Eurozone: Second Italian victory or extra time?

Last night, Eurozone leaders agreed on a first step towards a banking union. Short-term relief for Spain and Italy, however, remains very cryptic and limited.

After a nerve-racking night, Eurozone leaders this morning made a first step towards a banking union and at least gave the impression that Spanish and Italian pleas for emergency action have been addressed. Both countries had earlier withheld their agreement to the 130bn euro growth package.

In the early morning, Eurozone government leaders had agreed on the following: 1) start of a single bank supervisory mechanism with first proposals by the end of the year; 2) EFSF/ESM loans for Spanish bank recapitalisation will not have seniority status; 3) once a single supervisory mechanism is established the ESM could have the possibility to recapitalise banks directly. Moreover, Eurozone leaders emphasised that existing EFSF/ESM instruments will be used in a flexible and efficient manner. What this latter exactly means remains to be seen. Judging from comments after the meetings, the flexible use could mean more preventive liquidity support but also more active bond purchasing by the EFSF/ESM.

Despite the initial enthusiasm by some politicians and also market participants, it is important to stress that this morning’s meeting did not agree on direct bank recapitalisation for Spanish banks (yet), neither did it decide on debt collectivisation nor on immediate support for Italy (although EFSF/ESM intervention might do the trick). Even the possible direct bank recapitalisation once a banking supervision has been established remains conditional. The only real concrete decision taken this morning is the start of a single bank supervision. In the end, the German principle of conditional integration is still intact.

All this means that there are still many hurdles ahead. Just think of national parliaments and legislation, starting already today when the German parliament will vote on the fiscal compact and the ESM Treaty. At first glance last night’s decision could look like the second Italian victory over Germany within less than 12 hours. At second glance, however, it is rather a draw, bringing the game on the euro crisis into extra time. If the aim is to take to ease tensions on the Italian and Spanish bond market on a more sustainable basis, we probably will need to have more assurance on the fire power of the ESM. Therefore liquidity support from the ECB looks inevitable. It is not impossible that we might already get an answer on that point before the markets open on Monday morning.

Sequel or sequencing?

The vision thing is out. However, this week’s summit will rather be the sequel of a crisis evergreen than the start of the sequencing towards a Eurozone 2.0.

When EU president Van Rompuy presented his report “Towards a genuine economic and monetary union” yesterday, even the last one should have realised that this week’s European Summit will hardly conclude with a roadmap towards more integration. This will only be an overview map but without sequencing or a detailed timetable. Nevertheless, no one could accuse Van Rompuy or his co-authors (the presidents of the European Commission, the Eurogroup and the ECB) of a lack of ambition.

As expected, the report presents four building blocks for a Eurozone 2.0:  1) an integrated financial framework (with the main features being a banking union with a European bank supervision, a common bank resolution mechanism and Euro-wide deposit guarantees); 2) an integrated budgetary framework (which could include a Eurozone finance minister, a loss of national budgetary national sovereignty and eventually common debt issuance); 3) an integrated economic policy framework (going beyond the Euro Plus Pact towards more coordination and harmonization); and 4) ensuring democratic legitimacy and accountability. While all of this is indeed highly visionary and includes in our view the right elements for the Eurozone to survive, it remains vague and is far from being a road map.

So far it is only a loose collection of crucial elements and hardly any of these elements are likely to be agreed at this week’s summit. Coincidence or not, shortly after Van Rompuy had released his report, news wires quoted German Chancellor Merkel saying that total debt collectivization in the Eurozone would not happen as long as she was alive. Let’s hope that this will not lead to any assassination attempts in Brussels.

For this week’s summit, all of this means that the most concrete conclusion will be the growth initiative of €130bn and a wider growth compact. The expected discussion on more flexibility for the ESM and even direct ESM support for banks should be blocked by the German government. Let’s not forget that Germany has still not ratified the ESM Treaty. Changes to the ESM would definitely not increase the German parliament’s appetite for ratification. Finally, as regards the vision thing, Van Rompuy’s report has something for everyone and remains non-committed enough for all Eurozone government leaders to embrace it and to ask Van Rompuy to return with a more detailed plan after the summer. The only element this week’s summit could already decide, is a European bank supervision, which could be regarded as a first step towards a banking union.

