Storm clouds are once again massing over the eurozone, and this time the problems are political. Europe's febrile bond markets have been calmer in recent months, thanks to the agreement of a "fiscal pact" requiring governments to limit their debts. But public backing for the painful deficit-reduction programmes needed to meet such targets is waning, taking support for mainstream political parties with it. And with elections in Greece and France this weekend – and in the Netherlands in a few months' time – the political consensus on how to tackle the crisis is in danger of unravelling. The consequences would be catastrophic.
It was Spain that hit the headlines last week. Not only is the Spanish economy back in recession, but one in four are out of work and, after another downgrade, the Government's credit rating is just three notches above junk status. Although bond yields are not yet unequivocally in the danger zone, they are steadily rising, and few expect Madrid to deliver its fiscal plan.
But Mariano Rajoy is not the only leader facing a restive electorate losing its appetite for austerity. In Italy, Mario Monti's popularity is also fading fast, and in the Netherlands – one of only a handful of EU countries with a triple-A credit rating – the minority government was this month toppled by a spat over cuts. Meanwhile, François Hollande, currently tipped to beat incumbent Nicolas Sarkozy to the French presidency, has pledged to re-negotiate the fiscal pact to promote growth as well as limit borrowing. And in Greece – where a fifth consecutive year of recession is set to slash another 5 per cent off the economy in 2012 – voters' disaffection is such that Sunday's elections may produce a coalition so fragmented it struggles to govern.
Neither is the scepticism restricted to the eurozone. Last week's evidence that Britain too has slipped back into recession has led to a chorus of unfavourable contrasts with the economic growth in the un-austere US. In fact, such comparisons are too simplistic, overlooking both the security offered by the dollar's status as the global reserve currency and the debt trouble Washington is storing up for the future. But the implications of the first real test of support for the coalition's economic strategy are no less significant for all that.
In economic terms, the austerity problem is easy to diagnose: reduced government spending threatens to create a downward spiral of cuts, recession, and more cuts. The solution is also easy to identify: private sector growth. But it is tricky to deliver while businesses lack confidence and bank lending remains sclerotic; and the traditional Keynesian remedy of turning on the government taps is simply not available. Any softening of deficit reduction plans will cause panic in the bond markets.
There is a glimmer of good news amid the gloom. Recent remarks from both Mario Draghi at the ECB and Herman van Rompuy, the head of the European Council, on the need for a co-ordinated growth policy suggest the message may, finally, be getting through to top European policymakers. But long-term reforms to boost the single market, while welcome, will not meet the immediate challenge.
There are other options. The German Chancellor is not wrong to stress fiscal co-ordination and strict controls on borrowing. But if all cut back at once it will suck the life out of the whole European economy, as we are already seeing. While those countries that are struggling to stay afloat have no option but to slash their spending, their more solvent counterparts – such as Germany and the Netherlands – should be upping their borrowing, boosting demand and helping pull the whole bloc out of recession, throwing a political lifeline to debt-reduction plans in the process. Until then, the storms in Europe are far from over.