After yet another summit, “Europe’s leaders for once exceeded expectations”, says Economist.com. Consequently, the post-summit rally late last week lasted longer then the usual ten minutes. On Friday, the euro gained almost 2% against the dollar, while the Italian stockmarket index’s 6.6% jump marked its biggest one-day increase in over two years.
What’s changed?
There were three significant announcements at the summit. Firstly, the new permanent bail-out fund, the European Stability Mechanism (ESM), will now be able to recapitalise banks directly rather than via governments. This marks a “first step in trying to end the dance of death in which weak banks and weak sovereigns progressively stifle each other”, says Economist.com.
The €100bn facility for Spain’s banks would have been disbursed to the government, thus adding to Spain’s overall public debt burden. The new arrangement would stop the banks further infecting the government balance sheet. It could ultimately help Ireland too.
Another key change is that the debt owed by Spain to the rescue fund will not be senior to private investors’ loans. Loans from bail-out funds “so far have perversely driven existing private-sector investors out”, says John Authers in the FT, because they would be behind official creditors in the queue to get repaid in the event of a default. As a result, interest rates for indebted states have remained high.
This change “could help to fix the dynamic that has pushed up sovereign borrowing costs throughout the crisis”. Finally, the ESM will now be allowed to buy peripheral debt, thus hopefully easing the interest rates paid by Italy and Spain.
Still, there are “many unanswered questions”, says Fiona Maharg-Bravo on Breakingviews. One problem with the ESM recapitalising banks directly is that this must wait until the eurozone has created a new banking supervisor at the European Central Bank – a first step towards a banking union. That won’t begin to happen until the end of the year, and Spain’s banks need help before then. So for a while at least, Spain’s government will have to take on new debt.
Meanwhile, investors “may not take at face value the seniority concession on Spain”, says Richard Barley in The Wall Street Journal. That’s because they were “burned by the European Central Bank’s decision to make itself a senior creditor in Greece’s debt restructuring”.
Moreover, ongoing political disagreements may unpick some of the measures broadly agreed at the summit; early this week, for example, the Netherlands and Finland both said they were unhappy about the idea of the ESM buying bonds.
In any case, as Wolfgang Munchau points out in the FT, “no matter how you twist and turn it, the ESM is simply not big enough”. After the Spanish banking bail-out, it has around €400bn left. That’s the equivalent of 15% of the Italian and Spanish bond markets. This supposed bazooka, says Capital Economics, “lacks ammunition”.
What hasn’t changed?
The upshot is that while the summit produced “a better short-term fix than [many] had expected”, says Pimco’s Philippe Bodereau, it doesn’t appear “anywhere close to a permanent solution”. The eurozone economy continues to deteriorate, especially in the periphery, so struggling countries are highly unlikely to hit their deficit targets.
Markets will continue to fret about Italy and Spain defaulting and overwhelming the rescue fund in the process. The summit may have tempered fears of this scenario happening in the very near future, but it is still a danger. Nor has there been any significant movement on further political and fiscal integration, which would reassure investors that the eurozone as a whole could stand behind the struggling states’ debts. The crisis, says Hugo Dixon on Breakingviews, “is still there”.