Can German Muscle Force a Thrifty Euro Zone?

With the euro under pressure on Monday euro zone and European Union finance ministers heading for a meeting in Brussels over the next 48 hours, the German government is pressing other members of the euro to adopt their own versions of the so-called balanced budget law.

That law would prohibit European governments from running a deficit of more than 0.35 percent of gross domestic produce (GDP) by 2016.

German Finance Minister Wolfgang Schauble will present the plan at a meeting on Friday, according to the Financial Times.

With Italy reportedly set to unveil budget cuts worth €27 billion ($33.21 billion) over two years, euro zone members are desperate to show they are serious about cutting runaway government spending in many countries that has led to concerns of contagion from the Greek crisis.

On Friday, European stock markets fell heavily with banking stocks in most major markets sharply lower as fears grew over their exposure to European sovereign debt. Default or restructuring remains a major threat leading many investors outside the euro zone to avoid the market completely.

“Although the stabilization package provides a backstop facility for financing sovereign debt, the strict austerity measures that are required to be followed by member countries raise both political and social concerns and questions the long-term economic potential of the euro zone,” Edmund Shing, the head of European equity strategy at Barclays Capital, said.

Shing predicted the euro will hit $1.20 over the next three months.

“There is a downside risk due to a potential inability to meet the requirements of the austerity reforms” Shing said. “Stress on GDP growth due to fiscal consolidation and loose monetary policy are euro negative”

How to Trade the Weaker Euro

Sectors like semiconductors, beverages, luxury goods, industrials and information technology software in Europe should benefit the most from a lower euro, Shing said.

“This is primarily through positive transaction effects and, to a lesser extent, through translation effects (income from subsidiaries based in a foreign country),” he said.

UBS raised its growth forecasts for the EU Monday, claiming a lower euro and low borrowing costs will more than offset higher risks and additional fiscal tightening.

But growth will be highly divergent, Paul Donavan, senior international economist at UBS, said in a research note.

“Positive elements will disproportionally impact healthy countries like Germany while the additional negative impact is concentrated on troubled countries,” Donavan said. “Our aggregate GDP forecast is nudged up by 0.2 percent.”

The European Debt Crisis - See Complete Coverage
The European Debt Crisis - See Complete Coverage

Germany will be boosted by exports, restructuring potential and smaller fiscal problems than its peers, according to Donavan. “In addition, stronger-than-expected GDP growth in Q1 and an upward revision of Q4 now lead us to believe that German GDP will grow by 2 percent this year, outperforming the euro area more clearly than forecast so far.”