Europe and the danger of soft-pedalling

January 21, 2013

No one really questions Angela Merkel’s supremacy in Germany but losing the key state of Lower Saxony in a Sunday election, albeit by the narrowest of margins, means we’ll have to put on ice proclamations that her re-election for a third term in the autumn is now merely a procession. The centre-left SPD and Greens won the state by a single seat. Merkel and others will speak about the result today. What it probably does affirm is that the Chancellor will be extremely cautious about agreeing to more euro zone crisis fighting measures before the national election is safely out of the way.

We’ve been here before. When the drumbeat of market pressure eases, euro zone policymakers have tended to lose their sense of urgency. Today’s meeting of euro zone finance ministers, the first of the year, could be a case in point. The agenda lists “progress” on Cyprus, Spain, Ireland, Portugal and Greece with no decisions expected.
The meeting is set to anoint Dutch Finance Minister Jeroen Dijsselbloem as its new chairman after France dropped its objections on Sunday. He will attend the final press conference so it will be interesting to hear his pitch.

The most important area of debate will be the euro zone’s rescue fund and its ability eventually to recapitalize struggling banks directly, thereby breaking the “doom loop” whereby weak governments drive themselves further into debt by propping up listing banks while the lenders are stuffed with that government’s bonds which are liable to lose value. EU leaders seemed pretty clear at last June’s summit that this would be done but there are now suggestions that governments will remain on the hook to at least some extent. That would be a very significant backward step.

Germany, Finland and the Netherlands say the ESM should be allowed to take stakes only in banks that get into trouble in the future, from 2014. National governments will deal with existing problems, in other words this will do nothing to solve the current crisis. If direct assistance for banks would only apply if they ran into fresh difficulty, it would dramatically cut the chance of such aid being given. There are also proposals floating around that governments could foot some of the bill in future too, or have to indemnify the rescue fund against losses. That is very, very different to what we thought was promised last summer though we should note that today’s meeting will only be one staging post in this debate.

One interesting point to consider is whether, given these glimmers of back-pedalling, the European Central Bank will start to consider that its verbal intervention has worked too well. Since it pledged to buy euro zone government bonds in potentially unlimited amounts to save the currency bloc, borrowing costs have plunged.


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