MacroScope

What to do about Britain and Europe?

By Mike Peacock
January 10, 2013

After a long, long wait, Britain’s David Cameron is poised to make his big speech on his country’s future ties with Europe.

It was supposed to be delivered in the autumn but has been delayed as the realization has dawned that there is no obviously good outcome for the ruling Conservative party’s leadership which faces implacable eurosceptics within its rank-and-file, many of whom want out of the EU completely. Cameron almost certainly doesn’t want out but may be pushed in that direction if he cannot deliver the repatriated powers from the EU that he has suggested are possible.

It’s hard to see other European leaders playing ball, particularly since Cameron took the unusual step of wielding Britain’s veto at a summit just over a year ago. Whatever he says, a bout of internecine warfare in his party is quite possible on an issue that has ripped it apart before.

America’s top man on Europe upped the ante yesterday, saying Washington wanted Britain to stay in the EU and retain a powerful voice. To do otherwise would damage U.S. interests (and therefore its own), Philip H. Gordon, assistant secretary of state for European and Eurasian Affairs, told reporters in London.

With Washington increasingly interested in a free trade pact with the EU, if Cameron allowed Britain to slide towards the exit it could be even more damaging. Irish premier Enda Kenny has voiced similar concerns and we get another opportunity to put it to him and European Commission president Barroso at a news conference today. The timing of  all this is unlikely to have been coincidental. Cameron’s speech, we think, will be delivered next week.

On the euro zone front, the European Central Bank is likely to keep the policy tiller steady today. Despite signs that the fourth quarter was pretty ghastly for the currency area’s economy, there are signs of improvement early this year, for its stronger members at least. Nonetheless, Mario Draghi’s words will be parsed by the markets with their usual care.

We also get the first Spanish bond auction of the year. The Treasury said earlier in the week that it would need to shift 121 billion euros of debt this year, up nearly 8 percent from 2012. (and that presupposes that Madrid does not miss an eye-wateringly tough deficit target and/or the regions don’t blow up further). However, there is little immediate pressure on the government to seek help from the euro zone rescue fund, which would allow the ECB to start buying government bonds and put its money where its mouth is.

Spanish 10-year yields are now little above five percent – having peaked at 7.5 in the dog days of last summer. Even if the ECB did get the opportunity to intervene, it’s unclear it would want borrowing costs dramatically lower than that, for fear of taking the pressure of the government to continue its debt-cutting and reform drive.  As our Breakingviews colleague’s put it yesterday, the ECB’s verbal intervention may be working too well in keeping the market at bay. For longer-term stability, what both it and Spain needs is the opportunity to prove that the era of shorting the euro zone periphery is over.

One of the pressure points could be that Spanish banks hoovered up the lion’s share of government bonds issued last year and are reaching saturation point. That means Madrid will have to lure significantly more interest from international investors as it tries to shift about 10 billion euros a month in bonds through the year. But for now, the benign conditions are even reaching the corporate sector. Both Caixabank and utility Gas Natural issued bonds on Wednesday.

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