MacroScope

Hollande’s search for an elusive winning formula

After a local election drubbing, French President Francois Hollande duly sacked his prime minister last night and tempered his economic reform drive, vowing to focus more on growth and “social justice”. A fuller cabinet reshuffle is expected today.

Interior minister Manuel Valls, anything but a left-wing firebrand whose appointment could stir unrest on the left of the ruling Socialist party, takes the premiership with a mandate to pursue cuts in labour charges for business but also tax cuts to boost consumer spending and employment.

Hollande said France would still cut public spending to pay for a 30 billion euro reduction in labour charges on business, part of a “responsibility pact” with employers he launched in January. But he said Sunday’s elections also showed the need for a “solidarity pact” offering workers tax cuts and assurances on welfare, youth training and education.

Brussels would have to cut it some slack with its budget deficit, he said. Paris has already been given until the end of 2015 to bring the deficit below the EU limit of 3 percent of GDP. Data released on Monday showed the deficit stood at 4.3 percent in 2013, higher than the government’s 4.1 percent target.

Some of the euro zone and EU finance ministers meeting in Athens, which has the EU presidency for six months, may well look askance at all that. Southern European countries have endured sharp economic pain to reduce their debts while Germany remains doubtful of the austerity/growth trade-off which Hollande is pushing.

A tale of two budgets

 

It’s deadline day for euro zone member states to submit their 2014 budget plans to the European Commission for inspection and we’re waiting on Italy and Ireland.

Having survived Silvio Berlusconi’s attempt to pull the government down, Prime Minister Enrico Letta’s coalition has to overcome differences on tax and spending policy.
The aim is to agree a 2014 budget that reduces labour taxes by some 5 billion euros but also undercuts the EU’s 3 percent of GDP deficit limit, so spending cuts will be required.

Rome has a chequered track record in that regard. The cabinet will meet at 1500 GMT to try and agree a comprehensive package. A Treasury source said the scale of tax cuts would be dictated by how much the various government ministries are prepared to forego.

Euro zone on the move … too slowly?

With Spanish Prime Minister Mariano Rajoy calling for a new euro zone fiscal authority to manage the bloc’s finances and send markets a signal that EU leaders mean business about defending the euro, it is clear that the push towards fiscal union, led by Germany, is gathering momentum. Germany has also conceded that Spain should get an extra year to make the spending cuts demanded of it, suggesting it is aware that the crisis is lapping at its door again.

But economic union, even if agreed (it runs contrary to generations of French political culture to relinquish that amount of national sovereignty) will take many months even years to put into practice, given the complex treaty changes that will be required.

The hope is that a strong signal of intent at the end-June EU summit will calm markets and encourage the European Central Bank to hold the fort in the meantime. The former looks like a somewhat heroic hope. On the latter? Well, the ECB has made it quite clear it wants government to sort out the mess but has also consistently proved itself to be the only institution capable of moving quickly enough when the crisis turns acute. So it will almost certainly intervene again if the bloc reaches the point of calamity, though that is more likely to take the form of an interest rate cut and a third round of three-year money creation than a serious revival of its bond-buying programme.

Brussels throws gauntlet down to Berlin

The European Commission leapt off the fence yesterday proposing many of the policies – a bank deposit guarantee fund, longer for Spain to make the cuts demanded of it and allowing the euro zone rescue fund to lend to banks direct (though there were some mixed messages on that) – that would buy a considerable period of time to move towards its ultimate goal: the sort of fiscal union that would make the euro zone a credible bloc much harder for the markets to attack.

The proposals would go a long way to removing Spain from the firing line, and suggests Brussels at least has decided it now urgently needs to shore the country up. But Germany opposition to all three still appears to be steadfast.

Time to dust off the golden rule of this crisis – dramatic decisions are taken only when the bloc is staring right into the abyss. We’re not quite there yet, though not far off, so there has to be a chance of something seismic resulting from the end-June EU summit which follows June 17 Greek elections. The leaders of Germany, France, Italy and Spain meet in between, just after a G20 summit which will presumably press Angela Merkel hard too. As European Commission President Barroso said yesterday, speed and flexibility will be of the essence although at least some of what is being discussed would require time-consuming treaty change.

Time to get real?

Spain’s plans to revive Bankia with state money and sort out its regions’ finances have well and truly unnerved the markets. It seems that Plan A — to inject state bonds straight into the stricken bank so that it could offer them to the ECB as collateral in return for cash — was roundly rejectd by the European Central Bank, so Madrid rapidly produced a second plan which will involve the government raising yet more money on the bond market, not helpful to its drive to cut debt.

That leaves the impression that Spain is making up policy on the hoof, not something likely to endear it to the markets. That’s particularly unfortunate since it has actually done an awful lot on the austerity and structural reform front over the past two years. But not enough.

It’s not all one-way traffic. Madrid is pressing its insistence that the ECB should be the institution to deliver a decisive message to the markets that the euro is here to stay – presumably by reviving its bond-buying programme (highly unlikely at this stage).

