By Dean Popplewell
Germany has been outflanked twice in a day, both by Italy and once on the football pitch. This EU summit was in danger of getting away without anything of substance being produced. However, with global capital markets watching on, and investors tired of the can being kicked down the road, something of worth had to finally be produced and now we have it. Eurozone leaders have agreed, early this morning, to take action to bring down the spiraling out of control borrowing costs of Spain and Italy and have promised to take those first important steps towards a European banking Union by creating a single supervisory body for EU banks by the end of 2012.
The summit attendees agree that euro area rescue funds could be used to stabilize bond markets without forcing countries that comply with EU budget rules to adopt extra austerity measures or economic reforms. The plans are expected to be completed during next month. On the face of it, Germany seems to have heeded to pressure from Spain and Italy, who earlier withheld support from an plan for a growth package worth +EUR120b, to demand emergency action to bring down some of their finance costs. Spanish and Italian leaders have been worried that their countries could soon be shut out of international markets and forced to seek financial assistance.
Members have also agreed that the ESM program would be able to lend directly to recapitalize banks without increasing “a country’s budget deficit, and without preferential seniority status.” The members aim was to create a “supervisory mechanism for euro-zone banks involving the ECB to break the vicious circle of dependence between banks and sovereign governments. Spain and Italy have succeeded in pressurizing their colleagues to help. Both economies had agreed to come to this summit to block growth package changes unless something was done to take pressure off the refinancing costs of the third and fourth largest economies in the euro-zone. Their gamble so far has paid off. With banks to be recapitalized directly represents a concession by northern European countries, including Germany.
Until the +EUR500b ESM program comes on line next month, the eurozone is to make more “flexible” use of the existing bailout funds for “well behaving nations” to reassure capital markets and provide some sovereign bond stability. This is supporting the EUR for now. Is the “deal” struck at the twentieth summit since the crisis erupted two years ago sufficient? Market positioning would tell you probably not. Perhaps the current disconnect between Paris and Berlin will end up being potentially the largest destabilizing factor and not the periphery debt scenarios.
The deal does not improve the solvency of indebted nations. Allowing banks again easier access to more monies is not solving the problem, it is in fact making the problem worse. The solution to “too much debt is not more debt.” What the euro-zone members have technically agreed to is a quicker fix that allows banks a chance to have even more debt for a while longer.
Are we to repeat the typical Summit pattern? The EU leaders have had a meeting, the markets have rallied, two days later the market says wait a minute, this does not solve the problem and we trade back in the hole again. Even the technicals like this scenario. The summit announcement had the EUR soaring through its 21 DMA in the O/N session. Despite potentially having the scope for a return to its upper bollie intraday target just shy of 1.27, selling rallies to this trend line remains favored.