–Germany To Eventually ‘Reluctantly’ Agree to ECB Intervention
–Believes Another Fed Quantitative Easing Program Unlikely

By Brai Odion-Esene

WASHINGTON (MNI) – The Eurozone’s sovereign debt crisis could
potentially escalate into a “generalized banking crisis” on the
Continent, economists at Wells Fargo warn, arguing in a report Wednesday
that only the European Central Bank is large enough to halt the meltdown
of the sovereign debt markets.

Germany, the report said, will “reluctantly” agree, eventually.

In its 2012 Economic Outlook, Wells Fargo also said given its
expectation that inflation in the United States for the first half of
next year will be just above 2%, additional quantitative easing by the
Federal Reserve is unlikely.

On Europe’s struggles, Wells Fargo projects economic activity in
the Eurozone will contract about 1% over the next two quarters, and that
economic weakness in Europe will exert a modest slowing effect on the
overall global economy.

“We look for the European Central Bank, which reduced its policy
rate from 1.50% to 1.25% in November, to cut rates further by 75 bps by
the end of the first quarter,” Wells Fargo said.

As for the potential worsening of the sovereign debt crisis, Wells
Fargo noted that because Italian and Spanish banks hold significant
amounts of their country’s government debt, the insolvency of the
Italian and Spanish governments, should that occur, could lead to the
collapse of those banking systems.

“Banking crises in Spain and Italy would quickly spread to other
European countries due to extensive financial ties in the continent,” it
said. “In our view, a restructuring of Italian government debt would be
a ‘Lehman-like’ event that would have profound global ramifications.”

So how does this crisis end? “We are becoming increasingly
convinced that the only institution large enough to stop the meltdown
that is occurring in the European sovereign bond market is the ECB,” the
report said, adding that the ECB will need to eventually commit to
unlimited purchases of Italian government bonds, either directly or
indirectly.

Euro power Germany, however, remains opposed to ECB involvement in
bailing out struggling Euro Area nations.

But according to the Wells Fargo report, when faced with “the
unpalatable choice between unlimited ECB purchases of Italian government
bonds and the dissolution of the EMU … Germany will reluctantly agree
to ECB intervention.”

This will just be the first step, the report warned, as Italy will
need to improve its long-run growth prospects in order to truly resolve
the crisis. Noting that newly minted Prime Minister Mario Monti has
promised to introduce reform legislation, Wells Fargo said it will take
some time to ascertain whether the measures, if agreed to by the
parliament, are working to eventually lead to stronger growth in the
Italian economy.

“In the meantime, financial markets likely will remain volatile and
the global economic outlook clouded,” it said.

With regard to the United States, Wells Fargo stressed that its
outlook for the world’s largest economy assumes Europe does not “blow
up.” It forecasts U.S. real GDP to grow 2.0% in 2012, “with small gains
from many sectors of the economy as opposed to a major contribution from
any one segment.”

The report said the outlook is based on the idea that consumer
spending will continue to add to economic growth. On the other hand, it
also expects the slow pace of job creation, slight improvement in
personal income and modest inflation pressures in the first half of the
year to keep consumer spending in check.

Approximately 1.5 million jobs are expected to be added over the
next year by Wells Fargo, an average of 123,000 jobs per month. “The
pace of job growth will be disappointing as structural challenges in the
labor market persist,” it said.

This sluggish pace of job gains should result in only a marginal
improvement in personal income, the report added. As for inflation, it
expects prices to remain “somewhat elevated” in the first half of 2012
at 2.3% before moderating in the second half of 2012.

The outlook for inflation, combined with “only marginal personal
income gains,” will limit personal consumption to 1.5% in the first half
of next year, the Wells Fargo report said, before somewhat stronger
growth emerges in the second half of 2012.

The government sector is expected to remain a drag on economic
growth in the year ahead, not surprising given current cuts in spending,
with more on the horizon. “State and local governments will continue the
process of aligning spending with the slower pace of revenue growth,”
Wells Fargo said.

The report believes local governments, in particular, will likely
continue to aggressively reduce spending over the next 12 months due to
falling property tax collections and fewer resources from the federal
and state governments.

On the monetary policy front, Wells Fargo said given its inflation
forecast for the first half of the year, “we believe that another QE
program is unlikely.”

However, it added, “if such a program were implemented, our outlook
for interest rates would be adjusted downward in the short run, but,
depending on the size of the program, another round of QE would not
likely affect our outlook for economic growth.”

** Market News International Washington Bureau: 202-371-2121 **

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