Wednesday, June 27, 2012

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.

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