European progress?
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There are clear signs that over the past week a number of what had seemed to be previously unshakeable bargaining positions in the Euroland dilemma have started to shift.
Most important, we can discern that politicians are now focusing on how to create sufficient agreement on fiscal union that progress can be made ahead of fuller treaty changes, that will be allowed to follow on.
This will likely take the form of some deal to make the frequently flouted and toothless Stability Pact rules far more binding under a side agreement between Euroland members that can be put in place very quickly.
It would require countries where government debt or deficits exceed the Maastricht criteria to cede key aspects of fiscal sovereignty to a central authority, and would probably be backed up by conditional lending to support new issuance in Spain and Italy from the IMF, and possibly a lightly leveraged EFSF.
Meanwhile, the most senior politicians have generally stopped trying to tell the ECB what to do, which may be a big hint that the ECB is considering responding positively provided there is no taint of it bowing to political pressure. But in any case there is now, or very soon will be, enough justification for the ECB to act within its own mandate in at least two ways.
First, to extend long-term funding to the banks (it is already asking the biggest banks whether they would
participate in a 2 yr or 3 yr Long-Term Refinancing Operation).
Secondly, to cut interest rates to 1/2% or 3/4% and then do “conventional” QE of say €1 trillion – that is buy sovereign bonds across the board in proportion to GDP/ECB capital shares.
The first action goes with its financial stability mandate, the second is fully consistent with its price
stability mandate since the Euroland economy is starting to behave exactly like it did in the period that followed the collapse of Lehman. Meanwhile, we should not lose sight of the reality that ongoing closure of sovereign debt markets, let alone a euro break up, would bring a plague of deflation, depression,
downgrades and default to the whole region.
There are grounds for expecting that the recent bounce in risk appetite can extend further between now and the 8th/9th December, (ECB and European Council meetings) but that does not preclude a renewed sell-off into end-year/early January until the deals are sealed, at which point, there will be a fair chance that virtually all G20 central banks will be easing, including China.
This would then permit global reflation, and the end of the current extreme crisis, although the embedded problems of de-leveraging will still present significant ongoing challenges.
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
