Summary: No new innovations, but agreement to utilise the EFSF/ESM to support sovereign debt under an MoU; attention now turns to whether the leaders can agree on a ‘roadmap’ today.
While the conclusions to last night’s euro area summit were close to those we had expected in our preview (EU Summit preview: Drawing a roadmap for fiscal, financial and political union), the debate was evidently very tense, thereby shedding light on the still significant disagreements on how to address the challenges facing the euro area. In particular, it emerged that Italy and Spain had refused to sign off on the previously agreed growth pact until agreement had been reached to use the EFSF/ESM funds (which will amount to EUR500bn when the ESM is established) to purchase their sovereign debt (under a MoU, i.e. representing ‘light’ conditionality).
Such an agreement was anyhow possible within the existing framework, and we note that no new instruments were agreed to (for example, there was no comment on earlier proposals by some countries that the ECB could give the ESM a banking licence, while no details were given of the possible size of such interventions to buy sovereign debt). The communique did state that financial assistance would be provided by the EFSF to the Spanish banking sector, and that this would then be transferred to the ESM without acquiring seniority status, but there was no comment about suspending seniority from ESM financing. Additionally, the summit requested that a single euro area supervisory authority for banks, involving the ECB, be agreed by the EU Council by end-year.
In summary, the key conclusions from the euro area summit are:
* Establishment of a single bank supervisor for euro area banks, “involving the ECB”
* Following the establishment of the single supervisor, the ESM could recapitalise euro area banks directly (under an MoU).
* The summit reaffirmed that financial assistance provided to Spanish banks would be from the EFSF until the ESM became available, and then the transfer to the ESM would be without the support acquiring seniority status.
* Irish banks are also to be examined under this framework “with the view of further improving the sustainability” of the Irish official programme and “similar cases will be treated equally”.
* The leaders affirmed their “strong commitment to do what is necessary to ensure the financial stability of the euro area, ini particular by using the existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilise markets for Member States respecting their Country Specific Recommendations and their other commitments including their respective timelines, under the European Semester, the Stability and Growth Pact, and the Macroeconomic Imbalances Procedure”. The communique went on to say that the conditions for EFSF/ESM intervention “should be reflected in a Memorandum of Understanding” (MoU).
Taken together with the agreement on the Growth Pact (which includes extending EIB capital, allocating structural funds, and the pilot programme for project bonds, the overall package of measures is in line with our earlier expectations, but it stops short of new decisive measures that would definitively mark a turning point. That said, the summit is not yet over, and if it could also deliver later today agreement on at least some aspects of a roadmap for greater fiscal integration, this would greatly increase the chance that the ESM in its current form, possibly with some help from the ECB, could act as a bridge for a couple of years.
Still, however, in our view markets will also need some commitment that member states with high public debt levels could eventually (say, in a couple of years) receive further significant support from others, such as through a debt redemption fund. Such support would need to be accompanied by effective controls for and a mandate from national electorates to national fiscal consolidation and pro-growth reforms. This would require fundamental changes in European treaties, referenda and constitutional changes in various member states, and take at least a few years. Despite significant implementation risk ahead, clear commitment to go down that road may instil some much needed confidence in the cohesion of the euro area.
Nonetheless, we continue to look for the pattern of incremental adjustment to continue, in particular with easing by the ECB next Thursday (we continue to look for a 50bp reduction in the main ‘refi’ rate, taking it to 0.50%, and a reduction in the deposit rate, taking it to either zero or to a small positive level, such as 0.05% or 0.10%). Such ECB easing measures would provide some further support in particular to banks in the periphery, who are the heavy borrowers from its main operations. We would also acknowledge that the deposit rate might not be lowered at all, on account of potential concerns about the impact on the money markets, and that there is also some risk of only a 25bp reduction in the refi rate.
Barclays Capital