We’ve been saying for some time that while the immediate heat may be off the euro zone, therein lies a danger – that policymakers will relax their efforts to remould the bloc into a tougher structure that can withstand future crises, and possibly even allow this crisis to flare back into life.
Exhibit A has been the apparent backsliding on what we thought was a concrete plan to allow the euro zone rescue funds to recapitalize banks directly from next year, thereby removing the onus on highly indebted governments to do so. Over the weekend we got Exhibit B courtesy of a Reuters exclusive.
We reported that the European Central Bank had rejected Ireland’s solution to avoid the crippling cost of servicing money borrowed to rescue its failed banking system – debt servicing would amount to around 3 billion euros a year for the next 10 years. Dublin wanted to convert the promissory note into long-term bonds. The ECB decided last week that that crossed its red line of monetary financing.
The Irish government responded to our exclusive on Sunday by saying it would change its proposal, saying a failure to resolve it would have a “potentially catastrophic effect”. What is certainly true is that it would make exiting its bailout this year – which looked like it was almost a certainty after recent forays into the bond market – much more complicated. The next payment falls due at the end of March.
Irish debt yields have plunged in recent months but as the head of the country’s debt agency said last week, markets have “to a greater or lesser extent” priced in a promissory note deal.
Also on the debt ledger, Italy comes to the market with two-year zero coupon and five-year inflation-linked bonds worth up to 6.75 billion euros. Even before these tenders (with more to come later in the week), Rome has shifted around 10 percent of its annual funding needs already in January and Spain has done even better, getting through 14 percent. For Italy, there is still precious little sign that the impending elections are having any real impact on market sentiment even though a fractured, messy outcome is quite possible. That could yet change.
The other theme of the new year has been intensifying language about competitive currency devaluations – a currency war – after Japan dived head first into monetary and fiscal policies of expansion which are driving the yen lower. We remain firmly in the realms of the rhetorical so far and have steers from a number of sources over the past few days that there is no immediate pressure within the G20 for Japan to do anything different. Since the G20 urged Japan to do more to reflate its economy last year, it can hardly complain that it is now doing so, unless it intervenes directly on the currency market to weaken the yen further. The first 2013 meeting of G20 finance ministers and central bankers is a bit over two weeks away.