Waiting for the summit

June 26, 2012

Cyprus became the fifth euro zone country to seek a bailout last night though its needs – maybe up to 10 billion euros – will not put a dent in the currency bloc’s resources. We’re still waiting to see precisely how much money Spain will take for its banks of the 100 billion euros offered. Moody’s cut the ratings of 28 of 33 Spanish banks by one to four notches last night, an inevitable consequence of the sovereign downgrade earlier this month.

Markets seems to have decided that they will be disappointed by the crunch summit at the end of the week. There was a somewhat discordant meeting between the big four euro zone leaders on Friday, with Germany’s Merkel refusing to budge in key areas, but she and French President Francois Hollande have the chance to strike a more positive note when they meet bilaterally on Wednesday abnd hot off the press we have a meeting of the finance ministers of Germany, France, Italy and Spain this evening — so maybe there is a concerted effort to get on the same page.

Lael Brainard, the U.S. Treasury guru who liaises with Europe, spoke for the rest of the world when she told us in an interview that EU leaders had to put “more flesh on the bone” of their ideas to resolve the crisis.

The intention for the summit is to set out a road map to economic and banking union. EU officials hope the latter can be done in a year, though Germany is only happy to consider vital aspects such as a deposit guarantee structure once the path to fiscal union is set in stone. That requires treaty change and will take a lot longer. And even if a banking union was in place this time next year, it would not resolve the immediate crisis.

A strong signal of intent at the summit might settle the markets, not least because it could be crucial in persuading the ECB to hold the fort if needed, although its levers are not problem-free. A widely expected interest rate cut probably may not make much difference, its three-year money splurge bought three months of time last time, maybe less if it does it again, and would reinforce the “doom loop” of weak banks and sovereigns leaning on each other for support. Reviving the bond-buying programme faces stiff internal opposition and, since the ECB is now viewed as a preferred creditor having avoided a writedown as part of the second Greek bailout, it could drive private investors out if it came in. ECB hardliner Weidmann was out last night saying the central bank had reached the limits of its mandate but in extremis it would surely act again as that would be precisely in line with its mandate to maintain financial stability.

Today we have Spain selling up to three billion euros of T-bills, Italy pushing inflation-linked bonds and the Netherlands offering 10-year debt. The latter should benefit from demand for “core” assets.

Greece remains chaotic with the prime minister missing the EU summit due to eye surgery and the newly-picked finance minister resigning after collapsing last week. The two men had been set themselves the task of softening Greece’s bailout terms but now the EU/IMF/ECB troika of inspectors has delayed its return to Athens.

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