Glacial progress flagged at G20

June 20, 2012

The G20 summit may have marginally exceeded the lowest common denominator of expectations with euro zone leaders pledging to work on integration of their banking sectors as part of a push towards fiscal union. But it’s not clear that a banking union will happen any quicker than we thought before.

Germany is happy for cross-border oversight, maybe in the hands of the European Central Bank, to be zipped through but on the really vital parts of the structure – particularly a deposit guarantee scheme to guard against bank runs – it has clearly said it would only be possible once the drive towards fiscal union is set in stone. It will also not countenance mutual debt issuance until the fiscal union is in place.

Onus was put on next week’s EU summit to put flesh on the bones, although no definitive decisions are expected there and EU Commision President Barroso he would present its plan on banking integration in September. Here’s the reality check: European Council President Van Rompuy spelled out the vision of a much deeper economic union to underline the irreversibility of the euro project and said it would take less than the 10 years that ECB chief Draghi has talked about. And for many countries, particularly France, the surrender of that much sovereignty will be very hard to take.

At the G20, French President Francois Hollande and Italian Prime Minister Mario Monti appear to have pressed for the ESM bailout fund, which comes into force next month, to buy Spanish and Italian bonds on the secondary market, although the former said no decisions had been made. The pair of them will discuss the subject further with Merkel and Rajoy when the four leaders meet in Rome on Friday. That could give the bond market pause for thought – and relieve pressure on the ECB to revive its own bond-buying programme. The ESM’s rules allow it to do this but there are problems. History shows us that to really alleviate selling pressure, the ECB had to buy 10 billion euros of bonds or more per week last year. That wouldn’t be required week in, week out but the ESM’s maximum 500 billion euros could start to dwindle fairly quickly if sellers didn’t back off, making the resources for a full sovereign bailout look even thinner.

Also, there will be a certain amount of stigma attached, of the sort that Spain in particular finds very difficult to swallow. Before intervening, a request from the recipient country is required as is a memorandum of understanding, which may attach conditionality. Tellingly, the final G20 communique referred vaguely to aims to reduce borrowing costs for struggling euro zone countries, but no more.

Having said all that, Spain cannot cope with 10-year yields at 7 percent – they are bang on that level again – indefinitely. A refunding hump in October looms large and last night clearing house LCH.Clearnet raised the cost of using Spanish bonds to raise funds, making it even less attractive to hold Spanish debt. It holds a bond auction on Thursday which will be a very nervy moment.

In Greece, the effort to form a pro-bailout coalition continues with Socialist leader Venizelos saying it will be done today. PASOK and New Democracy agree they must push for easier bailout conditions – getting four years rather than two to deliver the cuts demanded of Greece. They may get an extra year, as Spain has, although the fact that it is not under an aid programme makes it a very different case. But there have been mixed messages from euro zone policymakers with some saying Athens should only get a few weeks leeway to compensate for the period of election limbo.

A senior euro zone official told us that trying to enforce the original terms of the 130 billion euro bailout would mean “signing off on an illusion”. Before any changes are made, the troika will have to return to look at the books. It’s an open secret that Athens has already fallen behind its latest target while its recession is deeper than the bailout programme assumed. Even an extension of the timeline will mean more money from somewhere, and that can only come from reluctant euro zone governments.

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