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Recovery in Europe's Periphery? Not So Fast

Tuesday, 2 Jul 2013 | 5:16 AM ET
altrendo images | Altrendo | Getty Images

An improvement in macro-economic data for the euro zone's periphery has offered investors hope that the region is slowly emerging from the crisis, but analysts warned that a political backlash as well as moves by the Federal Reserve to taper its asset purchases could derail a return to growth.

"The data is improving but this could only suggest that there is a stabilization to a very moderate recovery," Derek Halpenny from the Bank of Tokyo-Mitsubishi UFJ said.

(Read More: Euro Zone June Manufacturing PMI Rises to 16-Month High of 48.8)

Data released on Monday showed that peripheral economies Spain and Italy experienced near two – year highs of output in June on the back of increasing exports orders. "It's too early to say whether austerity is working…but the rate of contraction is easing," he told CNBC.

(Read More: Watch Out, Euro May Be About to Flex Its Muscle)

There was some good news for Greece as well. The Greek manufacturing sector remained in contraction at the end of the second quarter, but rates of decline were the slowest for around two years.

Disagreements over the process of fiscal reform, undertaken to meet strict targets to plug public deficits, threaten the fragile recovery however. In Portugal, public anger over sharp tax hikes and high unemployment culminated in the resignation of Portugal's finance minister Vitor Gaspar on Monday. Meanwhile in Italy a coalition partner in Prime Minister Enrico Letta's coalition government threatened to withdraw its support for the already fractious government, citing frustration with the slow pace of reforms to tackle a deep recession.

(Read More: Is Italy on a Collision Course With Europe?)

News that the Fed will slow the pace of its bond purchases could do even more damage.

"It's all about growth in the euro zone," Halpenny said. "For the moment the economy is stabilizing but there's going to be clear upward pressure on bond yields as the U.S. economy continues to recover and the Fed ends its quantitative easing program. Rising yields across Europe will scupper growth and that's what markets will be looking at," Halpenny said.

As the U.S. economy show signs of healing, the Fed plans to start scaling back its asset purchases - currently $85 billion in mortgage-backed securities and Treasurys a month. The news has already prompted a selloff in bond markets, which translated into higher yields in the euro zone periphery as well. Yields have since stabilized again after the Fed tried to calm fears over a reduction in monetary stimulus.

One strategist said that the euro zone's depressed periphery was now "in a race against time" to recover. "While the economic contractions may be less severe, euro zone economies are hardly roaring back to life," Nicholas Spiro, head of Spiro Sovereign Strategy, said.

(Read More: Spain Will Bottom Out This Quarter: Santander Exec)

"One of the big questions is whether economies can recover meaningfully before the politics of reform sour to such an extent that the entire fiscal and structural reform agenda - critical to improving the growth outlook in the long-term - collapses. Indeed, in some countries, this is already happening," he said.

Lothar Mentel, chief investment officer at consultancy Paradigm Group told CNBC's "Worldwide Exchange" was more upbeat. He argued that although Europe was a hostage to U.S monetary policy, any improvement in the global economy would in turn buoy the region.

"The peripheral European economy is still exporting a lot within the EU so if Germany does better because the global economy does better, so will Spain and Italy."

"If there's a worry in our general central investment scenario at the moment then it's peripheral Europe," Mentel said. "If the global economy doesn't accelerate quickly we'll have bigger problems ahead in the periphery because those banks are still very weak."

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt

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