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Write-down exclusions welcomed, 'but not central' to EU treaty talks

Merkel and Sarkozy's relaxation on rules on the private sector taking losses on future eurozone bailouts are welcomed by the markets, but experts focus on the importance of the ECB's role

Market participants have welcomed new proposals to relax rules on private sector bondholders taking losses on future eurozone bailouts, after France and Germany arrived at a comprehensive agreement on fiscal change this week.

“[Bond]holders include banks across Europe, not just in Greece," says Tim Skeet, managing director DCM EMEA at RBS. "[Initially] making them accept write-downs has intensified the bank funding crisis and caused problems to banks’ balance sheets, as was made evident by the recent stress testing by the European Banking Authority. Taking this off the agenda is a good thing.”

Earlier this week, in what could be a promising shift in the eurozone crisis, German chancellor Angela Merkel and french president Nicolas Sarkozy came to an arrangement to introduce stricter budget discipline in the EU treaty. Proposals will include sanctions for countries that run budget deficits of more than 3% of their GDP, ensuring budget and deficit discipline will be written into the constitution of eurozone members as well as excluding private sector write-downs.

The new rules will require further changes for stretched nations already bearing the brunt of tight austerity packages.

A resolution and changes to the treaty will be discussed in greater detail at the European Union summit on Thursday.

“Merkel’s about-face on the prospect of further write-downs for private bondholders will be strongly welcomed by the markets and banks themselves,” says Joshua Raymond, chief market strategist at City Index. “This was a controversial call in the first place, but by actively stating that this policy won’t be adopted again, it helps to support bank prices and shareholder sentiment in the near term."

In October, Merkel encouraged European leaders to agree on a 50% write-down of Greek debt from the private sector. In a bid to control the escalating eurozone crisis and potential Greek default, write-downs led to unintended consequences.

International concern over state bonds throughout Europe drove market fears, and the move by Merkel came under much scrutiny.

However, focus on Merkel’s change of heart is not the main priority, as there are more pressing issues that need to be dealt with first.

“Nobody is reading specifically into Merkel’s comments with regard to write-downs while the treaty changes get formulated, but clearly it is another aspect around the better tone in the credit markets,” says Paul Young, head of European DCM at Citi in London. “More important in the immediate [future] will be the ECB stance with respect to a more aggressive intervention and any announcements they make on Thursday with respect to things like lowering collateral requirements and increasing the term of their repo operations."

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