keep a lid on unemployment, governments have deployed trillions of euros in stimulus. The response has been uneven across the bloc, however, and attempts to broker a joint approach are mired in disputes over burden-sharing.

Leaders have asked the commission to present a recovery plan that builds on the bloc’s common budget as a way of funding an economic recovery. Countries are split on whether aid should be in grants or loans, with Italy and Spain arguing for European solidarity. Germany and the Netherlands have led opposition to joint debt.

That’s put a huge burden on the ECB, which plans to buy more than 1 trillion euros of bonds this year to prop up the economy.

Even the central bank’s role, though, is subject to some doubt after a ruling Tuesday by top German judges on the nature of its aid. The uncertainty widened the premium of Italian debt over its German equivalent by eight basis points this week, ahead of a Friday review by Moody’s Investors Service, which rates Italy one notch above junk.

©2020 Bloomberg L.P.