MacroScope

An IMF team will conclude its annual review of the French economy and hold a news conference this morning.

It’s a safe bet that the Fund’s prescription will be similar to that of the EU and most other interested observers – the two extra years France has been given by Brussels to meet its debt-cutting targets must be used to liberalise and reform its economic structures. That was certainly Angela Merkel’s message to President Francois Hollande last week and also implicit in the Franco-German position paper which is intended to lay the ground for an EU summit at the end of the month.

The paper apparently contained a string of concessions from Germany – such as accepting a full-time president of the Eurogroup of euro zone finance ministers and paving the way for the next stage of a European banking union by accepting a “resolution board” to deal with restructuring or winding up failed banks, although that would be based on national authorities not the central body advocated by the European Commission and European Central Bank.

But the real story is what Hollande signed up to in return. The smart money says he promised to deliver on labour and pension reforms which will be tough for his socialist allies to swallow. Without that, France’s gentle economic decline could continue until the Franco-German motor which has traditionally driven the European project, could become solely the German motor.

By apparently giving ground – although how much remains to be seen as EU negotiations continue – Merkel may have given Hollande the political cover to act. His irate response to the European Commission’s policy demands last week showed that more than anything else, he cannot afford to be seen to be bowing to the demands of others.

With little sign of economic recovery in Europe and governments incrementally loosening their austerity drives (Britain being the exception) the focus turns to the big central banks on our patch and what more they might be able to do to foster some recovery.

With the European Central Bank meeting on Thursday, President Mario Draghi is in Shanghai saying the euro zone is on track for only a “very gradual recovery”. It’s hard to tell at a glance whether that is a rhetorical downgrade of the existing forecast for a pick-up in the second half of the year with downside risks attached. Either way, the pressure on the ECB to act again is growing.

However, don’t expect anything at its monthly meeting on Thursday, although a further interest rate cut could come this year and there is still talk of cutting the deposit rate – the return banks get for parking funds at the ECB – into negative territory to try and get them to lend. The big question is would that achieve much? Despite being in a world awash with central bank money, there is clearly a reluctance among banks to push money into the real economy. The latest data showed bank loans to euro zone businesses and households contracted for the 12th month in a row in April.

Euro zone unemployment figures will emphasize just how far the currency bloc is from recovery while inflation data due at the same time could push the European Central Bank closer to new action. If price pressures drop further below the target of close to but below two percent we’re moving into territory where the ECB has a clear mandate to act, although the consensus forecast is for the rate to push up to 1.4 percent, from 1.2 in April.

Market attention is focused on the ECB cutting its deposit rate – the rate banks get for parking funds at the ECB – into negative territory to try and get them to lend. But will that do much? Despite being in a world awash with central bank money and stock markets in the ascendant, the fact that safe haven bond markets such as Bunds and U.S. Treasuries haven’t sold off much – and are now starting to climb after Ben Bernanke’s hint that the Federal Reserve could soon start slowing its money-printing programme — denotes ongoing nervousness among banks and investors. Data this week showed bank loans to the euro zone’s private sector contracted for the 12th month in a row in April.

Despite the (now waning?) European market euphoria – started by the ECB’s pledge to do whatever it takes to save the euro and given a further shot in the arm by Japan’s dash for growth – the economic numbers look grim. Euro zone unemployment is forecast to edge up to 12.2 percent of the workforce. Last night, official data showed French unemployment hit a new record. Germany is in better shape but even it will barely eke out any growth this year. Retail sales, just out, posted a 0.4 percent fall in April.

Today’s big setpiece is a meeting of German Chancellor Angela Merkel and French President Francois Hollande ahead of a June EU summit which is supposed to lay the path for a banking union. The traditional twin motor of Europe has sputtered – not least because the French economy is so much more sickly than Germany’s – but also because of real differences of opinion.

When the Franco-German relationship was running smoothly, the two countries’ leaders routinely met before EU summits to prepare a joint position which more often than not prevailed (much to the annoyance of some of their partners). But Merkel and Hollande have conspicuously not done so on a number of occasions since the latter took power a year ago.

Hollande wanted a banking union including a structure to wind up failing banks and common deposit guarantee. The latter is already dead in the water and Germany is wary of the liabilities the former might impose upon it. The European Central Bank may have taken euro break-up risk off the table – though its pledge to save the euro is still to be tested – but banking union is still a huge issue. Without it the seeds of a future crisis, or even a revival of this one, will have been sown.

It’s May Day and most of Europe, barring Britain, is taking a holiday so maybe it’s a day to take stock.

