 High Noon (this time for real)
Eurointeligence Comment and AnalysisA proposal on how the ECB could defrost the European bond markets while remaining within its mandate.
We have been observing European summits for quite some time now, but this one promises to be more interesting than the others before. Germany has raised the stakes to an extent that surprises us (in a positive way). Angela Merkel insists on a full blown treaty revision, and newspapers report that she is furious about the leaked reports according to which Herman van Rompuy was going to resort to a dirty little trickle of confining the treaty amendment to Protocol 12 TFEU, the protocol on excessive deficits. The van Rompuy strategy is to make only small change to this Protocol, small enough to allow a fast-track treaty ratification process, bypassing the EP and national parliaments, leaving the remainder of the German proposals to secondary legislation. Van Rompuy has chosen to recommend this option as several member states indicated their opposition to a full-scale treaty change. The countries known to be sceptical include not only the UK, but also the Czech Republic, and the Netherlands, a German ally during the eurozone crisis. Merkel believes that only a full-scale treaty change would deliver a sufficiently credible statement. (We agree with her, except that we believe that the German proposals are too one-sided, and too much focused on fiscal discipline, and not enough the other causes of the eurozone crisis.)
Germany rejects Van Rompuy’s proposal
Quentin Peel of the Financial Times has spoken to a senior German official, who summed up the German position with great clarity:
“A number of actors have not understood the seriousness of the situation,” the German official said, warning that a “bad compromise” of small steps or “little tricks” would not meet the expectations of the public or the financial markets. …We propose that those new rules and commitments should be enshrined in the European treaties.”
The “little tricks” he referred to is the Protocol 12 procedure, which the German government considers indecent and illegal (we completely agree. It would be illegal also in our view, and a disastrous political statement, trying to establish a fiscal union in an annex of a Treaty. Who is going to take this seriously? It seems to us that there is still a large number of people in Brussels who do not understand the nature of this crisis, and the outside world’s disillusion with unworkable fudges.) Also Van Rompuy angered Berlin by reintroducing ideas the Germans thought they had already killed such as eurobonds, a bank licence for the ESM and increasing the financial firewall by letting the EFSF and the ESM co-exist for a while. „We get the impression that some people have not yet understood the gravity of the situation “,an unidentified German top official is quoted by the papers (seeSüddeutsche Zeitung and Frankfurter Allgemeine Zeitung) „Some find it easy to always come up with new sources of financing. They find it much more difficult to correct the errors in the construction of the monetary union.“ As result Germany gave a very downbeat assessment of the chances for success at the crisis summit that will start in Brussels later in the day. Part of the German irritation comes from the fact that Van Rompuy challenges Merkel’s and Sarkozy’s claim to undisputed leadership in Europe. After their meeting in Paris on Monday the chancellor and the president drafted a letter which they thought would be the roadmap for the summit. By sending out his own letter without waiting for the Franco-German text Van Rompuy claimed the leadership role for himself. (We are now in an interesting situation. If Germany prevails, the attention of the financial markets will immediately focus on the implementation risks – referendums in several countries etc. If van Rompuy prevails, everybody will know that Germany will not consider the agreement sufficient. The ECB may not consider it sufficient either, and there would then be no pretence of a comprehensive solution. Ms Merkel has raised the stakes in this debate to such an extent that a fudge would become harder to sell.)
Consternation in the EU over Merkel’s Eurozone Treaty
The FT reports also quotes a senior EU official as saying that there was absolutely no enthusiasm for a treaty change, though a majority was now in favour of Ms Merkel’s approach. There is particular concern that a treaty change might take too long. What is causing particular consternation is Ms Merkel suggestion of a Treaty Change among the 17 eurozone countries, which would effectively seal a permanent split between the eurozone and the non-eurozone EU. So these are the two options that Ms Merkel is going to present to the European Council. We will change the Treaty together, or we going to split the EU. Reuters quotes the senior EU official as saying:
“A solution that does not involve 27 states will be a serious problem. It will show the EU is divided and that is not good for the markets,” said the official. “We’re not going to save the euro if the result of the summit is a split Europe.” The FT reports that the German proposal includes not only a new system to implement fiscal discipline, but also common rules on financial regulation, real economic convergence, harmonisation of corporate taxes, and the creation of a financial transactions tax, and also labour market policies. This list obviously goes too far for the UK. Germany also opposes proposals to let the EFSF run concurrently with the ESM, thus effectively doubling the firepower. Merkel also remains opposed to giving the ESM a banking licence (Though we suspect that these are among the concessions Merkel is likely to make to get her treaty revision.)
