S&P’s year-end broadside

December 20, 2013

Any sense of euphoria EU leaders felt about agreeing a plan to underpin Europe’s banks – which should have been muted anyway – may be tempered by S&P’s decision to cut the bloc’s credit rating to AA+ from AAA.

In global terms that’s still rock solid but the rationale – flagging “rising risks to the support of the EU from some member states” has some resonance. On the upside, the agency affirmed its rating of Ireland following its bailout exit and kept its outlook positive. Presumably, S&P is clearing the decks before Christmas because it also reaffirmed the UK’s top notch AAA rating, and reaffirmed South Africa too.

The EU quote packs a punch following a banking union deal where Germany successfully saw off plans for euro zone countries to help each other in tackling problem lenders.

The fact that bank creditors and investors will get hit first in future diminishes the threat to euro zone governments but for several years at least there is no mutual backstop so the buck will continue to stop with them and the potentially ruinous link between failing banks and heavily indebted sovereigns is unbroken.

Cohesion has diminished, S&P concluded.

The history of the euro zone crisis has been that when the pressure diminishes, policymakers lose their sense of urgency so if there was another crunch they would doubtless rush to bolster their defences. The power of ratings agency rulings to roil financial markets is also much diminished – the euro edged down but no more – but there is something to this analysis.

European Central Bank chief Mario Draghi endorsed the banking deal last night, having criticized pretty much exactly the same plan on Monday for potentially being underfunded and overcomplicated. I guess given the deal is now done, the key policymakers have to row in behind it although others – notably in the European parliament and EU commissioner Michel Barnier have been critical.

Also in Brussels, Germany’s Angela Merkel pressed euro zone leaders to agree on binding contracts to reform their economies, offering financial support to countries that commit to overhauling their labour markets, public sector, education, research and welfare policies, under the monitoring of the EU. An agreement is sought by late next year.

Ukraine will cast a long shadow over day two of the summit. As well as weighing Kiev’s decision to turn away from an EU trade deal, the leaders will debate the message they want to send to Ukrainians protesting against President Viktor Yanukovich’s move, and fashion their approach to Russia which has comprehensively bailed its neighbor out.

Portugal is hoping to follow Ireland’s lead and exit its bailout programme next year. On Monday, the EU and IMF gave a positive verdict on its latest bailout review. But it faces a trickier path not least because of its constitutional court which has already thrown out various government austerity measures and late on Thursday rejected a bid to cut public sector pensions.
The measure would have saved the best part of 400 million euros, a sum the government will now have to save elsewhere.

The lower house of the Italian parliament will hold a confidence vote on the government’s 2014 budget to ensure final parliamentary approval of the fiscal package before a year-end deadline. The Senate will follow suit on Monday. If the government loses it will have to throw in the towel but Prime Minister Enrico Letta can rely on a solid majority in both houses.

The IMF will release its second review of the Cypriot progress under a 10 billion euros bailout programme. Fund officials have already praised painful economic adjustment, but likely to state island now needs to focus on a privatisation programme in coming years.

Germany’s GfK index, just out, showed consumer morale hit its highest level in nearly 6-1/2 years heading into January as shoppers confident that Europe’s largest economy is on an upward path became more willing to spend.

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