The Greek election result has helped avoid a euro break-up, at least for now. But unless European leaders can find a long-term solution to their problems, investors can expect more uncertainty ahead, warn Stephen Halmarick, Head of Investment Markets, and Senior Analysts Belinda Allen and James White.
For investors around the world, the victory by pro-euro and pro-austerity parties in the recent Greek election provides some welcome relief. The centre right New Democratic party emerged as a clear winner with 30% of the vote, enabling them to form a coalition with centre left PASOK and avoid the risk of an early Greek exit from the European Union.
But while we have avoided the worst case scenario, significant risk remains. The Greek coalition government will now turn to the difficult task of renegotiating its agreement with the so-called "troika" - the European Union, European Central Bank and International Monetary Fund. Meanwhile, the Greek government will seek to continue pursuing the austerity measures already agreed to, while facing aggressive opposition from the anti-austerity party Syriza.
More pain to come
Of course, it isn't only Greece that's causing headaches for the European authorities and international investors. Elsewhere in Europe, the recent €100bn bailout package hasn't succeeded in allaying concerns over Spain's troubled banking sector.
The Spanish government continues to pay a premium for its borrowings, with 10 year Spanish government bond yields now above 7%, as shown in the graph below.
Looking for leadership
Nonetheless, there is reason to hope. There are signs that Europe's political leaders recognise that it is necessary to break the connection between Spain's government and its banks, ending the feedback loop that has seen a troubled financial sector putting pressure on government finances.
Markets will also be hoping for concessions from Germany at the European Union Leaders summit in late June, giving some respite to the troubled economies on Europe's margins.
At the same time, it is also clear that financial markets have become less willing to give the political leadership the benefit of the doubt. While new policy announcements continue to drive short term relief rallies on global markets, their impact is become more and more limited, with investors rapidly recognising the shortfalls of the policy prescriptions served up so far.
As a result, it's likely that this mismatch between the expectations of financial markets and the solutions that politicians are willing to deliver will see volatility continue for some time, with more uncertainty for investors around the world, including Australia.
Written by the Investment Markets Research team, Colonial First State
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