The measures taken at the summit are a significant step forward in terms of stabilising the region’s financial markets, says Standish’s Brendan Murphy.
However, we are yet to see a detailed roadmap to Eurozone fiscal and political union and further policy action from the ECB is likely in an attempt to boosts the European Stability Mechanism’s (ESM) effectiveness.
“We view the measures taken at the EU Summit last week in Brussels as a significant step forward in stabilising European financial markets,” says Murphy.
“These measures should go a long way towards breaking the negative feedback loop between banks and sovereigns and be supportive of risky assets in the near term. However, they do not solve the problems of excessive debt and weak economic growth that are likely to continue to weigh on the Eurozone. More will be needed to permanently bring down funding costs for sovereigns to more sustainable levels,” he adds.
“While volatility is likely to persist in financial markets, the steps taken at the summit, combined with evidence of more supportive policy shifts from major central banks, give us confidence to increase the amount of risk we are willing to take, in particular in areas like corporate credit and emerging markets where valuations are attractive and fundamentals remain solid,” says Murphy.
Plans afoot
The following proposals have been made and will be considered by national governments:
The European Stability Mechanism (ESM) can be used to recapitalise banks directly
“This provision attacks the most contentious aspect of Eurozone policy coordination: explicit debt mutualisation,” explains Murphy.
“Core Eurozone countries have been reluctant to use the ESM as a direct bank recapitalisation tool because the liabilities within the banking system can be large, thus rendering them politically untenable. Yet, if handled properly – we are scant on details for the moment – this could break the financial links between banks and sovereigns, thereby freeing up sovereigns to focus on credible macroeconomic reform,” he adds.
“It is possible that this provision can be extended retrospectively to previous bank recapitalisations in Ireland, Portugal, Greece, and Spain. Furthermore, in reading the statement, we do not believe that this will require full ratification of the treaty by national parliaments. Nevertheless, the ESM itself still needs to be ratified by the parliaments of the majority of Eurozone governments.”
Establish a single supervisory mechanism for the banks in the Eurozone, which should involve the European Central Bank (ECB)
“We believe that this is a positive step in preventing future crises. However, critical measures to prevent inter-regional contagion are still missing, such as pan-European deposit guarantees.”
He continues, “The fact that the ECB is involved suggests that these regulatory efforts will pertain solely to the 17 countries participating in the monetary union, rather than the 27 members of the European Union as a whole.”
The Spanish bank recapitalisation will be financed through the European Financial Stability Facility (EFSF) and transferred to the ESM without assuming senior status
“The Spanish bank bailout will move from the EFSF onto the balance sheet of the ESM when it becomes functional, but the ESM will not hold senior status on the Spanish loan programme,” says Murphy.
“At this time, this provision is specific to the Spanish recapitalisation programme only,” he adds.
Establish a €120 billion fund for immediate growth measures. These measures will be financed via the European Investment Bank (€60 billion), the EU budget (€55 billion), and the new Project Bond issuance (€5 billion)
“The European Commission has pushed for growth financing for investment projects and jobs. While the amount is small and does nothing to alter the near-term outlook for the region as a whole – these funds represent just 1.3% of 2011 Eurozone nominal GDP – it could be helpful to the smaller programme countries,” explains Murphy.
“On balance, we believe that material progress has been made on breaking the financial link between the sovereigns and their banks, but there are few signs of a detailed roadmap to fiscal and political union.”
He continues, “We expect further easing from the ECB in response to this positive Summit outcome in order to provide the national governments time to implement the new measures related to the ESM’s expanded capabilities and create a new regulator. Our view is that these measures are a step forward in stabilising European financial markets and welcome this demonstration of policy coordination.”
10 July 2012
