Euro crisis rumbles on amidst calls for Treaty change

The European Commission will today present proposals “that bring further stability to fiscal policy of the euro area”, involving tighter control over national budgets and consequently, some loss of sovereignty. Those proposals would nonetheless not require changes to the EU Treaty. The Commission is also expected to present its discussion around the introduction of eurobonds – where changes to the Treaty are most likely required – that we presented earlier this week.

Meanwhile, in Italy, Il Corriere della Sera has reported that the government is working on a law decree to be presented at the ECOFIN meeting next week and approved before the 9 December heads of state meeting, at the latest. The law decree should include extra austerity measures for 2012-13 (of at least EUR 15bn or 1% of GDP) to secure the 2013 balanced budget target – a tax on home ownership or another form of wealth tax and further assets sales are most likely to be included. The decree should also include a first set of pro-growth measures, such as liberalisations and a reform of closed professions.

Looking back, yesterday, Germany’s Chancellor Merkel called for Treaty changes, saying, “We have to change the construction of the euro area […] Treaty changes are for me an immediate part of solving the crisis, the political response to a politically derived confidence crisis”. She added that decisions need to be taken quickly and if changes were difficult on the European level, they should be addressed at the euro zone level. “I don’t see any other alternatives currently. One can’t muddle through anymore”. Finally, she said that the EU Heads of State meeting on December 9 was significant and that “in extraordinary times, one has to be prepared to take extraordinary steps”.

France’s Prime Minister Fillon also said that Treaty changes are “necessary, but take time” and a partnership of French and German governments is essential in the meantime to deal with the crisis.

The Netherlands’ finance minister said that eurobonds are “absolutely not a solution in the context of the crisis. Put more strongly, it would be a perverse incentive because you remove the last stimulus to reform and cut spending”. Germany’s Finance Minister Schaeuble held a similar view.

ECB’s Weidmann again rejected pressure for the ECB becoming a lender of last resort, saying “[The ECB] would overstretch its mandate and call into question the legitimacy of its independence by accepting a role of lender of last resort for highly indebted member states”. He also implicitly rejected the idea of the ECB doing QE stating, “It is up to all of us to work against the general loss in confidence […] Therefore, we must not limit our focus to short-term crisis fighting and nor should we adopt unseen proposals that have been developed for other currency areas”.

On Italy and Spain, Weidmann said “In both cases, I am confident that these countries need no outside help but rather that they can comfortably help themselves, and that the new governments will take the necessary measures”.

European Commissioner Rehn said that the proposal for a euro zone debt redemption fund was worth studying seriously and further. “The proposal balances risk-sharing – which is limited in time – with very stringent programmes for fiscal consolidation”. However, Germany’s Chancellor Merkel initially responded that such a mechanism would face several constitutional problems that would require Treaty changes and it would be “impossible to implement in reality”.

The IMF introduced a flexible liquidity line, called the Precautionary and Liquidity Line, that would act as “insurance against future shocks and as a short-term liquidity window to address the needs of crisis bystanders”. It said that the new line would be available for six months to countries with relatively sound policies that are facing short-term balance of payments needs due to exogenous shocks. Access under the sixth-month arrangement could be as much as 500% of a country’s quota and come with few conditions. The line could also be used for longer-term programmes under 12- to 24-month arrangements with access up to 1000% of a country’s quota, which would be subject to reviews by the IMF board every six months. It remains unclear whether this facility is designed for euro area countries.

Bank of Italy Director General Saccomanni said, “We’re currently discussing within Europe the possibility of setting up guarantee schemes for banks’ medium-term issuance”, a policy tool presented at the October Euro summit. Saccomanni added, “If a bank issues bonds on the market with the guarantee of its state, this would satisfy the necessary characteristics to be used to get financing at the ECB and it may be sufficient condition to satisfy inter-bank lending. […] There’s a problem of facilitating the distribution of [ECB] liquidity to all banks […] This is a pathological situation. The central bank creates liquidity but the liquidity is not transmitted”. Cutting interest rates further would not solve the problem, according to
Saccomanni. On the SMP, Saccomanni said the “ECB never targeted any specific bond yield, the ECB intervenes to reduce the bid/ask spread, when markets are not working”.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla