Greece Calls New Elections After Coalition Talks Fail

German growth staves off euro zone double-dip; anti-austerity sentiment continues in Europe

Greece will hold new elections after the three major parties and President Karolos Papoulias all failed to form a governing coalition that could agree on how to handle the country's debt burden.

Citing a spokesman for Papoulias, Reuters reported Tuesday that a caretaker government to see the country through the new vote will be apponted Wednesday.

Meanwhile, unexpectedly strong economic growth in Germany warded off a double-dip recession for the euro zone as a whole, although worries over the continuing efforts to form a government in Greece weighed on markets.

Bloomberg reported Tuesday that the German economy grew 0.5% in the first quarter, reversing a fall of 0.2% in Q4 of 2011 and far outpacing economists’ predictions. The growth was due to a boost in exports to emerging markets, which took up the slack from falling demand in the euro zone, and greater demand domestically as unemployment continues to fall and wages rise.

“With this morning’s numbers, the German economy has not only avoided recession but could have even helped prevent the entire euro zone economy falling into technical recession,” Carsten Brzeski, senior economist at ING Group in Brussels, said in the report. “One thing is at least for sure: the German economy remains the powerhouse of the euro zone economy.”

The news was good for Germany, but could not lift the overall aura of gloom that lay over the euro zone as Greece continued to struggle in the wake of its May 6 election. Rebuffs of austerity from Greek voters resulted in a standoff between parties supporting measures that are prerequisites for the country’s second bailout and those who insist that such measures are too extreme.

Still, Greece itself may have glimpsed its own ray of light: European government officials who met on Monday to discuss the situation hinted that they might give the country more time to meet its budget-slashing targets, set by the troika of the European Union, European Central Bank (ECB) and International Monetary Fund (IMF), so long as politicians manage to form a government that will remain committed to austerity.

That objective is far from the wish of Greek voters, who have courted an exit from the euro zone in their protest against harsh budget cuts that have left the country with record unemployment and reduced pensions and wages. The party most outspoken against the bailout, Syriza, has thus far stood firm in its rejection of any compromises to form a government unless they include an abandonment of the troika’s rules for the bailout. In addition, Syriza’s popularity since the election has grown to the extent that the party could be the big winner if new elections must be called.

Should Greece fail to adhere to the terms of the bailout, however, it could trigger a default on bond payments. Despite that, Greece would make a bond payment due on Tuesday to the holdout owners of an instrument coming due that day, according to an unnamed government official. The official said in a Reuters report that the remaining holders of the May 15 Hellenic Republic note, which had been partially exchanged during a debt restructuring early in March, would receive payment. It is the first issue to expire since the debt swap was concluded. The official did not say whether other holdout owners of other issues of Greek debt might expect to be paid.

Greece also sold 1.3 billion euros ($1.67 billion) of three-month T-bills on Tuesday, although yield rose 14 basis points from its previous level at an April auction. The proceeds will cover a rollover of an earlier 1.6 billion-euro issue that comes due on May 18.

The other outcome of rejecting the bailout that is feared across the euro zone is a possible exit of Greece from the joint currency bloc. While former Prime Minister Costas Simitis said on Tuesday that an exit from the currency would be a “catastrophe” for Greece, European leaders have begun to discuss the possibility they once regarded as impossible. There is no provision in the euro zone’s treaties for the exit of a country from the group.

Marchel Alexandrovich, a senior European economist at Jefferies International in London, acknowledged this when he was quoted saying in a research note, “The euro breakup story is gathering steam again. If Greece were to ever exit the euro, no amount of reassuring comments will convince investors that other countries won’t soon follow.”

Europe faces additional unsettling changes, with the inauguration on Tuesday of the newly elected President Francois Hollande, whose anti-austerity, pro-growth platform carried him to victory over former President Nicolas Sarkozy. The rejection of austerity by the French as well as the Greeks, in addition to a resounding defeat over the weekend of Chancellor Angela Merkel’s party in North Rhine-Westphalia, Germany, indicate that change may well be coming to the way Europe does battle with its fiscal woes.

Although Merkel has said that her view on tight fiscal measures has not changed, other viewpoints have been swayed by the number of defections among the members of the euro zone. Most of the governments in the E.U., as well as the European Commission (EC) and the IMF, have become convinced that it may be necessary to allow some countries, in particular Spain, additional time to get deficits under control.

Charles Grant, director of the Center for European Reform in London, was quoted saying in the report, "Merkel will find it hard to resist them all." She may indeed be compelled to consider changes in domestic policy as well; her party’s defeat over the weekend, coupled with infighting among the members of her governing coalition, could cause her to face the prospect of instituting growth measures at home as well as abroad.

Ireland in particular is watching these struggles, particularly in Greece, with concern. An upcoming vote on the new E.U. fiscal treaty set for May 31 has been more or less turned into a referendum on whether that country wants to remain in the euro zone. Ireland has been under stringent austerity measures since the collapse of its real estate bubble, and while other countries point to it as an example of sterling behavior in its adherence to those measures, the Irish themselves are growing weary of their strictures and could vote against the treaty.

Should Ireland reject the E.U. treaty, however, it would no longer have access to funding from the European Stability Mechanism (ESM) and would likely be unable to return to world financial markets as it has hoped, since it would be viewed as a higher default risk without the ESM funding as a support. A change in policy toward Greece, however, could open the door to a change for Ireland as well—something many in its government have been pushing for.

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