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The EU Summit has Eased Tensions for the Time Being


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The EU Summit has Eased Tensions for the Time Being

  1. 1. QNB Economics EU Summit has Eased Tensions for the Time BeingThe Eurozone crisis continued to unnerve investors Spanish government, leading to an increase in publicduring June in the run up to an EU leaders’ summit at debt. Worries about higher debt levels drove upthe end of the month. Despite a positive market sovereign bond yields.reaction to the summit, underlying issues remain andare likely to lead to a re-emergence of tensions, Also prior to the EU summit, European leadersaccording to a report from QNB Group, prompting EU appeared to be divided on how to tackle rising bondleaders to take more focused and concrete action. yields for Spain and Italy. Germany was insisting on a focus on fundamental long-term issues, such as givingDuring June, in Greece, anti-austerity parties more control to EU institutions over national budgetsthreatened to derail Greece’s bailout programme, but and economic policies. This led to little optimism thatelections returned a majority for the pro-bailout agreement on short-term crisis measures for Spain andparties. Following these elections, the focus of Italy would be reached at the EU summit on June 28th-concerns shifted to Spain and Italy. 29th.After months of speculation, the Spanish government However, in fact, leaders at the EU summit didwas finally forced to call for a bailout for its banks, succeed in reaching an agreement on a short-term fix.which are suffering from large exposure to a Spain and Italy were able to force action by refusing toworsening real estate market. These stresses and a discuss anything else until crisis measures weregenerally worsening outlook for the European agreed.economy, led to concern about Italian sovereign debt,driving up bond yields. During June, the yield on Consequently, at the summit it was agreed thatSpanish and Italian sovereign debt reached levels that Spanish banks could be recapitalised directly, reducingare generally regarded as unsustainable in the long projected government debt levels by 6%-10% of GDP.term, breaching the 6% mark in Italy and 7% in Spain. It was also agreed that the European Stability Mechanism (ESM) could purchase sovereign bonds Ten-Year Government Bond Yields without an accompanying monitoring programme. (Mar-July 2012) This cleared the way for the Italian government to (%) request assistance in its bond market. 7 The surprise positive result led to the largest daily drop Spain in Spanish and Italian ten-year bond yields this year, Italy from 6.95% to 6.33% for Spain and from 6.20% to 5.84% for Italy. It wasn’t just bond markets that 6 reacted positively, the Euro Stoxx 50, an index of leading European companies, gained 4.96% for the day and the Euro rallied 1.77% against the dollar to 5 €1:US$1.2662, also the largest daily gains this year. Despite the positive reception in financial markets, it is likely that tensions will re-emerge in the near future. 4 While the summit was successful in making some key 01 Mar 12 01 Apr 12 01 May 12 01 Jun 12 02 Jul 12 decisions, the agreement did not outline the details of implementation, making it potentially problematicSource: Bloomberg and QNB Group analysis with potential treaty changes and parliamentary approvals. More details should be revealed around aPrior to the summit, European leaders were able to meeting of EU finance ministers on July 9th.pledge up to €100bn for the bailout of Spanish banks,considerably more than the initial estimated The recapitalisation of Spanish banks was agreed onrequirements of €40bn. However, this was insufficient the basis that a Eurozone-wide banking supervisor, runto allay market concerns, according to QNB Group, as by the European Central Bank (ECB), would also bethe money would initially be lent to the banks via the created, consolidating 17 different organisations into a 1
  2. 2. QNB Economics“banking union”. This is complex and will take some an economic boost to EU countries. However,time to implement (the intention is to have it in place according to QNB Group, this involves tackling theby the end of this year), possibly leading to delays and symptoms of a weak Eurozone economy, not thedoubts about when recapitalisation loans will be structural debt issues that are driving the crisis.transferred from sovereigns to banks. The change inmandate for the ESM to be able to recapitalise banks The ongoing debt crisis is having a harsh impact ondirectly may also require a change in EU treaties, the real economy, according to QNB Group. Datapotentially creating complications. released on July 2nd indicated that Eurozone unemployment had risen to a record high in May ofFurthermore, the summit has not changed the 11.1% and a manufacturing activity survey was closeresources available to EU institutions to tackle the to 2009 lows. Manufacturing surveys last weekregion’s debt issues, according to QNB Group. The pointed to weakening economies around the world,combined Eurozone bailout funds have about €500bn suggesting the Eurozone crisis is having a wideof new lending available to them, or €400bn with the ranging impact.Spanish bailout deducted. With around €600bn ofrefinancing needs falling due for Spain and Italy in Should the European and global economies weaken2013, should these countries lose access to debt further, this would be likely to lead to greater stress inmarkets, the bailout funds would soon be exhausted. the EU banking system and sovereign debt marketsCurrent rescue funds are therefore insufficient to and would necessitate more drastic actions from theprotect the Eurozone system in the event that the crisis authorities.worsens, and this alone is likely to be sufficient to leadto investor concerns re-emerging. The key measures that could be taken are further long- term refinancing operations (the provision of cheapAdditionally, little progress was made at the EU loans to banks), increasing the size of the rescue fundssummit on addressing the fundamental issues to (the ESM), a Eurozone bank deposit guarantee schemeresolve the crisis in the long term. Germany gained a that also protects against the risk of redenominationcommitment for the European Council President to into new currencies and making the ECB anddevelop a time-bound roadmap for the achievement of European Commission more democraticallya genuine economic and monetary union, which would accountable as tighter union will strengthen theirinclude EU institutional oversight of budgets as well authority. An alternative means of bringing downas economic and monetary policies. However, a borrowing costs in the Eurozone periphery, issuingroadmap to stronger union does not bode well for swift jointly guaranteed debt, or Eurobonds, has been firmlyaction on the controversial issue of sovereign powers. rejected by Germany.A “growth pact” was also agreed to use €120bn ofpotentially available funds for investment to provide 2