Lots on the plate today, so we’re breaking our EuroWatch into two parts today, with the first focusing on the latest moves by the European Commission and the central bank to shore up the euro.
Our second part will focus on the latest from Spain and Greece, plus some news from Ireland, France, Britain, and more.
The EC issues its diagnosis
Caught up in the throes of economic chaos, the European Commission issued its diagnosis today, a thousand pages of prescriptions and proscriptions, declaring that the single currency zone risks “financial disintegration.”
Part of the solution is a system of direct bank bailouts plus more centralzied regulation of banks through a formal integration of banks into a common system.
A summary from The Guardian’s Ian Traynor:
Delivering more than 1,000 pages of diagnosis and policy prescriptions on the dire condition of the European economy and how to try to end almost three years of euro crisis, the commission also talked up the merits of eurobonds or pooling of eurozone debt, a proposal gaining in traction but strongly resisted for now by the biggest economy, Germany.
With international attention focused on Spain wrestling with an escalating banking crisis, the commission was surprisingly critical of Mariano Rajoy’s attempts to chart a way out of an extreme predicament – recession, soaring national debt, a ballooning budget deficit, the highest unemployment in Europe, and the banks sitting on tens of billions of toxic assets from the bust property bubble.
The commission said that there were signs of banks deleveraging, retreating behind national borders and divesting their foreign subsidiaries.
“To counter this trend of financial disintegration, more co-ordination at European level is required in supervision and crisis management frameworks. More specifically, closer integration among the euro area countries in supervisory structures and practices, in cross-border crisis management and burden sharing, towards a ‘banking union’ would be an important complement to the current structure of monetary union.”
“To sever the link between banks and the sovereigns, direct recapitalisation by the ESM might be envisaged,” it added. The proposal is again fiercely resisted by Berlin, but supported by the new French president, François Hollande, by Washington, and is also gaining support at the European Central Bank.
And a warning for France
The EC wants more austerity, and soon, demanding more spending cuts to reduce the national deficit to three percent of GDOP next year.
“Although this year’s target of 4.4 percent of GDP appears achievable, the distance to the three percent of GDP threshold remains significant,” it said.
“French authorities need to specify the measures necessary to ensure that the excessive deficit is corrected by 2013,” the commission added.
French President Francois Hollande, who took office this month after defeating right-winger Nicolas Sarkozy, has vowed to balance the country’s budget by 2017.
But he has also raised concerns with plans to hire 60,000 teachers and partially reverse one of Sarkozy’s key reforms by allowing those who have been working since they were 18 or 19 years old to retire at 60 instead of 62.
The commission said it was important that increases in public spending remain below potential GDP growth, “with special attention to the trend in social and local government spending.”
More from the New York Times’ James Kanter and Paul Geitner:
Olli Rehn, the E.U. commissioner for economic and monetary affairs, said he would give Spain an extra year, until 2014, to meet its deficit targets as long as it continued to rein in spending by regional governments and presented credible budget plans.
In the case of France, the commission said the government would need to take significant steps to bring next year’s budget deficit down to the E.U. limit of 3 percent of gross domestic product, a finding that may restrict the ability of Mr. Hollande to follow through on campaign promises to revive growth.
“Although this year’s target of 4.4 percent of G.D.P. appears achievable, the distance to the 3 percent of G.D.P. threshold remains significant,” said the commission, adding that Paris might need to make “additional efforts.”
The EU demands more austerity from Greece
As if Greece wasn’t already suffering from massive cuts to essential services and a growing austerity, the EC is demanding yet another pound of flesh.
From Jonathan Stearns of Bloomberg:
“Greece will therefore have to make substantial additional expenditure cuts in the coming months,” the commission, the European Union’s executive arm in Brussels, said in a report today. “Comprehensive international financial assistance can continue to be provided only if policy implementation improves.”
The commission cited “insufficient progress” by Greece in bolstering tax collection and improving public procurement and said the sale of state-owned assets has been “slower than planned.”
Such shortcomings have increased skepticism in euro nations such as Germany, the Netherlands and Finland about aiding Greece, while a Greek recession in its fifth year has made domestic voters critical of the fiscal-austerity demands.
What’s is all about? Saving the euro
And just how bad is the single currency’s light?
The euro hit a two-year low against the dollar on Thursday and forex strategists say there is a growing possibility that the single currency could fall to parity if Greece were to exit the euro zone.
Overnight, Barclays’ Global Head of Foreign Exchange Research, Paul Robinson, revised down the bank’s target for the euro, forecasting the currency to fall to $0.98-$1.11 under a Greek exit scenario – up to 25 cents downside from current levels, according to CNBC.
