"The escalation of the euro area sovereign debt crisis makes it the main systemic risk for the global economy, which, otherwise, remains on its post 2009 recession recovery path, albeit at a slower pace than in the early part of the year. So long as euro area policy makers have not taken decisions able to secure the funding of both solvent governments and banks, risk aversion may increase further in global financial markets, despite positive macroeconomic news from the US and emerging markets, China in particular. With liquidity drying up for the Italian government, which we deem solvent, and Italian debt yields skyrocketing above 7%, we believe that it is only a matter of time until the European Central Bank intervenes in the secondary sovereign debt market on a much larger scale than it has done so far.
We also think that the ECB is the only policy maker in position to fend off a dangerous deflationary spiral in the euro area, where the recession that started in September will be aggravated by the combined effects of pro-cyclical fiscal policies and banks deleveraging their balance sheets in order to meet new capital requirements. For that reason we believe that the ECB will bring down short term interest rates close to zero in a first stage and will then have to undertake both credit and quantitative easing in order to prevent a contraction of credit and money supply. Provided that the ECB steps in on time and that euro area governments take the right decisions regarding their domestic economies and the governance of the euro area, the worst, i.e. a disorderly break up of the euro area should be avoided, and European economies should recover in the latter part of 2012, thus rejoining the global recovery."