Slow slow quick quick slow

July 9, 2012

Euro zone finance ministers meet later today to try and put flesh on the bones of the EU summit agreement 10 days ago. The trouble is there probably won’t be enough meat for markets which failed to rally significantly after the summit deal and are now unnerved by fresh signs of global slowdown.
Friday’s weak U.S. jobs report is the latest evidence to rattle investors so there is unlikely to be any let-up.

Spanish 10-year yields are back above seven percent. Madrid is fortunate not to face a heavy debt issuance month but August is a bit more demanding so time is short to turn things around. Italy’s Mario Monti said on Sunday the euro zone ministers must act now to lower borrowing costs and Spanish Prime Minister Mariano Rajoy more dramatically said the credibility of the entire European project rests here. He continues to do his bit, pledging on Saturday to produce further deficit-cutting measures, probably on Wednesday. They could include a VAT hike and cuts to public sector benefits.

The Eurogroup is unlikely to dramatically change the terms of trade. It has a lot on its agenda – the proposed bailout of Spanish banks of up to 100 billion euros, a much smaller bailout of Cyprus as well as firming up the summit agreement that the euro zone’s rescue fund should be tasked with intervening on the bond market to bring borrowing costs down and, once a cross-border banking supervision structure is in place (another highly ambitious plan which is supposed to take shape in an even more ambitious six months), to be allowed to recapitalize banks directly.

None of that is likely to be signed off tonight, particularly since so much hangs on the banking supervision plan. That is the nub of it. The summit deal was not unimportant but is on a much slower track than markets will countenance. There were also some notable absences from the discussion in Brussels, such as a euro zone deposit guarantee fund which could prevent any threat of a bank run.

In fact, there has already been signs of unraveling with the Finns and the Dutch resisting the ESM rescue fund being able to act in the secondary bond market (though not the primary) and Berlin making quite clear that claims from southern Europe that bond-buying support would not have strings attached for government are simply not true. The central question as to whether individual countries or the euro zone assumes liability for banks that are rescued by the ESM remains open. Monti blamed the latest widening of bond spreads squarely on the Finns, suggesting unity really is fraying.

Heaping uncertainty upon uncertainty, the ESM will not come into being as planned today because Germany’s constitutional court will take time on Tuesday to examine complaints about the permanent bailout fund, though the judges are not expected to block it. Germany’s president says he won’t sign it into law without the court’s go-ahead. A minor delay will pose no problem. A lengthier one could jolt investors.

The Eurogroup could  also be a baptism of fire for Greece’s new finance minister. He has conceded that Athens was off-track with  its bailout obligations, after meeting the troika of EU/ECB/IMF inspectors. Athens is seeking up to two more years to meet its debt-cutting targets but is unlikely to get cut that much slack. Yannis Stournaras reiterated on Saturday that Athens needed more time but pledged to press on with structural reforms and a privatization drive.  The privatisation agency will accept Greek government bonds as payment in a bid to encourage investment. Greece will probably run out of money next month without further bailout aid being paid over.

Before the finance ministers meet, ECB President Mario Draghi will testify at length to a European Parliament committee. The central bank cut rates last week but showed no inclination to dust off its more dramatic policy tools – the government bond-buying programme or a repeat of the long-term liquidity flood which prevented a bank credit crunch a few months ago. It’s unlikely Draghi will change tack today but the point may not be far off where the ECB has to swallow hard and drop some of its principled objections, or see the euro zone face calamity.

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