MacroScope

Greek turning point?

Greece will unveil its draft 2014 budget plan which is expected to forecast an end to six years of recession.

The draft will include key forecasts on unemployment, public debt and the size of the primary surplus Athens will aim for to show it is turning the corner. The government has said any further fiscal belt-tightening will not bring cuts in wages and pensions and that savings will be generated from structural measures.

If even Greece has passed the worst then maybe the euro zone crisis really is on the wane. The FT reports that billionaire John Paulson and a number of other U.S. hedge funds are investing aggressively in Greece’s banking sector, expecting it to get off its knees – an interesting straw in the wind.

However, some form of further restructuring of Greek debts – now largely held by euro zone governments and the European Central Bank – is still firmly on the cards at some point if the country is ever to get back on its feet. Its debt is due to peak at around 175 percent of GDP this year.
Berlin has ruled out “haircuts” on Greek bonds. Instead extension of repayment terms and cuts in interest rates on bailout loans are more likely.

The trigger for such a deal will be Athens’ ability to deliver a primary surplus – a surplus of tax revenue over public spending once debt interest payments are taken out of the equation – next year. In fact, sources told us last month that Greece and its lenders are close to agreeing that Athens will achieve a small primary budget surplus this year.

Banking union shift

For most of the year, the biggest question for the euro zone was whether the pace of reform would pick up after German elections which are now just six days away. Thanks to a Reuters exclusive over the weekend it appears the answer could be yes, at least incrementally.

Senior EU officials told us that Germany is working on a plan that would allow the completion of a euro zone banking union without changing existing EU law. Until now, Berlin has insisted the EU would have to amend its Treaty to move power to close or fix struggling banks from a national to a European level – a process which could take years.

In exchange, a cross-border resolution agency would only rule over the fate of 130 euro zone banking groups that will be directly supervised by the European Central Bank from the second half of 2014. That would leave Germany’s politically sensitive savings banks under Berlin’s control.

Back from the beach

Back from a two-week break, so what have I missed?

All the big and ghastly news has come from the Middle East but there have been interesting developments in the European economic sphere.
It seems safe to say that Britain’s economic recovery is on track, and maybe more broadly rooted than in just consumer spending and a housing market recovery (bubble?).

Slightly more surprisingly, the euro zone is back on the growth track too with some unexpectedly strong performances from Portugal and France in particular in the second quarter. Latest consumer morale data have been strong and as a result European Central Bank policymakers have begun downplaying thoughts of a further interest rate cut. However, it’s unlikely that all these countries will grow as strongly in the third quarter. Tuesday’s reading of German sentiment via the Ifo index will be key this week.

Perhaps the biggest surprise was Germany’s Wolfgang Schaeuble admitting what was widely known but hitherto unacknowledged – that Greece will need more financial help. The real shock was not the news but the source; the assumption had been that no one would whisper a word until the German elections are out of the way in four weeks’ time. Angela Merkel has been notably more circumspect about Greece than her finance minister.

A day to reckon with

This could be a perfect storm of a day for the euro zone.

Portugal’s prime minister will attempt to shore up his government after the resignation of his finance and foreign ministers in successive days. The latter is threatening to pull his party out of the coalition but has decided to talk to the premier, Pedro Passos Coelho, to try and keep the show on the road.

If the government falls and snap elections are called, the country’s bailout programme really will be thrown up into the air. Lisbon plans to get out of it and back to financing itself on the markets next year. Its EU and IMF lenders are due back in less than two weeks and have already said the country’s debt position is extremely fragile.

Given the root of this is profound austerity fatigue in a country still deep in recession a further bailout is increasingly likely. Portuguese 10-year bond yields shooting above eight percent only add to the pressure; the country could not afford to borrow at anything like those levels. President Anibal Cavaco Silva’s will continue talks with the political parties today.

ECB in court

The major euro zone event of the week starts on Tuesday when Germany’s top court – the Constitutional Court in Karlrsuhe – holds a two-day hearing to study complaints about the ESM euro zone bailout fund and the European Central Bank’s still-unused mechanism to buy euro zone government bonds.

The case against the latter was lodged by more than 35,000 plaintiffs. Feelings clearly run high about this despite the extraordinary calming effect the mere threat of the programme has had on the euro debt crisis. Some in Germany, including the Bundesbank, are worried that the so-called OMT could compromise the ECB’s independence and would be hard to stop once launched.

