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The euro crisis is escalating and has returned to haunt financial markets
Equity markets around the world have weakened and ten-year bond yields in Spain
are again above six percent
Meanwhile, safe haven flows have pushed ten year German bund yields to fresh record lows
and US treasury yields are also historically low
So why is the euro crisis escalating?
Well, the Greek electorate's rejection of austerity has put Greece's position in the
Monetary Union in jeopardy
Problems in Spain are also mounting
The Spanish government again has revised upward last year's budget deficit
and a banking sector struggling under the weight of rising bad loans
We suspect that, ultimately, foreign help for the Spanish banks might have to be
brokered
As for Greece:
our baseline scenario is that Europe will try to keep it on board, by
making concessions in return for a pledge from a new government to comply
with the bail-out programme
These concessions might come as targeted growth initiatives using structural
EU funds
Whether or not Greece indeed stays in
the ECB is likely to take further action
Against this backdrop
the euro's exchange rate looks set to weaken further
even though it is already at nine year lows in trade-weighted terms
A weaker euro would improve the Eurozone's export outlook. In fact
significant euro depreciation could be a key ingredient in preventing the
crisis from turning really ugly