Euro Caught in Constitution Crossfire

The back-to-back "no" votes in France and the Netherlands on the European Union constitution may leave the euro zone economy deeply scarred, damaging confidence, budget and monetary policies and structural reforms, economists said Thursday.

The most visible blow so far was suffered by the region's single currency. The euro has fallen nearly two percent against the dollar since Friday, a reaction to the resounding rejection of the EU charter in both countries.

The greatest fear among economists and investors is national budgets getting out of control in Germany, Italy and France, where public deficits have already exceeded EU limits for several years.

The three large European countries are also facing the domestic political point of view, the "no" vote on the treaty could paradoxically advance the structural reforms that the European economy needs, Ferry said. Another impetus may come from Britain, which is outside the euro zone, and takes over the rotating EU presidency in July, he added.

Ferry predicts that Europe is moving toward more fiscal and social competition, more restructuring and outsourcing of industries and less intervention. In other words, the opposite of what the French "no" voters wanted.

On the other hand, politicians may focus on their national priorities and give in to more populist anti-Europe rhetoric, according to Bank of America economist Laurenzo Codogno.

More populist policies "would push Europe even further away from the kind of supply-side reforms that are desperately needed to stimulate growth," Codogno said. It would also put more pressure on the ECB "to rely on lower interest rates to solve problems that should more properly be addressed by means of economic reforms," he added.

The International Chamber of Commerce, a business organization, echoed that advice. "The more closed a society, the more vulnerable is its economy and that is exactly what we don't need," said Maria Livanos Cattaui, ICC secretary general.

ECB head dismisses euro fears as "absurd"

Meanwhile, the president of the European Central Bank, Jean-Claude Trichet, dismissed "absurd" speculation that the euro may be abolished in the wake of the Dutch and French rejection of the EU constitution.

"It is totally absurd" and "complete nonsense", Trichet said at a press conference following a meeting of the ECB's central governors.

The speculation intensified on Wednesday after German magazine Stern claimed that the German finance ministry had blamed the euro for weak economic growth in Germany, where unemployment is hovering around the five million mark, or 11.6 percent of the workforce.

That prompted the ministry and the Bundesbank to throw their support behind the euro. "German Finance Minister Eichel and Bundesbank President Weber see the euro as a singular success story and an important step towards securing the future of Europe," a Bundesbank spokesman insisted.

Concerns that 'no' votes are the harbingers of doom

Although the EU's constitution contains little in the way of economic policy, the crisis the rejections have sparked is raising new questions over Europe's already cloudy economic outlook, analysts say.

"True, viewed in isolation the French and ... Dutch 'no' votes might look like one of the occasional setbacks for the European project that are usually overcome as time goes by," Morgan Stanley economist Joachim Fels said.

"But viewed in conjunction with other political undercurrents, I think they serve to underscore that Europe is on a slippery slope towards disintegration and instability -- a stunning reversal of the long march towards integration and stability in the last half century," he added.

"Of course, nobody can confidently predict the endgame of such developments."

Nationalist, rather than EU, reforms possible

Although the collapse of Europe's joint economic undertakings is a highly unlikely worst-case scenario, its mere mention makes policy-makers cringe with fear. ING economist Rob Carnell said that the likely reaction from EU politicians eager to regain their dwindling political capital would be to seek a more "nationalist", rather than European, approach to economic problems.

That would translate into a general apathy for painful reforms and budget discipline, especially in the run up to elections in the next couple of years in big countries such as France, Germany and Italy.

Enter the age of Fortress Europe?

As tensions flare up with China over textiles and the United States over aircraft makers, an internal EU political crisis could also cause members to become more combative on international trade issues and seek a so-called "Fortress Europe" to ward off foreign competitors from steeling jobs.

"I doubt we'll see a return to quotas and tariffs but what is more likely is that you will get some more argumentative and fractious disputes, for example the dispute over Airbus and Boeing is likely to turn ugly," Carnell said.