In Europe: EU deal for Spain, Italy buoys markets but details sketchy

29 June 2012

Broad plan agreed upon, but the fine print still needs tweaking in Europe.

Under pressure to prevent a catastrophic breakup of their single currency, euro zone leaders agreed on Friday to let their rescue fund inject aid directly into stricken banks from next year and intervene on bond markets to support troubled member states.

They also pledged to create a single banking supervisor for euro zone banks based around the European Central Bank in a landmark first step towards a European banking union that could help shore up struggling member Spain.

“It is a first step to break the vicious circle between banks and sovereigns,” European Council President Herman Van Rompuy told a final news conference after talks which stretched right through the night.

The deal was widely seen as a political victory for embattled Italian Prime Minister Mario Monti and his Spanish counterpart, Mariano Rajoy, over German Chancellor Angela Merkel, who had brushed aside any need for such emergency measures earlier this week.

European Central Bank President Mario Draghi endorsed the “tangible results”, which sent the euro sharply higher and cut Spanish and Italian bond yields. European shares rose, led by banking stocks buoyed by the prospect of moves to backstop the financial system.

“I am actually quite pleased with the outcome of the European Council. It showed the long-term commitment to the euro by all member states of the euro area,” Draghi told reporters.

Most economists polled by Reuters expect the ECB to cut borrowing costs at its July 5 meeting, which takes place against a darkening economic backdrop. But internal resistance to the central bank reviving its bond-buying program remains high.

After 14 hours of intense talks that ended at 4.30 a.m. (2230 EDT), the 17 leaders agreed on a series of short-term steps to shore up their monetary union and bring down the borrowing costs of Spain and Italy, seen as too big to bail out.

To that end the euro zone’s temporary EFSF and permanent ESM rescue funds will be used “in a flexible and efficient manner in order to stabilize markets” to support countries that comply with EU budget policy recommendations, a joint statement said.

It gave few specifics, but euro zone officials said the funds could buy bonds on both the primary and secondary markets on the basis of a memorandum of understanding signed with the requesting state and up to a funding limit to be agreed.

Both Italy and Spain said they did not intend to call on that mechanism to stabilize markets for now, hoping the Brussels agreement will serve as a sufficient deterrent.


In a key concession by EU paymaster Germany, the leaders agreed to waive the ESM’s preferred creditor status on lending for Spanish banks, removing a key deterrent to investors buying Spanish government bonds, who feared having to take the first losses in any debt restructuring.

“We have taken decisions that were unthinkable just some months ago,” European Commission President Jose Manuel Barroso said.

Despite the concessions by Berlin allowing euro zone rescue funds to be used more flexibly, questions remained about the conditions, size and supervision of any future aid for Spain and Italy.

Monti, determined to avoid the political stigma of the bailout terms imposed on Greece, Ireland and Portugal, said countries that complied with EU budget recommendations would not receive extra austerity conditions or be subject to intrusive inspections by a “troika” of international lenders.

Merkel, eager to minimize any concessions to avoid giving the impression back home that she had blinked first, said strict conditionality would still apply to the use of rescue funds and countries would face stringent monitoring by the EU Commission and the ECB.

“There was pressure here to find a solution and I saw my role as ensuring that these solutions should respect the procedures that we already know and have, and the guidelines given by the Bundestag,” she said.

The Spanish and Italian leaders threatened to block a package of measures to promote growth to pressure Merkel to accept measures to ease their borrowing costs, delaying the talks for hours.

New French President Francois Hollande has backed the need for bold steps to help the bloc’s third and fourth biggest economies, adding to the pressure on Merkel, who earlier in the evening had to watch Germany lose to Italy 2-1 in the Euro 2012 soccer semi-final.

Hours before the lower house of the German parliament was due to approve the euro zone’s permanent rescue fund and a fiscal compact treaty to enforce budget discipline more strictly, she reaffirmed her firm opposition to common euro zone bonds.

But Merkel failed to achieve any immediate progress on her demands for EU authorities to be given the power to override national budgets and economic policies. The issue was kicked down the road to October, when top EU officials led by Van Rompuy will deliver a more detailed report.


The leaders also postponed a decision on the future heads of the Euro group of euro zonefinance ministers and the ESM rescue fund and an ECB executive board position because Merkel left early to attend the parliament debate in Berlin.

That avoided another setback for Germany, since veteran Euro group chairman Jean-Claude Juncker of Luxembourg was set to be reappointed for a limited period because other countries including France did not want German Finance Minister Wolfgang Schaeuble to get the job, to avoid the impression that Berlin is calling all the shots in the euro zone.

Market economists applauded both the short-term measures to steady markets and the longer-term direction, saying that for once, after 20 summits since the crisis began in early 2010, euro zone leaders had exceeded admittedly low expectations.

“I think the ECB being made the banking supervisor is actually the biggest long-term step because it points the way to banking union,” said Megan Greene, analyst at Roubini Global Economics, which is often deeply pessimistic about the euro zone’s future.

“The EU summit surpassed expectations by taking a significant step towards banking union,” Commerzbank economist Nick Kounis said in a note.

“The move to recapitalize banks directly is a big deal and will help to break the ‘vicious circle’ between banks and sovereigns that has been at the very heart of this crisis.”

While the ESM’s ability to inject capital directly into banks will come too late to help Spain recapitalize its debt-laden lenders immediately this year, Madrid should benefit next year when the banks should be able to repay the state money borrowed from the ESM, euro zone officials said.

The ESM will be empowered to make such direct loans to banks once a single European banking supervisory body is set up. Merkel said finance ministers would have to work out whether the state or the banks would be legally responsible for repayment of the loans thereafter.

Some analysts were more skeptical about the benefits of the deal, given the level of detail left open.

“It is one step on a very long road,” said Charles Diebel, head of market strategy at Lloyds Bank, adding that Germany’s acquiescence suggested leaders were increasingly adopting a “whatever it takes” approach.

“But we don’t have any details and arguably the detail is where the risk lies because the market will start to pick holes in it, as we’ve seen previously.”

Ireland, which had to take an EU/IMF bailout in 2010 after suffering a similar bank meltdown and property bust to Spain, hailed the decisions as a “game changer”, saying it would seek similarly favorable conditions for its own taxpayers.


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