In our view, such an outcome would clearly not lower bond yields in peripheral countries, but it could at least be sufficient to keep the ECB at it. While this would not automatically trigger new non-standard measures, it could at least be another argument for a rate cut next week. Beyond this week’s summit, the Eurozone will need to hurry up to transform the overview map into a real roadmap with a detailed sequencing of the way towards a Eurozone 2.0. Ideally, the Eurozone reform would come with one big bang, one total package. However, given the legislative process and Treaty changes involved, this would probably take far too long. We therefore think that a first next step could be more flexibility for the ESM through ECB liquidity support. Direct bank recapitalisation will only come once first steps towards a banking union have been taken. If the situation worsens and the ESM capacity is insufficient, shorter-term Euro t-bills could follow. However, this first step of joint liabilities would probably only be accepted by the German government if strict conditionality is ensured.

This week’s European Summit will be the sequel of what has almost become an evergreen: another decisive summit. The sequencing of the way towards Eurozone 2.0, however, remains a cliff-hanger.

Conditional integration

Even if the German government might be less dogmatic than some think, it will stick to the principle of conditional integration at this week’s crisis summit.

Ahead of this week’s European Summit, there does not seem to be a lack of ideas of how to solve the Eurozone crisis. Euro-bonds, a Eurozone banking union and a growth pact could, at least in the eyes of some politicians, market participants and commentators bring an end to the crisis. However, all these proposals still meet strict German refusal. What can we expect from the German government this week?

In a long interview, German finance minister Schäuble gave some insights in his and the government’s long-term view for the Eurozone. Germany wants to morph the monetary union into a political union. According to Schäuble, national constitutions are reaching their limits and it could be rather earlier than later that Germans would have to vote on a new constitution. Schäuble wants to shift political power from the national level to the European level, developing the European Commission into a European government. The president of the Commission should be elected directly. Europe would have to find its own, specific model of a political union. According to Schäuble, neither the federal system in the US nor in Germany could be a guideline for Europe. It is obvious that the German government is slowly on preparing the Germans for a political union. No fully-fledged political union but a Europe (or a Eurozone) based on a more accentuated subsidiarity principle.

Visionary for the long run but what about the short run? Ahead of this week’s summit, the main area of conflict between government leaders is exactly the different time horizons. While the German government wants to subordinate all next steps to the long term view for the Eurozone, most other Eurozone countries look more focussed on possible short-term fixes. A face-saving compromise for all countries is obviously the growth compact. Probably the most tangible result of this week’s summit. On Friday, government leaders from Germany, France, Italy and Spain agreed on a package to stimulate growth, amounting to €130bn (c.1% of EU GDP). This package needs to be embraced by all countries this week. As already decided earlier, funding of this package will mainly come from the EIB, unused European funds and private-public sector investment tools. Deficit spending will not be part of the package. To the contrary, in the more general growth compact, the new pro-growth initiative that should also be agreed this week, the German handwriting is more dominant than the French. Most emphasis seems to be on structural reforms not on more spending.

Up to now, the German government has been opposing proposals as direct EFSF/ESM loans to banks, Euro bonds, Euro t-bills or a banking union. Any kind of collectivisation seems to be like a red rag to a bull to the German government. It does not look as if the German government would change this position easily. This does not mean that the government is not committed and determined to save the Eurozone. It is. The German government simply sticks to its principle of strict conditionality.

In our view, all Eurozone countries will eventually have to poor some water into the wine but they will have to give up their strict ideas of sequencing. For Germany, possible first concessions could be a single European/Eurozone bank supervision and a Eurozone redemption fund. Most other countries would have to embrace the idea of more political integration and a loss of national sovereignty. As a result of this process towards a typical European compromise, this week’s summit should at least outline the basic principles of a more integrated Eurozone. Combined with a growth compact, the €130bn growth initiative and maybe even some short-term liquidity band-aid, this could be sufficient to at least convince the ECB to take action again.

Preparing the groundworks

Tomorrow’s meeting of Eurozone finance ministers will be the prelude to another European meeting marathon with the sole aim of getting a handle on the worsening debt crisis.

The announced bailout for Spanish banks and the Greek elections have not succeeded in restoring calm on financial markets. To the contrary, bond yields are still increasing and some market participants are already speculating about a full-fledged bailout for the Spanish government. It looks as if the Eurozone is running out of options and that stopgap measures no longer do the trick. It is obvious that next week’s European Summit with the scheduled fundamental discussion on the future of the Eurozone comes anything but too early.