Reuters reports that Finland objects to one crucial part of the Franco-German agreement, that decisions within the fiscal union require an 85% majority threshold, as opposed to unanimity.
The more sceptical comments by Germany has had an impact on financial markets, as Italian and Spanish bond yields rose again, ending a rally that has lasted several days.
Banking crisis gets a lot worse
The urgency of the situation in the eurozone was underlined by data yesterday showing a dramatic increase in the use of the ECB’s emergency lending facility by Italian banks, which according to Reuters borrowed €153.2bn in November, up from €111.3bn in October. Eurozone also tapped the ECB’s first dollar funding operation to the tune of $50bn, about five times as much as forecast. The expectation for today’s ECB governing council meeting is for a cut in the main repo rate to 1%, and a 2 or 3-year LTRO. Reuters reports that the ECB is also thinking about loosening its collateral rules by broadening the pool of eligible collateral. Specifically, they may increase the amount of uncovered bank bonds, whose portion in a bank’s collateral portfolio is currently capped at 10%.
The terrible consequences of a eurozone collapse
Willem Buiter has an important commentary in the Financial Times this morning. He asks what happens if the euro collapses? He says it would be chaotic. A complete breakup would create pandemonium. It would be precipitated by disorderly sovereign defaults and lead to collapse of systemically important financial institutions throughout the EU and the North America, and would trigger a global depression. He puts the probability of a Greek exit at 20-25%. If Greece were to go, most contracts would be redenominated in New Drachma, which would devalue sharply. The country’s banks would collapse, and so would the Greek economy. Greece would enjoy a temporary competitiveness gain, but a fast rise in wages and inflation would soon restore the status quo. Once Greece goes, the market would speculate on the next exit candidates, and this would trigger bank runs in various parts of the eurozone. Buiter concludes:
“Even if a break-up of the eurozone does not destroy the EU completely and precipitate the kind of conflicts that disfigured the continent in the past, the case for keeping the show on the road seems rather robust.”
Wolfgang Proissl warns the ultimate responsibility for saving the euro is with the governments, not the ECB
Writing a comment in FT Deutschland Wolfgang Proissl warns governments not to rely too strongly on the ECB for saving the euro in the next couple of days. While the ECB can and will do more to help such as cutting rates today, enhancing its role as lender of last resort to solvent banks and beefing up the SMP the ultimate responsibility for saving EMU lies with the governments. First the ECB should condition any additional support to an ambitious summit agreement on fiscal union. Secondly the ECB should not accept to become the lender of last resort for the eurozone states unless they are prepared to definitely pool their sovereignty in a fiscal union that goes much further than what Angela Merkel and Nicolas Sarkozy are prepared to accept at the moment. Should the governments refuse they must bear the consequence and accept the responsibility for a potential failure of EMU.
The Irish budget officially unveiled
No surprises from the budget 2012, when it was revealed officially in the last days. Michael Noonan announced revenue increases of €1bn through indirect taxes, including a well flagged rise of 2pp in VAT, an household charge, carbon tax, capital gains tax, motor tax and other measures. He also said it is determined to keep the country’s competitive 12.5% rate of corporation tax, the Irish Independent reports. Earlier Brendan Howlin delivered the first round of tough cuts, worth €1.4bn, cutting down significantly spending on health, education, agriculture and social spending, though weekly social welfare payments remains protected. The government also cut its forecast for Irish GDP growth to 1.3% next year, down from the 1.6%. The Irish Times has details about all the main measures.
Banks will undergo huge deleveraging in the near future
As a result of the stricter capital requirements the banking sector will undergo an unprecedented deleveraging process, a Deloitte study shows according to Handelsblatt. The study estimates that European banks alone will sell off assets in the volume of €1.700bn of which €522bn will come from German banks.
Switzerland prepares for the blow-up of the Eurozone
Switzerland is preparing contingency plans in case of a blow up of the Eurozone, Handelsblatt reports. Finance minister Evelyne Widmer-Schlumpf yesterday told the parliament that the introduction of capital controls and negative interest rates were under study in case EMU broke up. In the case of negative interest rates money held by foreigners in Switzerland would be subject to a penalty tax. „Obviously we are prepared for all possible alternatives“, she said according to the paper. The different options are being looked at by a task force that was founded to deal with the strength of the Swiss Franc.
Spreads, Forex, ZC Swaps and Ois-Libor Spreads
Bond spreads up again, ahead of EU summit show-down; inflation swaps come down over the whole spectrum; Euribor-OIS Spreads promise more stress to come in the next week.
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