Our lead today a seemingly contradictory set of news. If you go through this morning’s stories on Reuters you will find.

1.       Germany has ruled out any OSI.

2.       the Bundestag will not vote on a third package for Greece, so there will be no new money.

3.       Angela Merkel has decided against a Grexit, and will grant Antonis Samaras his extra two years.

The stories are a re-statement of the original eurozone contradiction: no bailout, no exit, no default. So where does the money come from without OSI or new loans? This is where the news gets more hazy. One article mentions that discussions focused on front-loading loans of the second programme, and using left-over EU budget funds. Other options discussed, according to a separate article, are bond buybacks, to be funded by the ESM, and direct bank recapitalisation by the ESM.

The second article also contains details from the forthcoming Troika report, according to which Greek debt would rise to 179.3% next year under the Greek government’s own scenario of a 3.8% fall in GDP.

(The troika has once been reported as forecasting a 5% contraction, so even this number looks optimistic. The bottom line is that the EU is scraping the barrel in the search to plug the funding gap. Bond buybacks do not work. Privatisation receipts will come, but it is unrealistic to expect a large windfall when everyone expects the country to default eventually. Germany rejects a full banking union and ESM programmes for legacy bank assets. And frontloading the programme makes a Greek exit dramatically more likely later on, as the second programme’s funds are depleted. So this pushes the can down the road for another year, during which the Greek economy will continue to implode. This is not a softening of the stance on Greece at all. This is about avoiding an accident before the German elections in 2013, at risk of increasing the probability of an even larger accident later on.)

Willem Buiter says the eurozone crisis is turning pear-shaped

Willem Buiter writes in the Financial Times that the crisis has turned for the worse, with Germany resisting a banking union, and the OMT remaining unproven in the absence of Spain applying for a programme. He says sufficient conditions for a solution of the crisis would be a full banking union (with resolution authority over all banks), and a managed debt default. But with growing bailout fatigue in the North and austerity fatigue in the South, the ECB will be pushed into the role of a Santa Claus, which will ultimately push out the strong countries.

(We agree with him that a solution of the euro crisis is becoming increasing unlikely – also in view of our main story that Germany accepts neither OSI nor new money, nor a full banking union. Germany would have to reverse all of those positions after the September elections, something we do not see as very likely. But where we are less certain than Buiter is the actual mechanism of a breakup.)

No hope for a deal on the Greek’s austerity package before Thursday’s summit

Efforts to conclude an agreement between Athens and the troika ahead of the European Union leaders’ summit on Thursday are unlikely to succeed as the two sides remained apart on the austerity measures and structural reforms needed to seal the deal, Kathimerini reports.  This means that a decision on the disbursement of Greece’s next loan tranche will have to be taken at an extraordinary Eurogroup meeting toward the end of this month or at the beginning of November. The troika’s latest demands, particularly the reduced dismissal costs and notice period, created frictions in the Greek government coalition. Greece’s lenders want the notice period to be reduced from six months to three and for the compensation to be a maximum of 12 months’ pay rather than 24.  Another sticking point is the troika’s demand for immediate sackings in the public sector. A meeting between visiting officials and Administrative Reform Minister Antonis Manitakis on Monday failed to yield results. The troika has rejected a plan for 15,000 civil servants to be dismissed with reduced wages for a year, demanding instead that bureaucrats from state organizations that are closed or merged be made redundant straight away.

Portugal unveils 2013 budget plan centred on taxes

The Portuguese government on Monday unveiled the final version of an austerity package centered on tax increases for 2013. Under the final budget programme, the government will raise €4.3bn in taxes, including €2.8bn from a cut in the number of income-tax brackets that will now range from 14.5% to 48%, and an extraordinary additional surcharge on income of 4%, according to Dow Jones Wires. There will also be an increase in charges over capital gains, property, house rentals, car ownership and a tax for financial transactions.  On the spending side, €2.7bn, the government will raise the retirement age in the public sector to 65 to match that of the private sector, will make sharp cuts in temporary working contracts it awards and will pay less for extra hours of work and sick leave. Most of the savings, however, will come from a monthly wage cut, out of the traditional 14 for public workers. Opposition reaction was fierce. Socialists called it a fiscal “bomb” thrown at the Portuguese, confirming once again that they will vote against the budget, Pedro Filipe Soares said it is a massive attack calling for the government to resign, Jornal de Negocios reports.

Consolidate with taxes or expenditure cuts: old debate with new arguments

Francois Hollande’s  choice for the 2013 budget to assure two third of its consolidation efforts through higher taxes and only one third through expenditure cuts provoked a debate among economists. Patrick Artus called it a huge error detrimental to growth and employment. Others cited research by Alberto Alesina, showing that over the last 40 years consolidations were more successful if they relied on expenditure cuts. But the French government counters that recent studies showed the opposite, Les Echos reports. A recent study by the IMF and the Federal Reserve showed that in a monetary union consolidation  based on taxes have less adverse effects in the short term (though much more expensive in the long term) and that a strong focus on expenditure cuts may be counterproductive if bond rates are close zero.

