Europe: less bad is enough for now

The flash European data were not exactly great; the EU manufacturing index was higher at 47.5, with it appearing that the declines in activity are coming close to an end.  The index for Germany picked up as indicated by other surveys released earlier in the week, while French manufacturing slipped in the month.

While these data don't herald a return to growth, the fact that it is less bad is now enough for markets not to be rattled.  This is because there has been meaningful progress made towards correcting some of the huge imbalances within the Euro area that caused the crisis in the first place.

For example, there has been a huge shift in current account balances within the region, with deficit countries switching to surplus.  Unit labour costs have also started to come down in countries struggling for competitiveness.

The cost of this adjustment has been extraordinarily high for some, with countries like Spain pushed into depression conditions.  But it has been made possible with the help of the ECB, which appears to have broken the vicious cycle created by austerity weakening depressed economies and shaking confidence in yields.

The Outright Market Purchases (OMT) program announce in September aimed at "conditional" purchases of sovereign bonds in the name of financial stability appears to have been a credible enough threat to bring yields down.  So far, this program has yet to be used.

While this threat enough for markets right now, it won't be unless economies across the the Euro area, and particularly the periphery, start to show signs of growth.  Growth while make a gigantic difference to the prospects of managing debt burdens.  Without it, there is a big risk that the credibility of European policy makers will be tested again in 2013.

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