Euro zone ying and yang

The ying.
Sources told us last night that Spain may recapitalize stricken Bankia with government bonds in return for shares in the bank. That would presumably involve an up-front hit for Spain’s public finances (it is already striving to lop about 6 percentage points off its budget deficit in two years) which might be recouped at some point if the shares don’t disappear through the floor.
The ECB’s view of this will be crucial since the plan seems to involve the bank depositing the new bonds with the ECB as collateral in return for cash. If it cries foul, where would that leave Madrid?

Spain’s main advantage up to now – that it had issued well over half the debt it needs to this year – may already have evaporated after the government revealed that the publicly stated figure for maturing debt of the autonomous regions of 8 billion euros for this year is in fact more like 36 billion. Catalonia said late last week that it needed central government help to refinance its debt.  If more bonds are required to cover some or all of Bankia’s 19 billion euros bailout, Spain’s funding challenge in the second half of the year starts to look very daunting indeed.

The yang.
Latest Greek opinion polls, five of them, show the pro-bailout New Democracy have regained the lead ahead of June 17 elections although their advantage is a very slender one. If the party manages to hold first place, and secures the 50 parliamentary seat bonus that comes with it, then it looks like it would have the numbers to form a government with socialist PASOK which would keep the bailout programme on the road … for a while.

Merkel under pressure … but unbending

Some interesting events to  ponder over the weekend, though not many of them came from the G8 summit which, as is customary, was strong on rhetoric but bare of any specific policy measures to tackle the euro zone crisis. However, markets seems to have tired of their panicky last few sessions. German Bund futures have opened lower as investors took profits rather than seizing on any positive news. European stocks have edged up.

It does appear that with the ascension of France’s Francois Hollande, the G8 firmament turned into G7 (or maybe 5 since we didn’t hear much from Japan and Russia) versus 1 (Germany) but as things stand we’re still heading for a fairly anaemic “growth strategy” unless euro zone leaders coalesce behind the notion of giving Spain and Greece longer to make the cuts demanded of them. Spain has moved the goalposts further in the wrong direction, revising its 2011 deficit up to 8.9 percent from 8.5 and blaming the overspending regions. That means its already loosened target of 5.3 percent for this year is now even harder to achieve.

Hollande is talking up the case for common euro zone bonds but that will not wash with Berlin for a long time yet. Sources said Monti used the G8 forum to promote a pan-European bank deposit guarantee fund. Good idea but that too will only be conceivable if the European financial sector is on the point of toppling. And who will underwrite it? There is talk too of allowing the EFSF to lend direct to banks to ease the Spanish government’s reluctance to ask for help. That may have a slightly better chance of success but Berlin doesn’t like this idea either.
Look no further than the German Chancellor’s take on the summit – it was all a great success, she said. Everyone agreed that we need both growth and fiscal consolidation.

Tumultuous euro zone week

A week where every facet of the euro zone debt saga will come from all angles.

The major events are the French presidential run-off and Greek general elections on Sunday, May 6.
 
In the former case, a likely socialist Francois Hollande victory could cause some market jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and actually there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than Sarkozy would. And, contrary to some reports, he is not intent on ripping up the EU’s new fiscal rules. And of course, the bond market will only allow so much leeway.

If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to stick with the austerity terms demanded by its international lenders.

Even if fears about a hard Greek default or even euro exit result, the threat of contagion looks far smaller. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is very much diminished.

Euro zone perspective – nowhere near out of the woods

After the Easter break, a bit of perspective — to paraphrase the immortal Spinal Tap, maybe too much perspective.

Over the past two weeks, Spanish and Italian borrowing costs have continued to rise – in the former’s case they have now relinquished more than half their fall since December and are heading back into the danger zone. Stocks have also appeared to have given up on their first quarter rally, presumably testament to the realization that the ECB and other top central banks are unlikely to be writing any more blank cheques for banks to reinvest.

Late last year, it was Italy that seemed to have the power to drag Spain into the debt crisis mire. Now, it’s the other way round and after the ECB anaesthesia  wears off, it’s clear the euro zone patient is still sickly.

Today in the euro zone – Bonds, strikes and firewalls

Big debt test for Italy which will sell 8 billion euros or more of longer-dated bonds. A short-term T-bill sale went okay on Wednesday but a day before, the secondary market reacted negatively to a sale of zero-coupon and inflation-linked bonds, pushing Italian yields higher.

The glut of ECB three-year money has ensured Italian and Spanish auctions have sailed out of the door so far this year but there will be no more largesse from the central bank so be on the look out for signs of that support fading. Analysts expect this sale to go well with Italian banks wading in again.

Euro zone money supply data on Wednesday showed Spanish and Italian banks stocked up on government bonds in February – and that was before the ECB’s second instalment of money creation to the tune of 500 billion euros. So bond sales should be underpinned for some time yet though it is clear that the central bank has bought policymakers time rather than solved the root problems.