Euro Zone Break-Up Still 'Worst-Case Scenario'

A break-up of the euro zone is increasingly predicted as the result of the current crisis in the region, but economists warn that this could be the worst possible outcome.

EU building flags brussels
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EU building flags brussels

"A break-up in some fashion is still the worst-case scenario for Europe in every respect: financially, economically and politically," Larry Hatheway, chief economist at UBS, told CNBC Tuesday.

The appointment of technocratic governments in Italy and Greece has failed to reassure the markets about the region's future, and there are still worries that the new leaders will fail to deliver.

"I think the appetite is there, but the mechanisms and the political resolve to take unpopular decisions are missing," said Hatheway, who doesn't think that European leaders will be able to shrink the euro zone to fewer than its current 17 members.

German Chancellor Angela Merkel's party approved the principle of a country exiting from the euro zone at its annual conference Monday night.

"Things are happening but we haven't really had the conclusive things that we need. There was great hope and then it faded," Chris Watling, chief executive of Longview Economics, told CNBC.

"What we need now is an excuse for people to buy Italian bonds, and that's a growth plan, which will let the country grow rather than be beaten down by austerity."

Mario Monti, the newly-appointed Prime Minister of Italy, is currently trying to form a new government from the ashes of Silvio Berlusconi's administration.

"The best case is a government of technocrats and also politicians from the two big parties, the PdL (Berlusconi's party) and the PD (the main opposition party)," Gianmaria Bergantino, Head of Asset Management, Bank Insinger de Beaufort, told CNBC.

"This will be enough for Italy."

The euro has fallen against the dollar in recent weeks as worries about its future grew.

UBS expects the euro to move towards $1.35 or lower this year, and to hit $1.25 or lower next.

"There's a really asymmetric price action at the moment," Geoffrey Yu, currency strategist at UBS, told CNBC.

"It probably takes three bits of bad news to push euro-dollar down 10 basis points, but half a piece of good news to push it up 20 basis points."

"The focus should be moving away from yields and all about growth," he added. "We need to look at the wider macro picture."

Germany and France posted solid growth in the third quarter Tuesday morning but euro zone GDP figures due out later Tuesday are expected to be worse, due to poorer growth in other economies such as Italy, Greece and Spain.

UBS is currently underweight on stocks over concerns about the euro zone.

"There has been too much optimism about what technocratic governments can achieve in Europe and therefore this is a dose of reality," Hatheway said.

He warned that 2012 will be similar to 2011, with an "unresolved crisis" in Europe and "continued worries about economic recovery."