The crisis and the regional divide

A new book written by economist Laurent Davezies made it to the front page of Le Monde with its stern warning that the crisis will lead to rising fractions among the regions in France. The austerity drive of the government will reduce the social stabilisers and the gap between productive and less productive regions become more pronounced. More than 20% of employment is geographically in regions vulnerable to such chocks, faced with a irreversible decline in productivity. In 120 out of 350 regions public employment progressed more in the last 10 years than private employment. They would be hit hardest by austerity.

Austria misses budget targets due to bank rescues

Der Standard reports that Austria will miss its 2013 budget targets because of problems with nationalised banks. Kärntner Hypo is due to receive a capital injection of €700m, plus a further €200m in guarantees. The bad bank of Kommunalkredit is due to receive a capital injection of €250m. The data are straight from a 2013 budget draft. Another problem is a downward revision in economic growth – from 2.3 to 2.1%. Further budget risks are likely to arise from pensions. The article concludes that Austria may also miss its 2012 target by a wider margin than previously assumed, and is unlikely to be released from the EU deficit procedure.

Catalan Premier to “internationalize conflict”, mentions Scotland and Flanders

Catalan Premier Artur mas has reacted to Spanish government statements against the legality of an independence referendum by threatening to “internationalize the conflict” by appealing to the EU, reports El Pais (English Edition). Artur Mas appears to accept the argument that Catalonia would be outside the EU if it seceded from Spain, but suggested that the treaties could be ‘interpreted’ otherwise, and that the EU ‘has to prepare itself’ for the eventuality of Scottish, Catalan or Flemish secession.

Rising poverty in Spain

A number of recent stories illustrate the biting effects of the Spanish economic crisis. El Pais (English edition) reports that the purchasing power of wages dropped by 2%, which along with recent tax increases has resulted in the biggest drop in disposable income in 27 years. Publico carries a report by trade union CCOO that 35% of workers earn less than the full-time minimum wage of €641 a month, that 12% of salaried workers’ households are below poverty level, and that 40% of self-employed workers (among the highest rates in the EU, second only to Romania) are at risk of poverty. The report refers to 2011, and forecasts a poverty rate of 28% in 2012. Meantime, El Pais (English edition) reports that social services are supporting 8 million people, a 20% year-on-year increase, while the state budget allocation for emergency aid administered by local authorities has dropped by 2/3 in the past two years. Finally, according to another story the Spanish government has cut the public school budget by a billion Euros in a year, leaving half a million students without aid for textbooks.

Voices continue to rise for and against a Spanish bailout 

El Pais (English edition) reports that Italy is wary of the costs of a second bailout for Spain’s economy. Finance Minister Vittorio Grilli estimated in an interview with La Repubblica that an additional €100bn bailout for Spain would cost Italy 1.5% of its GDP. On the other hand, a story in the NY Times surveys the opinions of Spanish “economists, analysts and business executives” who think Rajoy’s delay in applying for a bailout will increase the ultimate cost to both Spain and Europe.

Hugo Dixon on the Spanish delay

In his column for Reuters Breakingviews, Hugo Dixon writes from Spain that the two main reasons for Mariano Rajoy’s hesitation are uncertainty about the ultimate goal of the ECB’s intervention – is there a spread target or not? – and uncertainty whether Germany would accept a programme as there is a risk that Germany would turn down such a request, coming so shortly after the Bundestag approved the bank programme. Spain is also irked by Germany’s insistence that the ESM should not deal with legacy bank assets. Dixon concludes that the situation is unlikely to be resolved until there is another panic.

 

10-Y Spreads, Forex, ZC Swaps and Euribor-Ois
10-year spreads
	Previous day	Yesterday	This Morning
France	0.595	0.565	0.581
Italy	3.527	3.580	3.571
Spain	4.196	4.344	4.403
Portugal	6.541	6.471	6.739
Greece	16.547	16.067	-1.49
Ireland	3.306	3.286	3.427
Belgium	0.918	0.860	0.878
Bund Yield	1.453	1.479	1.488
Euro Bilateral Exchange Rate
	Previous	This morning
Dollar	1.292	1.2963
Yen	101.490	102.22
Pound	0.806	0.8066
Swiss Franc	1.209	1.2089
ZC Inflation Swaps
	previous	last close
1 yr	2.01	1.99
2 yr	1.81	1.8
5 yr	1.92	1.9
10 yr	2.15	2.02
Euribor-OIS Spread
	previous	last close
1 Week	-7.957	0
1 Month	-5.871	-3.871
3 Months	4.286	4.186
1 Year	50.114	50.114
Source: Reuters