A verdict won’t be delivered until later in the year but already there is already jockeying for position. Germany’s Spiegel reported that a limit had been set on the amount of bonds the ECB could buy – directly contradicting what Mario Draghi has said. That was swiftly and categorically denied by the ECB, then Executive Board Member Joerg Asmussen warned there would be “significant consequences” if Germany’s constitutional court rules the bond-buying programme was illegal.

Taking stock

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.

ECB eclipsed by BOJ

The European Central Bank takes centre stage. While others in the euro zone are saying the way Cyprus was bailed out – with bank bondholders and big depositors hit – could be repeated, the ECB insists it was a one-off.

Fearful of any signs of contagion it will continue to talk that talk and there’s no sign of it having to do more so far, with no bank run even in Cyprus let alone further afield. But the last two weeks has reignited debate about what the ECB might have to do in extremis. It’s no nearer deploying its bond-buying programme but it could flood the currency area’s financial system with long-term liquidity again if called upon.

Interest rates are expected to be held at a record low 0.75 percent. Hints of policy easing further out are not out of the question. As ever, Mario Draghi’s hour long press conference will be minutely parsed but there will be nothing to match the Bank of Japan which earlier announced a stunning revamp of its policymaking rules – setting a balance sheet target which will involve printing money faster and pledging to double its government bond holdings over two years.

Europe’s ‘democratic deficit’ evident in Cyprus bailout arrangement

The problem of a “democratic deficit” that might arise from the process of European integration has always been high on policymakers’ minds. The term even has its own Wikipedia entry.

As Cypriots waited patiently in line for banks to reopen after being shuttered for two weeks, the issue was brought to light with particular clarity, since the country’s bailout is widely seen as being imposed on it by richer, more powerful states, particularly Germany.

Luxembourg has accused the Germans of trying to impose “hegemony” on the euro zone.  The country, whose banking system, like Cyprus’, is very large relative to the economy’s tiny size, fears that similarly harsh treatment could be imposed on its depositors.

One-off or precedent?

Cypriot banks were supposed to reopen today but they won’t and when they do capital controls will be slapped on to prevent money fleeing its borders (was that how the single currency zone and single market was supposed to work?) The controls are supposed to be temporary but the Icelandic experience showed that once imposed they can be devilishly hard to remove. It seems pretty certain that there will be a bank run when the doors are reopened, which is now slated for Thursday.

Dutch Eurogroup chief Jeroen Dijsselbloem gave markets a jolt yesterday. In an interview with Reuters he said in future, the onus would be put on banks to recapitalize and if they couldn’t “then we’ll talk to the shareholders and the bondholders, we’ll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders”. He added that he wanted to get to a situation where the euro zone never needed to use its ESM rescue fund to recapitalize banks directly – a plan that was created last year at the height of the crisis. That all seemed crystal clear but after some adverse market reaction a later statement was put out on his behalf reverting to the earlier line that Cyprus was a one-off case.

So which is it? One-off or precedent? With a banking system eight times the size of its economy and awash with foreign money Cyprus clearly is unlike any of its euro zone peers. But it’s been also clear for some time now that Germany and other northern Europeans don’t want taxpayers to be on the hook for future bailouts and are not keen on using the ESM to recapitalize banks (that was supposed to break the doom loop between weak banks and sovereigns but maybe not any more). German Finance Minister Wolfgang Schaeuble was explicit after the bailout was agreed in the early hours of Monday morning, saying with the bail-in “we got what we always wanted”. As such, the Bundestag is almost certain to vote for it.

Cyprus Plan B – phoenix or dodo?

They’ve only been looking for it for a day but Cyprus’s Plan B has already taken on mythical status. A myth it might remain.

Ideas being floated include nationalizing the pension fund (back of the envelope calculations suggest that will raise less than a billion euros) and issuing bonds underpinned by future natural gas revenues (but no one is really sure how much they are worth). So to avoid default it still looks like the Cypriots may have to return to the bank levy they rejected so decisively in parliament on Tuesday, to raise the 5.8 billion euros the euro zone is demanding in return for a bailout.

Finance minister Sarris is still in Moscow hoping for some change out of the Russians and is out this morning saying discussions are ongoing about banks and natural gas.