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German Chancellor Angela Merkel’s government hopes for a verdict in favour of the ESM.


The debt-swamped euro zone shows signs of entering a rare, though perhaps fleeting, period of stability even as two of its largest economies, France and Italy, show no signs of revival and Greece continues to churn.

The biggest immediate threat to the euro zone's ability to stay whole had been Germany's court ruling, set for Wednesday, on the constitutional legality of the European Stability Mechanism, the new bailout fund with a mandate to take the edge off the crisis through the purchase of sovereign bonds in conjunction with the European Central Bank.

A ruling against the ESM, where Germany is the biggest single sponsor, would deny the euro zone of its prime crisis-fighting tool and plunge the 17-country monetary union into financial chaos. But both German Chancellor Angela Merkel and Finance Minister Wolfgang Schaeuble, who has typically taken a hard-line stance on exposing German taxpayers to sovereign rescues, have expressed confidence the ESM will pass the constitutional test.

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On Monday, Ms. Merkel's spokesman, Peter Gauweiler, said the government hoped for a verdict in favour of the ESM. He called the bailout fund "a central building block" to overcome the crisis.

Denver market strategist Marshall Auerback, a director of Toronto's Pinetree Capital, said he expects the court to approve the ESM. "Voting no right now would likely create a crisis which the Germans would just as soon avoid, so they'll fudge it with conditions, I suspect," he said.

The court ruling comes the same day that Dutch voters go to the polls in an election that been expected to produce a eurosceptic coalition government, one that could use The Netherlands' voting power to block crucial crisis-fighting decisions.

While Dutch voters remain deeply concerned about the pace and cost of European integration and sovereign bailouts, the latest opinion polls put two broadly pro-European parties, the Liberals and Labour, in a dead heat going into Wednesday's poll.

Confidence that the ESM can be spared from oblivion, that the Netherlands will embrace a pro-Europe government and that the ECB will buy sovereign bonds, delivered a jolt to the markets and the euro in the middle of last week. The rally lasted until Monday, when the markets fell, but only slightly. The euro traded at $1.279 (U.S.), down 0.10 per cent and near a four-month high. Bond yields in Italy and Spain remained well below their crisis peaks.

Despite the bullish run in sentiment and in the markets, Monday was not without its bleak spots. More evidence is emerging that Europe's biggest economies are losing momentum. Italy, the euro zone's third-biggest economy, contracted more than initially reported in the second quarter.

According to a revision released Monday by Istat, the national statistics agency, the Italian economy shrank by 0.8 per cent over the first quarter, against the first estimate of 0.7 per cent. The year-on-year contraction was 2.6 per cent.

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Economists said the fall was primarily due to lack of demand. "After the fourth quarterly decline in a row, the Italian economy looks set to remain in contraction territory for another few quarters," said economist Paolo Pizzoli of ING Financial Markets. "As austerity measures will continue kicking in against a deteriorating labour market backdrop, domestic demand looks set to remain the drag on growth."

Italy's recession is one of the deepest in Europe, and the fourth since 2001. France, meanwhile, has been flat lining in the last three quarters, with no growth, and some economists think the country's newly aggressive deficit reduction targets will push it into recession. Deutsche Bank predicts a 0.3-per-cent fall in French gross domestic product this year.

On Sunday, in a French TV interview, President Francois Hollande promised to turn the economy around within two years.

Greece, whose economy remains in near free-fall after four years of deep recession and a fifth to come, is negotiating this week for another round of painful spending cutbacks. The so-called troika – the ECB, the European Union and the International Monetary Fund – wants cuts valued at €11.7-billion ($14.6-million Canadian). The government, led by Prime Minister Antonis Samaras, is pleading for relaxed targets, though the troika has, so far, given no indication it is willing to give Greece more leniency after missing so many austerity targets since its 2010 bailout.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More


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