Despite the obvious attempt by Eurozone leaders to temper expectations about next week’s summit, there seems to be a growing consensus that more integration is needed to keep the Eurozone alive. However, the exact definition of more integration or even a political union still seems to be a matter of dispute. Judging from the proposals circulating officially and unofficially, the new vision thing could be a combination of burden sharing with more fiscal and political integration. Proposals for burden sharing are, for example, a permanent liquidity or funding facility (eg, Euro bills or Euro bonds), a banking union with a single Eurozone bank supervision and a Eurozone bank deposit guarantee. As regards further fiscal and political integration, ideas like a Eurozone finance minister and an independent budgetary authority are currently being discussed.

Eurozone experience tells that there can be a discrepancy between what is discussed and what eventually sees the political light and reality. In this respect, the German position remains crucial, as there will not be a Eurozone solution without German consent. While the German government wants fiscal and political integration first, before agreeing to any idea of joint debt issuances, the French government (and other peripheral countries) have exactly the opposite sequencing in mind. Bringing both extreme positions together will be the challenge of the next days.

Listening carefully to comments from the German government over recent days and weeks sheds some light on the possible flexibility on the German side. A single European or Eurozone bank supervision has found more German support but a full-fledged banking union will take more time. The same holds for common Eurobonds. A debt redemption fund and maybe even temporary short-term Euro bills could be a gnashing German sacrifice, but accepting Eurobonds right away still looks very unlikely. While the German government could turn out to be more flexible than some market participants, it still looks very determined to stick to the principle of conditional integration for as long as possible.

Obviously, Eurozone leaders still have many issues to solve before presenting a first draft and outlines of the vision thing. One thing seems clear, even if Eurozone leaders agree to some new principles and elements next week, there will neither be a banking union nor Euro bonds on 1 July 2012. Let’s not forget: most, if not all, of the potential elements of the vision thing require changes of the European Treaties and these changes always require ratification by national parliaments.

Tomorrow’s meeting of Eurozone finance ministers in Luxemburg is the kick-off of a new meeting marathon, preparing the groundwork for next week’s European summit. Even if the summit looks very unlikely to put an immediate end to the crisis, it could prepare the groundwork for a new architecture of the monetary union. While this could be crucial step in a historical perspective, it might not be enough to restore calm on financial markets. Maybe it is enough to bring the ECB back in action.

De strijd om de euro

De voetbalgekte is ook bij ons thuis volledig losgebarsten. Eindelijk kunnen we onze nationalistisch-chauvinistische gevoelens uitleven bij het kijken naar die Mannschaft. In een laatste wanhoopspoging probeerde mijn Nederlandse vrouw onze kinderen naar de oranje kant van het voetballeven over te halen. Na gisteravond een duidelijk succesloos project. Bij voetbal stopt de liefde. Rivaliteit tussen Europese landen en nationaliteiten, zelfs thuis, dat belooft niets goeds voor de eurocrisis.

Een bail-out 'light' voor de Spaanse banken, een mogelijke Griekse exit na de verkiezingen van aanstaande zondag, nieuwe zorgen over Italië en sombere vooruitzichten voor de economie van de eurozone verdwijnen bijna op de achtergrond: koning Voetbal duwt de eurocrisis even weg. Mensen kijken samen in de Europese straten naar voetbal en vergeten even de crisis. En ook economen zoeken afleiding en laten hun modellen draaien om de winnaar van het EK te bepalen. Alsof er niets beters te doen valt. Sinds het jongste WK weten we dat een octopus de beste voetbalvoorspeller is. De fascinatie voor voetbal en economie blijft groot. Eigenlijk is er geen empirisch bewijs dat een voetbalkampioenschap een groei-effect heeft. Integendeel. Een blik op de kampioenenlijst van de jongste internationale voetbaltoernooien geeft zelfs niet-economen een duidelijk antwoord. Bij de kampioenen Griekenland, Italië en twee keer Spanje is het moeilijk om te beweren dat voetbalsucces leidt tot economische welvaart. Misschien was voetbalsucces alleen het gevolg van opgeblazen financiën en economieën.

Het is duidelijk: ook een halve finale met Italië, Spanje, Portugal en Griekenland zal de eurocrisis niet oplossen. Dat moeten de Europese politici doen. Voetbal biedt helaas weinig richtsnoeren. Integendeel. Het feit dat van alle eurolanden alleen Duitsland een zege boekte na de eerste wedstrijden op het EK, heeft niet geleid tot een discussie over een trainingsunie onder leiding van de Duitse bondscoach of een gemeenschappelijke pool voor doelpunten. Ideeën die juist wel bij de oplossing voor de eurocrisis horen.

