Morgan Stanley On The Real European Story That Should Be Making You Depressed

Protest European Central Bank

[credit provider=”Ralph Orlowski / Getty”]

Europe is taking it on the chin today, the culprit seems pretty clearly to be Silvio Berlusconi and Italy, where market sare getting crushed, thanks to his desire to return to politics, and Mario Monti’s resignation.It’s debatable how big of a deal this is, really. Berlusconi has no chance of winning (per polls and pundits) and Monti was going to resign anyway, since elections are in the spring).

In his Sunday Start note, Morgan Stanley’s Joachim Fels has a different story in Europe that’s bringing him down. It doesn’t get as much attention as the flashy headlines, but it has to do with Eurozone leaders backtracking on the bigger efforts towards integration and common regulatory frameworks.

Says Fels:

What really drags me down, though, is the European political saga. Don’t get me wrong: I continue to think that the internal economic rebalancing in the euro area is progressing, with the crisis countries having implemented impressive structural reforms and gradually regaining cost competitiveness. Also, the ECB’s OMT backstop, though not activated yet, has been effective in reducing spreads and buying time for governments to implement what they need to do if the euro is to be forever – move towards banking and fiscal union. But here’s the problem: governments are not spending the borrowed time wisely. Rather, I believe they are squandering it by backtracking on banking union and fiscal union. Even though the van Rompuy ‘Towards a Genuine Economic and Monetary Union’ report submitted to governments ahead of the EU Summit this coming week was thoroughly un- ambitious, in my view, Berlin immediately criticised it as being too ambitious. And whether European finance ministers at their December 12 special meeting on the eve of the EU Summit can really agree on how to cobble together a banking union remains to be seen. I’m not holding my breath any more.

The ECB seems to have realised that, once again, governments fail to deliver their part of the bargain. Maybe this explains the puzzling inconsistency this past Thursday between a significant downward revision in the ECB staff’s forecast for economic growth and inflation and the reluctance of the Governing Council to cut official interest rates. It seems as if the Council wanted to keep up the pressure on governments to deliver on banking union and a fiscal union roadmap this coming week. I’m not sure though that the message (if this was indeed the intention) will be heard in Europe’s capitals.

This has always been one of the problems with European crisis management. They do better when the heat is on and the market vigilantes are demanding answers. When peripheral borrowing costs are falling to one and two year lows, there’s no rush.