But first, a nervous glance at little Slovenia. Last night Moody’s cut its debt rating to junk, forcing Ljubljana to abandon a planned bond issue which looked set to raise several billion dollars and making a fifth euro zone sovereign bailout much more likely. Given the ham-fisted effort to rescue Cyprus didn’t put markets into a spin, it’s unlikely Slovenia will upset the euro zone applecart but it’s a reminder that this crisis isn’t over and won’t be until the currency bloc gets serious about creating a banking union. Slovenia’s problems, like Cyprus’s, are rooted in the banking sector, which is stifled by about 7 billion euros in bad loans.

One bullet was dodged when the Cypriot parliament narrowly approved its bailout late yesterday, which will avert bankruptcy but at a painful cost.

Fresh from winning a vote of confidence in parliament, new Italian Prime Minister Enrico Letta heads to Berlin to meet Angela Merkel, pledging to shift the euro zone’s focus on austerity in favour of a drive to create jobs. He may be pushing at a partially open door. Even the German economy is struggling at the moment and the top brass in Brussels have declared either that debt-cutting has reached its limits and/or that now is the time to exercise flexibility. Letta will move on from Berlin to Brussels and Paris later in the week.

France, Spain and others will next month be given more time to meet their deficit targets and Berlin does not seem to object. Don’t expect Merkel to join the anti-austerity chorus but there are some hints of a shift even in Europe’s paymaster. Yesterday, it launched a bilateral plan with Spain to boost lending to smaller companies and said it could be rolled out elsewhere too. Details were very sketchy but something may be afoot. The European Central Bank, expected to cut interest rates on Thursday, is considering something similar although that is far from a done deal.

Forgotten about Cyprus, which only last month had financial markets in a lather and threatened to reignite the euro zone debt crisis? Today, Cypriot politicians vote on the terms of the bailout offered by the euro zone. It should pass but it could be tight. No single party has a majority in the 56-member parliament, and the government is counting on support from members of its three party centre-right coalition which have 30 seats in total.

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.

European Central Bank chief Mario Draghi and Germany’s Angela Merkel – the two most important people in the euro zone debt crisis response – take to the stage today, the former giving lengthy testimony in the European Parliament, the latter holding a news conference with foreign journalists.

With Greece sorted out for now, Spain and Italy fully funded for the year and markets simmering down, the crisis is in abeyance, in no small part thanks to these two. Draghi provided the game changer with the ECB’s bond-buying plan late in the summer but Merkel has shifted profoundly too during the course of the year – most crucially from considering a Greek euro exit might be a good thing “pour encourager les autres” to realizing it would be a disaster and acting to rule it out and also in backing Draghi’s bold move and ignoring a large measure of German disquiet.

Germany continues to go-slow on future steps, at least in part largely for domestic political reasons, but look where we are now – with an ECB prepared to act in a way that horrifies the Bundesbank, a permanent euro zone rescue fund, a banking union in progress and multiple bailouts agreed and help for Spain likely to come soon – and it’s remarkable to see how far Berlin has moved.

After months of bickering and struggle, the euro zone and IMF have agreed on a scheme which will notionally cut Greece’s mountainous debt to a level they view as sustainable in the long-term. Athens has now launched a buyback of its debt at a sharp discount from private creditors which should wipe 20 billion euros of its debt pile – a key plank of the plan.

Is the problem solved? Absolutely not. But has Germany achieved its goal of delaying any disasters, or really tough decisions, until after its elections in the Autumn of 2013? Almost certainly. So we could (famous last words) be in for a period of relative calm on the euro zone crisis front.

German Chancellor Angela Merkel and her finance minister have begun quietly hinting that euro zone government and the European Central Bank may eventually have to take a writedown on the Greek bonds they hold to make Athens’ debt controllable. That won’t happen for at least two years but in the meantime, bailout money will flow and Greece will survive.

So said Winston Churchill of Russia. The Greek debt saga isn’t quite that unfathomable but the economic necessities continue to clash with the political realities.

Eurogroup Working Group – the expert finance officials from 17 euro zone nations who do the clever preparatory work before their finance ministers meet – will convene to today try and get the Greek debt process back on track after a ministerial meeting got nowhere on Monday and in fact ended up in an unusually public spat between its chair, Jean-Claude Juncker, and IMF Managing Director Christine Lagarde.

The Eurogroup plus Lagarde will meet again next Tuesday and there are big gaps to bridge although we intercepted the IMF chief in Manila this morning, insisting that a deal was possible, or at least that’s one way of reading her “it’s not over until the fat lady sings” quote.