Angela Merkel plans to block central elements of the Group of Four (Van Rompuy, Barroso, Juncker, Draghi) proposal. Handelsblatt reports that she is in favour of strengthening a common euro area banking supervision but ruled out any agreement for a banking union that would contain a common deposit guarantee fund. Also the chancellor resists the mentioning of Eurobonds and Eurobills. All three proposals are “economically wrong and counterproductive”, the chancellor said. At the same time Merkel criticized the lack of ambition in the proposals concerning the common control mechanisms and the transfer of competencies to a political union at the European level.

(Please note that while this is not a good sign, this may well be her opening bargaining gambit. She wants a stronger commitment to political union, and if she gets that, she may accept some of the other proposals. The question is whether the ultimate package is sufficient coherent to solve the actual problem. In our view the real problem with Merkel’s vision of a political union is not a genuine democratic system, but the right by a central authority to override national policies, and impose vetos.)

Jens Weidmann endorsed the chancellor’s point last night. There can be no pooling of risk through euro bonds or other tools unless governments are prepared to give up some of their control over national finances, the Bundesbank president in Hamburg last night according to Reuters. “There’s a discussion about euro bonds, euro bills, pooling of risk, but not about giving up sovereignty,” he said.

Spanish bond yields came under intense pressure yesterday, as hopes for the summit had faded. Italian and Spanish had previously rallied for four consecutive days, partly on hopes that Mario Monti’s proposal on ESM bond purchases would be accepted. That now does not seem to be the case.

 

Number 4 and 5 in just a day – Spain and Cyprus are now in

Cyprus turned to the EU for emergency funding for its banks and its budget, only hours after Spain submitted a formal request to bail out its banks, Reuters reports. It is the fifth euro-zone country to turn to the EU for emergency funding. Tiny Cyprus has just four days to raise at least €1.8bn – equivalent to about 10% of its GDP – to meet the deadline set by European regulators to recapitalise Cyprus Popular Bank, its second largest lender whose balance sheet was severely affected by the Greek debt restructuring. Finance Minister Vassos Shiarly said the country would also seek enough money to help with its budget deficit. The FT cites some Cypriot economists saying that Cyprus could need as much as €10bn to cover the banking sector’s exposure to Greek private sector debt as well as the capitalisation requirements.

Cyprus suffered a further blow on Monday as Fitch cut it down its sovereign credit rating to junk BB+ grade, the FT reports. Fitch said Cyprus’s banks could still need up to €4bn in fresh capital on top of the amount needed for Popular Bank. That was a sum equivalent to about 23% of GDP, the agency said, and was likely to have to come from the government. The Fitch downgrade forces the ECB to stop accepting Cypriot government bonds as collateral. Cypriot banks will now have to find alternative assets to pledge or seek temporary aid – so-called “emergency liquidity assistance” – from the country’s own central bank. Cypriot banks are already thought to be getting several billions euros of ELA.  Once Cyprus formally negotiates a eurozone bailout it is likely the ECB’s governing council would agree to waive these collateral rules, as has already happened for Greece, Ireland and Portugal.

 

Spanish government officially launches EFSF request

Not much of a surprise here. The Spanish government official applied for an EFSF package for its banking system through a letter from Luis de Guindos to Jean-Claude Juncker. The latter says that a memorandum of understanding should be signed by July 9, and it should be based on the (in our view too optimistic) report by the report of the two independent consultants.

The most noteworthy aspect of El Pais’ story is that sense of foreboding. The story starts with the comment that there was a feeling in Madrid that the euro would crumble, not just this or that country, but the whole edifice.

 

Moody’s cut ratings of Spanish banks as Spain officially asks for an EFSF programme

El Pais reports that Moody’s cut the ratings of 28 Spanish banks between one and four notches, including banks that are considered safe, like Santander, which is now at Baa2, while BVVA is at Baa3 – which is also the level of Spanish sovereign debt. This is just a tick above what is euphemistically as investment grade. The article said Moody’s had already taken into account yesterday’s application for an EFSF programme. It is the second downgrade of Spanish banks by Moody’s since May.

 

Finance minister wanted!

Greece needs a new finance minister after National Bank President Vassilis Rapanos turned down the position on Monday for health and political reasons. Apart from his health problems he cites in his resignation letter, Rapanos is said to have serious concerns about the cabinet named by Samaras, Kathimerini reports. Rapanos is also said to be alarmed by the content of the coalition’s policy programme, published on Saturday. He is said to consider the programme to make it more difficult to achieve the fiscal targets and are likely to be challenged by Greece’s creditors. The post is currently held by caretaker Giorgos Zannias. One option is to keep the experienced Zannias in the position. Other candidates are Development Minister Yiannis Stournaras and ex-Interior Minister Tasos Yiannitsis. In any case, Zannias will accompany President Karolos Papoulias to the European Union leaders’ summit on Thursday.

President Papoulias is to lead the Greek team, after officials in Brussels said that Samaras choice of the foreign minister violates EU laws, which require prime ministers or heads of state at such summits.

