Eurointelligence Daily Briefing (Long Version), 19 August 2011.

Another day in the eurozone: Merkel says definitely No to eurobonds – and five small countries endanger the EFSF




After the initial excitement that Germany may be about to revert its position on Eurobonds, and her relatively mild language on the issue at her joint press conference with Nicolas Sarkozy, Angela Merkel yesterday categorically ruled them out. On a campaign trail in Mecklenburg Vorpommern, in deepest eastern Germany, Merkel said she would not yield to pressure on this issue. The eurozone was on the right track. She had, of course, heard about the eurozone bond debate, Der Spiegel writes. But she ruled it out. „I say no on this issue. This is not the right answer,“ she said. Just because Europe belongs together, there is no reason to collectivise the debt.” Every country was responsible for itself, she added.


(This is clearly campaign language, but given that she has got herself in this corner, it will be difficult for her to accept Eurobonds now. As we argued in our latest policy brief, we fear that she will postpone the debate until after the elections in 2013. Given the dynamics of the crisis, this is an unsustainable strategy. It means that there won’t be Eurobonds until the crisis gets a lot worse – by which time it may well be too late. )


 Small country politics endangers second bailout deal for Greece


 After Finland, four other small countries – the Netherlands, Slovenia, Slovakia and Austria – are calling for Greece to provide collateral for their share of the 109-billion-euro bailout, Kathimerini reports. Together with Finland, the five countries’ combined contribution amounts to 10% of the €109bn bailout. The separate agreement with Finland was subject of the discussions among finance ministries this Thursday. Harald Waiglen, Austrian finance ministry press officer, told Helsingin Sanomat (hat tip Newsroom Finland) that Austria is to reject the deal between Finland and Greece unless other eurozone countries also get guarantees. There are currently no official talks about other extra-deals.


The deal with Finland, not yet adopted, is rather complicated: Greece will deposit cash equivalent to a large chunk of the money it is to receive from Helsinki in a state account that Finland will use to invest in AAA-rated bonds. The interest generated will raise the amount to match the required collateral. Finland will return the money, plus interest, once the bailout loan is repaid, Finance Minister Jutta Urpilainen said.


 Peter Spiegel in the FT writes that the broadening demands for side deals could siphon away much needed cash for Greece to meet its deficit targets and cause further delays to finalise the Greek bailout package before the next aid payment due late next month. FT Deutschland warns that these additional claims endanger the second bailout package. The Greek finance minister came under pressure at home, as the opposition argues that he opened Pandora’s box by agreeing a deal with Finland in the first place.


This is a warning sign for what to expect with eurobonds


In a bitter comment in the Frankfurter Allgemeine, Heike Goebel writes that this is a typical example for these petty games in the EU, whereas countries use their veto power to bloc important decisions and to get the maximum out for their country. It is against the spirit of cooperation and it is likely to repeat itself if the eurozone were to issue eurobonds. In the end, some creditors will guarantee less and some more than their economic weight, and Germany is likely to be among the latter.


The oncoming recession


Global and European stock markets suffered another rout yesterday, as investors were spooked by the prospect of a recession in the US and in Europe. Economic sentiment has turned down dramatically in the last few weeks, as evidenced by the latest business activity index by the Philadelphia Fed.


The European response, as ever, is one of denial, as evidenced by the statement by Herman van Rompuy, who confidently predicted that he did not foresee negative growth. (Remember his statement in March that the ESM agreement had effectively ended the crisis?) The German Dax index lost 5.8% yesterday, bringing the total losses of the month to 20%, a performance that is reminiscent of the period after the collapse of Lehman Brothers. So is the dearth in money markets, where financing conditions have also been deteriorating. European and US markets were down in the 4-5% range, and the rout seemed to continue overnight in Asia.


Fed is worried over liquidity conditions of European Banks


Frankfurter Allgemeine, quoting the Wall Street Journal, writes that the Fed has held meetings with European banks to assess how their operations are financed. The meeting was triggered by the abrupt withdrawal of funds by US money markets into European banks by a cumulative €96bn during June and July to €340bn – a fall of a quarter. French and German banks were most affected by the drought. The paper also quotes the chief economist of the Swedish Riksbank warning that the money market might soon freeze again.


Didier Reynders says eurozone needs Eurobonds and an enlarged EFSF


Didier Reynders told the FT that he favoured eurozone bonds and an enlarged EFSF. He said a deal could consist of a Eurobond as a quid pro quo for debt brakes in national constitutions. “If it is possible to have rules in national constitutions about balanced budgets, and to have real economic integration, then I am sure it will be possible to have eurobonds,” he said. On Belgium, he said the country would not to undertake far-reaching reform to pay back its debt.


Thomas Fricke on why Eurobonds might prevent a recession


In his FT Deutschland column, Thomas Fricke focuses on the link between the economic downturn and the Eurobond debate. He says that German upswings have experienced tragic short lives in recent decades, and this latest upswing, too, is petering out well before the economic recovery has gathered sufficient speed. He says the reason is that the ongoing financial crisis has led to a deterioration in financial conditions, which is now hitting the real economy. The eurozone would benefit greatly from the creation of a large sovereign debt market of the size of the US.


France considers high-income tax


France will focus plans to tax the rich more heavily on those earning more than €1m per year, Budget Minister Valery Pecresse said according to Reuters. The plans are part of a package of deficit-cutting measures to be unveiled on Aug. 24 as pressure grows on France to speed up efforts to cut its public deficit. Other measures include reductions of tax exemptions; no expenditure cutting is envisaged so far. Tax on high-income earners is also picked up by the Socialists. Bertrand Delanoë called for a progressive tax on high income earners, according to Le Monde, to yield extra-revenue of €2.5bn per year.


Spreads, Forex, and ZC Swaps


Quite dramatic developments. 10 year German yields are down to a little over 2%, and Italian and Spanish spreads are moving back to 3% – not close to the peak thanks to ECB bond purchases but still very high indeed. Note also the inflation swaps. They point towards a serious inflation undershoot over the next five years. Previous Day Close Yesterday’s Close


This morning


France 0.634 0.673 0.662

Italy 2.719 2.971 2.982

Spain 2.731 2.918 3.102

Portugal 9.523 9.720 9.400

Greece 13.814 14.234 14.64

Ireland 7.791 7.850 7.966

Belgium 1.694 1.803 1.786

Bund Yields 2.221 2.088 2.077


Euro bilateral exchange rates:


€at last Briefing This morning Dollar +1.4387 +1.4303 Yen +110.25 +109.41 Pound +0.8714 +0.8681 Swiss Franc +1.1373 +1.1357 Zero Coupon Inflation Swaps previous close last close 1 yr 1.58 1.37 2 yr 1.67 1.41 5 yr 1.92 1.80 10 yr 2.14 2.02


 Source: Reuters

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