Back to banking union

June 19, 2013

The G8 produced little heat or light on the state of the world economy but if there was one clarion call it was for the euro zone to get on with forming a banking union – the last major initiative needed to draw a line under the euro zone debt crisis.

With the European Central Bank effectively underwriting the bloc’s governments with its bond-buying pledge, a cross-border mechanism to recapitalise or wind up failing banks would do the same for the financial sector.

The trouble is, not unreasonably, Berlin does not want to fall liable for the failure of a bank in a weaker country. Instead, it is pressing for a “resolution board” involving national authorities to take decisions on winding up failed banks, which sounds like the onus would remain on governments to sort out their own banks rather than pooling risk which would convince investors that a proper backstop was in place.

In other words, the “doom loop” of weak banks and sovereigns weighing on each other would be unbroken.

U.S. President Barack Obama, whose administration has been urging progress on this front, is in Berlin today for a lot of ceremony and some talks with Angela Merkel.

A meeting of euro zone finance ministers on Thursday will pave the way for an EU leaders’ summit the following week. EU economics chief Olli Rehn said yesterday the ministers’ meeting must hammer out an agreement over how to recapitalise banks. He speaks at a Brussels conference today alongside two ECB policymakers – Peter Praet and Erkki Liikanen.

There were some indications at the G8 that Japanese Prime Minister Shinzo Abe was given a nudge to get on with serious structural reforms although his version of events was that his fellow leaders expressed strong support for his “Abenomics” stimulus policies – which is true.

But Merkel made it clear they want to see more after Tokyo’s latest package of measures last week shied away from contentious areas such as increasing labour market flexibility and making it easier for companies to exit dying businesses while shifting to growth areas. Abe makes a setpiece speech in London today after stopping off in Dublin.

Spain remains deep in recession with staggering rates of unemployment. The International Monetary Fund will publish its latest review of the Spanish economy. At roughly, the same time Prime Minister Mariano Rajoy will unveil a plan to get rid of some government agencies over time and eliminate overlap. A drastic cut in public employees or government spending is unlikely to result in the short term.

In Britain, the Mansion House speeches delivered by finance minister and central bank chief are a fixture in the economic calendar. This time, it will be a further opportunity for Bank of England Governor Mervyn King to speak bluntly before handing the reins to Mark Carney next month. He is likely also to herald tentative signs of improvement in the UK economy.

George Osborne is expected to announce when the government might sell its 39 percent stake in Lloyds bank. A similar move for RBS will come later.

Overnight, an influential panel of British legislators, set up by Osborne to look at banking reform, called for new laws to make it easier to jail reckless bankers. Uncomfortably for Osborne, it added that the government had interfered in the running of the state-owned banks in an unacceptable way.

King has consistently called for the break-up of RBS, advocated tougher bank regulation than the government has delivered and urged the banks to lend more than they are, so there could be some discordant notes between the pair.

Selling some of the government’s 81 percent stake in RBS and 39 percent in Lloyds before the next national election in 2015 could help support Conservative claims that Britain’s economy is on the mend. The opposition Labour party are already decrying such a move as driven purely by electoral politics rather than getting the best return for taxpayers.

Earlier in the day, the Bank of England will release the minutes of its June policy meeting, which are likely to show Mervyn King was outvoted again, at his last MPC meeting before retiring, over his wish to print more money.

For the markets, the Federal Reserve’s policy meeting is the only game in town. Ben Bernanke has sparked a bout of market turmoil since announcing on May 22 that the Fed could begin slowing the pace at which it creates dollars (currently $85 billion a month). He is likely to keep options open about such a move later in the year following some mixed economic data.

The big question is to what extent this was a deliberate gambit aimed at taking the froth of stock markets that had soared in the early part of the year. Two weeks prior to that Bernanke had warned about concerns that investors were “reaching for yield”. If that was the intention, it’s certainly worked and is why the words he uses today will be so pivotal.

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