De strijd om Euro 2012 is niet de strijd om de euro in 2012. De een leeft van nationale rivaliteiten, de ander overleeft alleen met meer integratie. Misschien is het EK voetbal een van de laatste overblijfselen van het oude Europa van lidstaten. Nationale verschillen en rivaliteiten worden gekoesterd, maar in feite is het een feest der verscheidenheid. Zelfs wedstrijden die vroeger heel explosief waren, zoals Nederland tegen Duitsland, worden alleen nog gekenmerkt door sportieve rivaliteit.

Zoals veel vaders droom ik natuurlijk stiekem dat mijn zoon ooit in nationaal tenue speelt. Dat is dan geen blauwe shirt met gouden sterren, maar een wit met de Duitse Adler erop. Zijn salaris krijgt hij hopelijk wel in euro.

Deze column verscheen in het Belgische dagblad "De Tijd"

ECB meeting – Draghi’s poker face

At today’s meeting, the ECB left interest rates unchanged. At the same time, they announced an extension of the full allotment procedure for all its liquidity operations, at least until the beginning of next year. No additional measures were announced. The ECB looks determined to keep maximum pressure on Eurozone politicians.


Listening to the ECB’s macro-economic assessment was a bit like listening to whistles in the dark. It looks as if they are becoming increasingly worried but does not want to show it. The ECB still expects the Eurozone to recover “gradually”. However, today there was more emphasis on uncertainty and further weakening. Strikingly, the more cautious tone and increased uncertainty were not reflected in the latest ECB staff projections. In regards to the growth outlook, ECB staff expects the economy to contract by 0.1% in 2012 and 1% in 2013. In March, GDP growth was expected to come in at 0.1% and 1.1%. Looking at inflation, ECB staff expects headline inflation to come in at 2.4% this year and 1.6% in 2013, unchanged from the March projections. A much more cautious Draghi but unchanged staff projections seemingly shows a divergence in views between ECB staff and the Governing Council.

In regards to the future path of monetary policy, ECB president Draghi kept a very low profile. If at all, and admittedly with some good will, Draghi very gently opened the door for a future rate cut . “Heightened uncertainty, “increased” downside risks to the economic outlook and the fact that today’s decision was taken by consensus, not by unanimity will keep rate cut expectations alive. Remember that the ECB has never used code words to hint at future rate cuts, only rate hikes. However, back in October last year, former president Trichet had prepared the grounds for Draghi’s November rate cut by stating that a rate cut had been discussed.

More generally on the Eurozone crisis, Draghi just repeated last month’s inconvenient truth that there was no silver bullet for the crisis. For example, questions on the ECB’s vision on the future of the Eurozone remained basically unanswered. In fact, Draghi’s comments and body language at the press conference gave the impression that, at least as far as he was concerned, today’s press conference could have been skipped. It was the picture of a poker player who keeps his cards close to his chest.

The ECB wants to keep maximum pressure on Eurozone politicians. Draghi’s comment, that it was not the ECB’s task to fill other institutions’ lack of action, was very clear. In our view, even if Draghi today denied that there was a quid-pro-quo, it is hard to believe that the ECB would really stay on the sidelines when push comes to shove. Too much is at risk. However, at least for the time being, today’s press conference was a clear signal that ECB is tired of pulling the chestnuts out of the fire for Eurozone politicians.

German IP falls in April

Welcome to the euro crisis, Germany. German industrial production dropped by 2.2% MoM in April, providing evidence that the economy has finally caught the euro crisis virus. In annual growth terms, industrial production is down by 0.7 %. The drop was driven by all sectors, except for energy production. Production in the construction sector saw a drop by 6% MoM, from the strong weather-driven rebound in March (+26% MoM). At the same time, production of capital and consumer goods decreased by 3.6% MoM and 3.7% respectively.


The German economy’s immunity against the Eurozone sovereign debt crisis is clearly fading away. Strong growth in the first quarter could only temporarily put a gloss on the fact that the Eurozone’s biggest economy is also faltering. Latest drops in confidence indicators and shrinking order books do not bode too well for the near term outlook for German production. New orders from other Eurozone countries are currently down by more than 15% YoY and orders at hand are dropping and now at their lowest level in almost two year. At the same time, companies have started to reduce inventories. The safety net of low inventories and richly filled order books has become much thinner recently.

Even if it will not fall, the Eurozone’s last stronghold is faltering. For the time being, it is a stabilisation at a high level. However, latest data clearly indicate that Germany is not an economic island. The debt crisis has finally reached the German economy.