A trader reacts at his desk in front of the DAX board at the Frankfurt stock exchange. Photo: Alex Domanski/ReutersALEX DOMANSKI/Reuters
As chaos reigned in the euro zone and the continent's central bank warned of recession ahead, global stock markets took an unusual direction.
They churned ahead, with major indexes in North America gaining about 2 per cent Thursday and bourses in Europe rising between 2 and 3 per cent.
The surprising increase reflects a growing belief that euro zone leaders and its central bank are finally acknowledging the continent's fundamental problems. While agreement on a solution seems as far away as ever, market strategists welcomed the franker tone of discussions.
Stocks climbed through the day on expectations that the bailout package referendum, announced unexpectedly on Monday by Greek Prime Minister George Papandreou, would not in fact take place. The scrapping of the referendum, confirmed later in the day, removed a major element of uncertainty from the market and eased fears of an imminent Greek exit from the euro zone.
Sentiment had shifted even earlier, after European leaders finally delivered a harsh dose of reality to Greece, where for weeks rioters have taken to the streets to protest government cutbacks and the Papandreou administration has struggled to hold on to power.
"Does Greece want to remain part of the euro zone or not. That is the question the Greek people must now answer," German Chancellor Angela Merkel warned in a press conference late Wednesday.
After two years of uncertainty around the future of the euro zone, the ultimatum struck some observers as overdue.
"For a long time we have had a lot of stalling, negotiating, back and forth, half measures and firefighting," said Colin Cieszynski, an analyst with CMC Markets Canada. "This is the first time [European leaders]have come out and said, 'You have to decide if you want to stay in the euro or not, and if you are going to be in, it means you have to accept the benefits, responsibilities and the costs.' That's really important, because up until now nobody has really wanted to openly discuss that."
When the monetary union was created in 1999, it sidestepped the delicate issues involved in developing an integrated governing process to back up its economic marriage. That has left the euro zone using intermediate measures developed on the fly to manage the ballooning debt crisis.
Some investors are now betting that a clearer, more stable system will emerge from the crisis.
"This is a process of the EU finding itself, and defining itself...," Mr. Cieszynski said. "Nations have to ask themselves: are the benefits that they're getting from this worth the risk and prices they have to pay? ... Once these questions are openly discussed, then people can start to come up with real solutions and make real decisions."
While the decisiveness has breathed new confidence into markets, it is unlikely to translate into smooth gains for investors. There is now official recognition that Europe is verging on another downturn, with the new president of the European Central Bank, Mario Draghi, warning that the euro zone could subside into a "mild recession" late this year.
Mr. Draghi announced a surprise cut in interest rates by a quarter percentage point, to 1.25 per cent, despite the fact that inflation in the region is at 3 per cent, above the ECB's target of 2 per cent.
For the moment at least, investors were prepared to focus on the shift to looser monetary policy rather than fears that the European economy would begin shrinking again.
"The ECB's surprise rate cut is certainly welcome amid a sharply weaker outlook for Europe, as the sovereign debt crisis continues to weigh on regional activity," noted Benjamin Reitzes, senior economist and foreign exchange strategist at BMO Nesbitt Burns. "The incoming president might be making a statement with this unexpected move, perhaps signalling a change in tack by the historically hawkish central bank."
Unless economic conditions unexpectedly improve, another rate cut is probable in December, Mr. Reitzes noted. Lower rates are generally good for stocks.