This week, before they even have time to compare tans, European leaders returning from their summer holidays will be jumping straight back into the fray. With the euro-zone crisis continuing to impact the global economy decisive steps need to be taken. As it stands, whilst Italy and Spain inch ever closer to being shut out of sovereign debt markets the situation in Greece remains volatile and what methods will be implemented to aid these ailing countries is still unclear.
This week will be dominated by some high profile meetings and intensive diplomatic planning. Ahead of Greek Prime Minister Antonis Samaras’ travelling to Berlin and Paris at the close of the week, Luxembourg premier and head of the euro-area finance ministers Jean-Claude Junker will arrive in Athens and enter into discussions with Samaras regarding the requested two-year extension for Greece’s fiscal adjustment program. On Wednesday the leaders of the two euro-zone economic powerhouses, French President Francois Hollande and German Chancellor Angela Merkel, will also meet in Berlin.
Last Friday, despite general fears of German defiance, Merkel indicated that the country would conditionally support the proposed borrowing cost reduction methods compiled by the European Central Bank. The following day German Finance Minister Wolfgang Schaeuble implied that this support could be more conditional than some would like. Although the German economy would be hit the worst by a euro-zone breakup he stated that ‘there are limits’ to what the country will sanction to protect it. Schaeuble further asserted that the sovereign-debt crisis would not become a ‘bottomless pit’ for Europe’s biggest economy. He then ruled out the possibility of Greece receiving another aid program. Even though the majority of euro-zone members share the same view on the need for ECB action Schaeuble felt suggestions that the bank should be the financier of government debt should be rejected. He was quoted as saying that to save the euro ‘Many are telling us now to turn a blind eye to debt reduction [which] would only postpone the problem to tomorrow.’
Exactly what level of support Germany will offer could soon be put to the test. Although, like Italy, Spain has yet to declare whether a request for aid will be forthcoming, Prime Minister Mariano Rajoy did state on August 14th that a bailout would be considered if it was decided to be in the ‘best interests of Spaniards’. However, over the weekend the country’s 10-year bonds advanced for the first time this month and Spain advocated unlimited support from the ECB. According to news agency Efe, during an interview on August 18th Spain’s Economy Minister Luis de Guindos expressed the belief that when it comes to supporting Spain’s debt there should be no limit, either in size or duration, of ECB bond buying on the secondary market. Details of the level of assistance which will actually be offered are not to be discussed until the euro-zone meeting scheduled for the second week in September, but de Guindos felt that any new stipulations would not significantly differ from those already planned through to 2014. At the beginning of this month the European Commission received a budget outline from Spain which detailed cuts of more than 100 billion euro’s. If successfully executed this could reduce the 2014 shortfall for the Spanish economy from the 8.9 per cent of gross domestic product seen last year to 2.8 per cent.
Italian Prime Minister Mario Monti was also vocal over the weekend. He asserted that wider concerns for the euro’s future have resulted in Italy’s elevated bond yields. Monti commented that although the Cabinet had planned for ‘a quicker drop in yields’ this failed to materialise for a number of reasons that ‘were not so much due to Italy but due to lower confidence toward a problem-free continuation of the euro’.
Although the report is uncorroborated, yesterday Spiegel reported that during the early September meeting the ECB may decide to set yield limits on the debt of each country. Spiegel further commented that in light of the ECB’s ability to print money, there will exhaustive funds available to them with which to purchase securities – thereby preventing speculators pushing interest rates over the set level.
Daiwa Capital Markets Europe also published a note which indicated that investors could face disappointment as the ECB limits the size of potential bond buying whilst demanding that Italy and Spain sign a memorandum of understanding. Economists Tobias Blattner and Grant Lewis claimed that ‘Contrary to the expectations of many market participants, we do not think the ECB will announce an interest-rate or spread target for short-dated peripheral government bonds’ and may ‘announce a volume of future bond purchases instead’.
Speculation aside, it seems increasingly unlikely that definitive measures will be decided prior to the German high court ruling on bailout funding, due to take place next month. Only once the German Federal Constitutional Court has ruled on its viability will the 500 billion euro European stability Mechanism, the permanent rescue fund for the euro, be galvanised into action.