“We have revised down our euro-dollar forecasts. These are consistent with ongoing market stress in Europe, limited support from European policymakers, and election results in Greece,” Robinson said in a research note. “In our view, for all the discussion about a Greek exit, it is far from fully reflected in market price,” he added.
Another ratings service warning, for a continent
The rating agencies have played a leading role in the crisis, and while its arguable they play a rational service, one has to wonder occasionally just how impartial their ratings are.
At they very least, the downgrades add fuel to a fire that’s already raging, and the latest news from Fitch is unquestionably inflammatory.
From Greek Reporter’s A. Papapostolou:
Fitch Ratings said Thursday that although its main view remains that the euro zone will survive the region’s sovereign debt crisis intact, the risk of alternative outcomes is rising, with a Greek euro-zone exit the most likely of those alternative scenarios.
If that happened, Fitch said in a report, all euro-zone sovereign ratings would be placed on watch for downgrade, with Cyprus, Ireland, Italy, Portugal, and Spain most likely to be downgraded. Greece would probably have to re-denominate its debt and default again. The outcome in terms of downgrades of other euro-zone countries would depend on the level of contagion originating from Greece’s exit from the euro.
But even in its relatively benign “muddle through” base case, Fitch ratings believes some further euro-zone sovereign rating downgrades are likely. The majority of euro-zone sovereigns are on negative outlook, reflecting the economic cost of the crisis and rising political tensions that may hinder the implementation of effective policies.
EC wants direct aid to failing banks
Rather than funnel money to the finance ministries of member nations, the EU’s bailout machine should intervene directly with the banks, stripping yet another layer of sovereignty in the interest of feeding the debt beast.
From Deutsche Welle:
The European Commission has come out in favor of direct aid from the European Stability Mechanism (ESM) to shore up distressed banks in a move seen targeted primarily at helping overcome a worsening banking crisis in Spain.
In a major economic policy document issued Wednesday, the EU’s executive body said that the vicious circle of weak banks and heavily indebted states lending to each other must be broken.
In addition, the Commission proposed “tighter eurozone integration,” including a joint bank deposit guarantee scheme as well as closer financial supervision, Commission President Jose Manuel Barroso told a news conference in Brussels.
Among the other measures urged by the commission, ANSAmed reports, “The leitmotiv of the documents that accompany the European Commission’s recommendations to Italy, Spain and Portugal is reducing the tax burden on labour cost.”
At the same time, Italy was pressed to rein in tax evasion and lower government administrative costs.
For more on the banking measures, see here.
The eurobank rejects eight applicants
With at least four member states on the brink of collapse, the central banks in no hurry to admit other states to its creaky money game.
From Deutsche Welle:
Not a single nation on the waiting list to join the euro area has as yet fulfilled all the required membership criteria, the European Central Bank (ECB) said in its biannual Convergence Report on Wednesday.
The survey regularly assesses the progress made by EU nations towards adopting the dingle currency. While Britain and Denmark are sticking to their special opt-out clauses, the remaining eight candidates are seen by the central bank as not yet being fit to join the currency.
Bulgaria, the Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania and Sweden all revealed shortcomings on a number of counts, with many displaying weaknesses with regard to their track record on inflation, government finances, exchange rates, long-term interest rates and legal convergence.
Hedge funds raises bets against eurozone
The financial vultures who played the central role in destroying the American economy five years ago, leading tot he global collapse, are at it again, and Europe’s strongest economies are their prey.
Hedge funds are piling into bets against the bonds of core euro zone countries like Germany and France, signalling a growing fear that nations once considered safe havens could be dragged down by the crisis in peripheral states like Greece and Spain, according to Reuters.
After a buoyant first quarter for markets, when fears over the euro zone debt crisis receded thanks to a 1-trillion-euro cash boost from the European Central Bank, hedge funds have been quick to make sure they don?t miss out as concerns over the future of the single currency resurface.
Rather than bet on the likes of Greece and Spain, whose problems are now well documented, funds are shorting the bonds of core countries as a so-called ?tail hedge? – the purchase of protection against extreme events such as the launch of eurobonds, which would drive up the cost of borrowing for Germany, or even a breakup of the currency bloc.
While such bets have so far failed to pay off – rising French bond prices drove yields to their lowest since September 2010 on Friday – hedge funds are targeting core countries because liquidity is better than in peripheral markets and they feel their safe-haven status has been exaggerated as the crisis elsewhere deepens.