It was another nervous week for global capital markets, as attention stayed firmly on political
manoeuvrings ahead of the end-of-week two-day European summit taking place in Brussels.
Tensions continued to ratchet up throughout the week, before the announcement early on Friday
morning that 23 member states had agreed to sign up to the new treaty, but with the UK objecting
on the grounds that it was against British interests. No wonder then, that markets opened on Friday
with a sense of weary resignation that yet another opportunity to make progress had been hindered
by European in-fighting.
The week started brightly, with an announcement from German Chancellor Angela Merkel and
French President Nicolas Sarkozy that laid out their plans for greater fiscal unity. Franco-German
relations have been particularly cordial of late, with the two leaders seemingly determined to put
past differences behind them and impress the markets with their togetherness. What they came up
with included:
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An agreement that private sector bondholders would not in future be asked to bear losses
on their debts if a debt restructuring takes place – so the Greek haircut is to be a one-off.
Treaty changes for all 27 European Union members, although if this could not be achieved
they’d settle for the 17 Eurozone members instead (in the end they obtained approval from
23).
The treaty to include automatic sanctions on countries with a deficit above 3% of GDP.
A ‘golden rule’ written into the constitution of all countries signing up to the treaty, obliging
governments to balance their budgets.
Bringing forward the launch of the European Stability Mechanism (the permanent bailout
fund that will replace the much more clumsily named European Financial Stability Facility)
from 2013 to 2012.
But on Tuesday, with markets still digesting the possible implications of the announcement, ratings
agency Standard & Poor’s (S&P) warned that 15 Eurozone nations had been put on ‘negative credit
watch’ and could have their ratings downgraded. Moritz Kraemer, head of European sovereign
ratings at S&P, said “After a good two years of trying to manage the crisis, the political efforts have
not been able to arrest matters. It is our view that this is a systemic stress, a confidence crisis that
affects the Eurozone as a whole”.
S&P is expected to finish its review as soon as possible after the summit, clearly the worry for them
is that picking up the bill for the Eurozone solution will increase the economic strain on the triple A
countries (Germany, France, Austria, Finland, the Netherlands and Luxembourg) in particular. Once
again, it was the timing of the announcement that gathered sharp criticism from several different
quarters, although S&P denied there being any political motivations behind it. Still, it is no surprise
that the European Commission is pushing for tighter regulation of the ratings agency sector, worried
that it can arbitrarily destabilise markets at “inappropriate moments”.
ECB announces rate cut and bank aid – but markets still aren’t impressed
On Thursday, as the Bank of England opted to hold interest rates at 0.5%, the European Central Bank
(ECB) cut the interest rate for the Eurozone by 25 basis points to 1.0%. This means that in the space
of a month, new ECB boss Mario Draghi has reversed the 0.5% of base rate hikes made during the
summer that most market participants believed to be policy errors.
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The possibility of a rate cut had been well flagged, so there was greater interest in hearing about a
number of ‘non-standard’ measures aimed at supporting banks, and whether the ECB was willing to
consider extending its financial support to Eurozone sovereign nations as well. But the markets only
got half of what they wanted. In terms of support for banks, the ECB plans to offer what it calls
three-year long-term refinancing operations (LTROs) that will provide unlimited longer-term
financing for financial institutions. The ECB has also widened its range of what it considers to be
‘acceptable collateral’ which can be used for loans, with ratings thresholds reduced and loans to
small and medium sized enterprises (SMEs) also now made acceptable.
Draghi also signalled that he was not prepared to see the ECB wade unilaterally into government
bond markets, and that it would really be up to the Eurozone members to find their own way to fund
the mess they’d gotten themselves into. Mario Draghi has been impressive since taking over the role
as ECB president in November, delivering an approach that has been more pragmatic and less
focused on shaping policy suited to German interests than his predecessor. He’s been supportive of
Eurozone politicians and he’s carefully paved the way to enable the ECB to take a more aggressive
interventionist approach to the crisis, but with limits.
Does Cameron veto now leave Britain out in the cold?
On Thursday at the EU summit, Prime Minister David Cameron was quoted as saying that
negotiations with fellow members was “like playing chess against 26 different people rather than
one person – and I’m not that good at chess anyway”. But Cameron made quite a move on Friday,
wielding the British veto which could help see the European Union divided into two separate parts.
As things stand, the UK will remain outside of the new pact (along with the Czech Republic, Hungary
and possibly Sweden), because the other members were unwilling to give the UK concessions that
would ring-fence its financial institutions from the proposed new regulations. Cameron might have
appeased his party, but he’s certainly antagonised the rest of Europe and isolated the UK at a time
when markets have been crying out for solidarity and cohesion.
Oliver Wallin, 9 December 2011
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