Globe and Mail Update
Published Wednesday, May. 23, 2012 7:44AM EDT
Well, what did you expect?
I’m somewhat surprised that investors are somewhat surprised that today’s EU summit appears destined to fail.
Hopes had been building for something substantial at the informal dinner of European Union leaders in Brussels, but those hopes have largely been dashed amid continued opposition by Germany to the idea of a euro bond. Added to that are comments by the former prime minister of Greece, who warned in an interview with The Wall Street Journal of the threat of Athens quitting the euro zone.
“Today is the anniversary of the Defenestration of Prague in 1618, the start of the Thirty Years’ War,” said Chris Beauchamp, a market analyst at IG Index.
“Frankly, it seems as if this crisis has been going on for 30 years. Hopes for today’s EU summit have been well and truly chucked out of the window, as the Germans once again state their firm opposition to euro zone bonds as a means of solving the crisis. Berlin has ignored the pleas of the OECD, IMF and its allies in Paris and Rome, believing that such a solution would only worsen the spendthrift ways of their southern neighbours.”
As our European correspondent Eric Reguly writes in today’s Report on Business, a euro zone bond would be supported by the credit ratings of all the members of the 17-nation monetary union, but really by Germany’s triple-A standing.
Chancellor Angela Merkel doesn’t want it. Not only would such a move boost borrowing costs, from her point of view it would also kill the incentive for fiscal discipline among the laggards of the group.
That sets the stage for a summit with no clear outcome, and continued turbulence in markets as the two-year-old debt crisis rages anew.
France’s new president, François Hollande, is pushing the creation of a bond, and, given he also wants to focus more on economic growth and less on austerity, appears headed for a showdown with Ms. Merkel at some point.
“New French President François Hollande’s new growth mandate has seen him look to take the austerity fight to Germany, and while German Chancellor Angela Merkel may have been isolated at the G8, she remains much less so in Europe,” warned senior analyst Michael Hewson of CMC Markets.
German stand against euro bond sets stage for tense EU summit
ROME— From Wednesday’s Globe and Mail
Germany’s near-term borrowing costs fell to zero as euro zone turmoil ahead of a European Union summit reinforced the country’s status as the safest of havens.
The informal leaders summit, to be held in Brussels Wednesday, is unlikely to relieve the pressure on the bonds of the weakest countries. That’s because various German officials have made it clear Germany will not endorse euro bonds at the summit, despite strong pressure to do so.
Italy, France, the European Commission, the International Monetary Fund and the Organization for Economic Co-operation and Development have all pushed for euro bonds in the days before the summit. Such bonds would be backed by the credit ratings of all 17 euro zone countries, effectively exploiting Germany’s triple-A rating.
The co-mingling of debt would substantially lower the debt costs of the weakest countries, and raise costs for the strongest. If Germany’s borrowing costs were to rise to the euro zone average, its repayments would rise by about €50-billion ($64.7-billion) a year.
German Chancellor Angela Merkel has warned repeatedly that euro bonds would remove the weak countries’ incentive to clean up their fiscal act. German Finance Minister Wolfgang Schaeuble has stressed that the basis for economic growth lies in fiscal discipline through austerity, combined with close oversight of euro zone budgets. “Fiscal consolidation is the precondition for our goal, which is more growth,” he said this week.
Germany’s opposition to euro bonds is bound to make Wednesday’s summit tense. Frances’s new president, François Hollande, had made euro bonds, along with fresh growth policies to counteract the job-killing austerity programs, the centrepieces of his euro zone rescue plan.
In a note Tuesday, economist James Nixon of France’s Société Générale SA said, “Despite the smiles and show of unity, the respective positions of the two sides still look to be virtually immiscible. What is clear is the euro bonds will not be a white knight that rides to the rescue of the euro area’s immediate travails.”
The absence of euro bonds is likely to keep Germany’s borrowing costs at rock-bottom levels. The yields of the distressed countries, including Spain and Italy, will likely remain high as confidence in their economic salvation plans collapse.
Germany’s central bank, the Bundesbank, announced that it expects on Wednesday to sell two-year treasury notes that carry a zero-per-cent coupon. After factoring in inflation, that means bond investors are effectively paying the German government to protect their capital.
Yields across the German debt spectrum have plunged as sovereign bond investors dump the ailing debt of Greece, Spain, Italy and other euro zone countries mired in recession with little prospect of quick recovery. German 10-year bonds now yield less than 1.5 per cent, well lower than yields on U.S. and British debt. Only Japanese bonds, with a yield of about 0.85 per cent, are cheaper.
Berlin plans to sell €5-billion of the two-year, zero-coupon debt. In mid-April, it sold a similar issue with a 0.25-per-cent coupon, and Germany also plans to sell €1.5-billion of inflation-linked bonds, maturing in 2023, with a yield that is likely to fall into negative territory.
Economists and strategists said that sovereign bond investors are more concerned about return of capital than return on capital as the debt crisis, after a brief interlude earlier this year, gains momentum. Greece’s exodus from the euro zone is no longer unthinkable.
With euro bonds off the table at Wednesday’s summit, growth measures are expected to rise to the forefront of the agenda. The leaders probably will endorse a €10-billion increase in the capital of the European Investment Bank, which finances infrastructure projects.
They will probably also call for greater use of EU structural funds in the countries with the highest jobless rates. Reportedly, about €80-billion of structural funds are available but unspent.
The leaders may also discuss granting the European Stability Mechanism, Europe’s permanent rescue fund, which is to launch later this year, the ability to lend directly to banks. Currently, it is allowed only to lend to governments.
Against that backdrop, investors are in a foul mood this morning. Adding to the euro angst are weaker trade numbers from Japan.
“Markets are steadily giving back the gains made over the past two days, not helped by weaker trade data from Japan that hints at a slowing global economy,” said Mr. Beauchamp of IG Index.
Tokyo’s Nikkei sank 2 per cent, and Hong Kong’s Hang Seng 1.3 per cent.
In Europe, London’s FTSE 100, Germany’s DAX and the Paris CAC 40 were down by between 1.3 per cent and 1.7 per cent by about 9 a.m. ET.
“Former Greek PM Papademos told the Wall Street Journal there’s a risk the country could leave the currency union … nothing we didn’t already know, but the market doesn’t need reminders,” said Benjamin Reitzes of BMO Nesbitt Burns.
“In response, the euro touched its weakest level since August 2010. The data overnight were on the soft side as well, and the World Bank downgraded its growth forecast for China to 8.2 per cent for 2012 from 8.4 per cent. Commodity prices are down: WTI crude is down 1 per cent to $91, gold is off $13 to $1555, base metals are lower (COMEX copper is down 1.6 per cent to the lowest level year-to-date), while the grains are mostly softer.”