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EU summit is mostly work in progress
The EU summit Monday, was never really supposed to bring any radical new solutions to the debt crisis but rather serve as a working meeting ahead of the summit on March 1. As such the summit Monday didn’t disappoint. Three topics are worth mentioning in this respect:
1. EU leaders claim to have finalized the “Fiscal Compact” – which was first introduced at the EU summit in December. The key element of this compact is that rules on budget deficits will now have to be written into national legislation, preferably of constitutional nature. The Fiscal Compact has support from 25 EU member states, with the Czech Republic and the UK preferring to stay outside. I still think that the fiscal compact is more about preventing the next crisis, 10 to 20 years down the line, and less about putting up an effective firewall that can prevent further contagion right now.
2. Agreement to move the permanent rescue fund, the ESM forward by one year to 1. July 2012. EU leaders have not yet decided whether the resources of the ESM and the temporary European Financial Stability Mechanism are adequate, but they still pledge to review this question at the March summit in less than 5 weeks. The fiscal compact has sometimes been described as the price Ms. Angela Merkel demanded in return for giving the nod to a larger rescue fund, but judging from her comments at the Davos summit last week, this does not seem to be the case.Indeed I see a risk that the relatively good sentiment in Euro area debt markets (except for in Portugal – more on this below) following the ECB’s huge EUR 489 bn 3-year LTRO (and possibly even more coming on February 26) could lead Angela Merkel to conclude that there isn’t a need for beefing up the rescue funds after all. Considering that Sarkozy could easily be replaced by the Socialist Francois Hollande after the elections in late April/early May, Merkel will probably be wary of giving in on this issue – particularly since Mr. Hollande has pledged to renegotiate the fiscal compact if he is elected.
3. EU leaders expect a final deal on a voluntary debt restructuring for Greece to be announced later this week, with the actual debt exchange being executed in the middle of February. As we note in our in our Euro area update attached, a voluntary exchange is unlikely to produce a participation rate above 90%, necessary to bring debt down to “sustainable levels” and it seems highly likely that collective action clauses will be introduced retroactively at some point. Even then Greece still has a very long way to go, as the economy is mired in a deep recession making it extremely difficult to succeed in stabilizing public debt.
Oh yeah – I forgot to mention that EU leaders also agreed to focus on growth and job creation – who could disagree with that – but so far the proposals in this area are rather vague. Anyway, it is difficult to see what the EU can do in this area, when the policy menu is all about fiscal austerity.
The reaction in financial markets to the EU summit and the Greek debt negotiations were mostly negative on Monday. In particular the near finalisation of the Greek debt rescheduling agreement, seems to have shifted attention towards Portugal, driving Portuguese yields sharply higher. Euro area politicians have sworn that Greece was a unique case, not to be repeated in other member states, but investors seem to think that actions speak louder than words . To us it looks almost certain, that Portugal will have to ask for a second loan from the EFSF/ESM in 2013, when the country was otherwise supposed to return to markets. With rescue fatigue lingering under the surface, not least in Germany and Finland, a second Portuguese rescue package could easily lead to new demands for a voluntary rescheduling of Portuguese bonds.
Best regards, Anders Matzen, Chief Analyst, The Euro area Global Research Nordea Markets
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