“Risk” assets such as commodities and equities have rallied hard on the news that EU leaders have reached agreement on a plan to deal with Greece’s debt crisis. The euro has also risen sharply against the US dollar in response, with the Dollar Index (USDX) now back below 76. However, gold and silver prices have pulled back from the highs they reached yesterday.
The new plan for Greece calls for 50% losses on Greek government bonds held in private hands. Following adjustments to the value of government bonds they hold, large banks are also expected to maintain core “Tier 1” capital ratios of 9%. Leading banks in 13 countries have been given a deadline of June 12 next year to come up with an additional €106.4 billion of Tier 1 capital.
The EU has also approved moves to increase the eurozone bailout fund (EFSF) to €1 trillion, up from €440bn. Taken together, it is hoped that these three measures will protect Europe’s banking system, and set Greece on the road to recovery. Officials hope that this will result in Greece’s government debt falling to 120% of GDP by 2020. (Estimates currently put this figure at 130% of GDP, with others quoting 143% of GDP. The true figure is likely much higher).
However, debt write-downs are made harder by the fact that official lenders to Greece – such as the European Central Bank and the International Monetary Fund – will not accept write-downs on their Greek debt. As such entities hold around €140bn of total Greek government debt of €350bn, it remains to be seen whether or not the halving of private debt will be enough to get Greece out of its debt trap. Moreover, given the write-downs they are being forced to accept on Greek bonds, Europe’s largest banks will probably continue to face difficulties. Without official assistance (i.e., bailouts), it’s not clear how successful these institutions will be at successfully raising capital.
Banks, however, will have been comforted yesterday by comments from in-coming ECB chief Mario Draghi, who takes over from Jean-Claude Trichet on November 1. Draghi confirmed at a press conference in Rome that under his tenure, the ECB will continue buying the bonds of troubled eurozone states such as Greece and Portugal. Economists also expect the ECB to lower its benchmark interest rate by 0.25% at the bank’s next policy meeting on November 3 (the first chaired by Draghi).
As a sop to the inflation-phobic Germans, Draghi has stated that such measures will be “temporary by nature”. That remains to be seen. Given that advocates of “looser” ECB monetary policy include banks, many EU nations other than Germany – as well as US officials, who remain terrified of a European banking crisis spreading to America – it remains unlikely that the ECB will remain so tight under Draghi’s tenure. Money printing may be going global.