 

Portugal reassures it will meet its targets despite rising risks

Portugal faces €2bn budget hole by the end of 2012, titles Jornal de Negocios, due to the rise in unemployment to 15% and falling consumption. Tax revenues is coming in below expectation and Portugal’s core public sector budget deficit jumped 35% in the first five months of the year, Reutersreports. Prime minster Passos Coelho did not exclude further austerity measures but said that at this time, “it is too early” to think about new austerity measures.  He woed to   “We have goals and objectives to meet and we will meet them,” Passos Coelho told parliament, as he rejected a motion of no confidence in his centre-right government presented by the small Communist Party.

 

French government will introduce spending freeze for 3 years

Prime minister Jean-Marc Ayrault yesterday told his cabinet colleagues that the budgetary situation of France and the country’s obligation to meet the 3.0% deficit target next year required a spending freeze from 2013 to 2016, Les Echos reports. Since spending will not be inflation adjusted and since the Ayrault government will not continue the policy of the preceeding conservative government to cut the number of public servants there is a need to cut current expenditure and subsidies by several billion during that period the paper says.

 

Merkel aims at two-thirds-majority for ESM ratification

Contrary to her policy up to now, Angela Merkel now aims at a two- thirds-majority in Bundestag for the ratification of the ESM treaty this Friday, Süddeutsche Zeitung reports. So far the chancellor argued that while there where clear transfers of competences in the fiscal pact which required a two-thirds-majority the same was not the case with the ESM. But the chancellor changed her mind in order to be prepared should there be any attempts to challenge the constitutionality of the ESM at the constitutional court in Karlsruhe. According to the paper there will be no difficulty in getting the two-thirds-majority because the coalition had previously reached a global agreement with the opposition SPD and Greens on the fiscal pact as well as the ESM. There are already attempts to attack the constitutionality of the pact at the Karlsruhe court by a former SPD justice minister and others on the grounds that it impinges on the budgetary competences of Bundestag and Germany’s sovereignty.

 

Merkel distances herself from Schäuble’s ideas for an EU referendum in Germany

Angela Merkel was cool yesterday on Wolfgang Schäuble’s idea that a referendum on transferring more sovereignty to the EU level may came much sooner than many expected, Financial Times Deutschland reports. “Clearly we are not there yet”, the chancellor’s spokesman said yesterday. A referendum about further transfers of competencies was perhaps something for “the day after tomorrow”, he said. Merkel agrees in principle with Schäuble that further competencies will have to be transferred to the EU level in order to make EMU work. But she does not think that for the foreseeable future those transfers will reach an extent that would require a referendum. Referenda are foreseen according to the constitution in case the federal nature of Germany is reorganized or in case of really far reaching transfers of sovereignty. In its ruling on the Lisbon treaty the constitutional court had said that Germany reached the limits of transfers of sovereignty that were possible without a referendum.

 

The Bundesbank is likely to fail in its attempt to impose its “coronation theory” on banking union, Wolfgang Proissl argues

In his column for Financial Times Deutschland Wolfgang Proissl explains that the Bundesbank has resuscitated its “coronation theory” – that monetary union should follow political union. In a speech two weeks ago Jens Weidmann offered an updated version of this theory by demanding that a banking union with common supervision, deposit guarantee and a resolution authority was possible only after an agreement among the euro members on a fully fledged fiscal union with transfers of budgetary sovereignty, strict fiscal rules and quasi-automatic sanction. However, the new version of the coronation theory is likely to fail again as time constraints and market expectation will force Germany and the other euro members into agreeing on a much less ambitious banking union much quicker than Weidmann’s approach would allow for.

 

Paolo Manasse and Luca Zavalloni on why Monti’s programme is misdirected

This is not really about Monti, but about the interaction of financial markets and policy – but it has important implications for Italy. Writing in Vox, Paolo Manasse and Luca Zavalloni argue that after a long period of benign neglect, markets  have rediscovered that fundamentals and structural fragilities matter.

“The implications for the appropriate policy response required in order to become more resilient are straightforward: More emphasis should be placed upon the employment and growth so that fiscal consolidation does not backlash by plunging the economy into recession…Labour market reforms that reduce unemployment should have priority. However, structural reforms aimed at increasing flexibility and reducing firing costs – such as the one currently being voted by the Italian Parliament – may backlash if they raise unemployment in the short run.”

 

 

10-Y Spreads, Forex, ZC Swaps and Euribor-Ois

Getting worse again. Spanish spreads at 5.255%, and euro below $1.25.

10-year spreads
	Previous day	Yesterday	This Morning
France	1.028	1.121	1.139
Italy	4.229	4.670	4.654
Spain	4.772	5.176	5.255
Portugal	7.996	8.256	8.311
Greece	25.361	25.580	#VALUE!
Ireland	5.575	5.683	5.741
Belgium	1.706	1.787	1.848
Bund Yield	1.578	1.465	1.481
Euro Bilateral Exchange Rate
	Previous	This morning
Dollar	1.249	1.2497
Yen	100.000	99.44
Pound	0.803	0.8026
Swiss Franc	1.201	1.2008
ZC Inflation Swaps
	previous	last close
1 yr	1.1	1.13
2 yr	1.29	1.1
5 yr	1.55	1.5
10 yr	1.92	1.87
Euribor-OIS Spread
	previous	last close
1 Week	-6.986	-7.286
1 Month	4.043	4.143
3 Months	31.179	31.679
1 Year	96.521	97.221
Source: Reuters