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Silvia Quandt & Cie. AG, Merchant & Investment Banking: In-between the lines – Bernhard Eschweiler
Silvia Quandt & Cie. AG, Merchant & Investment Banking / Schlagwort(e): Sonstiges – Euro leaders agree on a vague vision for a tighter union but not on a road map – Merkel gets her way without giving much – ECB provides glue to keep Euro together and is likely to apply more – Market pessimism impacts business sentiment – 2011 déjà-vu? Financial markets continue to oscillate between hope and disappointment. The outcome of the Greek election, although widely viewed as Euro friendly, had little impact on sentiment. The G20 summit produced empty statements and the agreement by France, Germany, Italy and Spain on a EUR130 billion growth package contained nothing new to get markets exited. Nevertheless, markets have not given up hope that something positive may come out of the EU summit today and tomorrow. Don’t get excited. Yes, some commitment to a fiscal and banking union is likely to emerge, but the differences over the road map remain too large at the moment. The likely result: more muddling through. Indeed, expecting more would be naïve. While frustrating, however, this process is not necessarily doomed. Critical is the role of the ECB, which is likely to do more to keep the Euro on track. Completing monetary union in small steps The recognition, that monetary union requires a closer fiscal union as well as a banking union, is gaining weight. Most likely, the closing statement of the current EU summit will outline a vision of fiscal and banking union. Moving from that vision to a road map and concrete measures, however, will remain a process of small steps. Too large are the differences, especially between Germany and France. As we wrote before, asking German tax payers to transfer funds without retaining some control is politically not feasible. On the other hand, Germany is sufficiently committed to the Euro and the periphery so dependent on Germany that acute stress is likely to lead to step-by-step compromises. The box above outlines where compromise is likely or possible. Already announced or widely anticipated are the growth package, the Spanish bank recapitalization program, a rescue package for Cyprus and the supervision of the largest banks. Likely is also a stretching of fiscal targets. Greece will struggle to get much relief from the Troika, but countries like Spain, that comply with the fiscal requirements yet miss their targets due to poor economic conditions, can expect more sympathy. Open is whether fiscal targets will be officially stretched or deviations just tolerated. Unlikely at this moment are any measures to mutualize liabilities. For that to happen, Germany and its allies will require more democratic fiscal control at a pan-European level, which most other countries led by France are currently not willing to accept. Possible are measures that increase the emergency-response capabilities of EFSF and ESM. Formally, EFSF and ESM have the option to intervene in the government bond market. However, Germany has not yet given the final green light. That could be an outcome of the summit. Related is the issue of EFSF/ESM resources (bank license or funding increase). A decision is unlikely at this summit, but the issue will remain on the agenda, especially if the Euro comes under more pressure. ECB at center stage Critics argue that this muddling through is not sustainable as it fails to build market confidence. To be sure, that is a risk, but not an inevitable outcome. First, Ireland and Portugal are good examples that sticking to reforms can build market confidence over time. Both countries have seen sovereign spreads narrowing. In the case of Ireland, the Target2 balances also show that capital is coming back into the banking system. Second, there is the ECB that plays an underappreciated role in keeping the system together. While sovereign spreads for Italy and Spain have widened again, Euro interbank spreads have remained low. Last week’s easing of collateral standards was another small step in the ECB’s efforts to keep the banking system afloat. The market is increasingly anticipating an ECB rate cut at the council meeting next week. From an economic perspective, the ECB can justify a rate cut with weaker economic performance, falling inflation and stagnant bank credit. To be sure, cutting rates will have little direct impact on economic growth. However, lowering funding costs will have a substantial impact on the financial position of the banking system, given how much banks now depend on ECB liquidity. Thus, we expect that the ECB will lower the policy rate in two steps in the third quarter to 0.5%. Less likely is a near-term reactivation of the SMP. For the ECB, the SMP is a temporary emergency tool. Using the SMP more proactively would provoke German protest, which ECB president Draghi is trying to avoid as long as possible. German business expectations vs. conditions Last week’s IFO survey showed that Germany is not immune from the Euro crisis. The expectations component dropped notably and is back to the low of last October. Current conditions, however, improved modestly and remain in expansion territory. The question is whether current conditions will follow expectations downward or whether current conditions will hold up and expectations eventually improve as was the case last year. We think the latter. The improvement of expectations at the end of last year was triggered by better global economic conditions, notably the recovery in the US. We are optimistic that the US will not spiral into recession, but see the bigger potential for positive news coming from China, which is accelerating its stimulus program. In addition, we believe that German domestic demand will prove resilient. Thus, the better-than-expected consumer confidence survey was good news. But even more support is likely to come from residential construction.
Disclaimer This analysis was prepared by Bernhard Eschweiler, Senior Economic Advisor, and was first published 29 June 2012, Silvia Quandt Research GmbH, Grüneburgweg 18, 60322 Frankfurt is responsible for its preparation. German Regulatory Authority: Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), Graurheindorfer Str. 108, 53117 Bonn and Lurgiallee 12, 60439 Frankfurt. Publication according to article 5 (4) no. 3 of the German Regulation concerning the analysis of financial instruments (Finanzanalyseverordnung):
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