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Investors worry that euro summit fails to unleash ECB buying

No wonder investors despair at the statements coming out of Europe’s endless series of summits to save the euro.

The latest, delivered by the euro area heads of state is long on details for a new fiscal compact – a beefed up stability and growth pact that they promise will be better than the one they all broke so nonchalantly in the first decade of the single currency – but short on details of how to avoid financial calamity in the weeks ahead.

It starts with a declaration of bold determination. 

“General government budgets shall be balanced or in surplus.”

And then immediately undercuts it. 

“This principle shall be deemed respected if, as a rule, the annual structural deficit does not exceed 0.5% of nominal GDP.”

So the governments will deem their budgets to be in surplus even when they are in deficit.

Politicians don’t have much credibility with investors.

These normally amusing inconsistencies aren’t funny anymore. They diminish what little remains. Perhaps feeling the need to sound more assertive, the euro area heads of state resort to the written equivalent of shouting at markets: the dreaded bold type. 

“The rules governing the Excessive Deficit Procedure (Article 126 of the TFEU) will be reinforced for euro area Member States. As soon as a Member State is recognized to be in breach of the 3% ceiling by the Commission, there will be automatic consequences”.

This may be a vain attempt to go back in time and correct a failure that has already triggered a financial market crisis in the single currency area, but it at last sounds serious.

But then comes the inevitable concession: 

“unless a qualified majority of euro area Member States is opposed. Steps and sanctions proposed or recommended by the Commission will be adopted unless a qualified majority of the euro area Member States is opposed.”

The contorted wording springs from the delicate political niceties of pushing all this through. But the language merely reminds investors of doubts over political implementation: what bond and equity buyers call execution risk. What are the chances all these initiatives pass through Europe’s national political processes? Maybe 50%?

The markets are more interested in how policymakers intend to deal with the stresses in government bond markets right now. Here the heads of state had less to offer beyond an agreement to speed up the start of the European Stability Mechanism to July 2012 and run it in tandem with the EFSF to an overall maximum capacity of €500 billion: so no big bazooka there. The European states, led by the bigger economies, will together advance €200 billion to the IMF which it will then have available to lend back to the weaker European states.

Does any of this give the markets what they want?

Euromoney speaks to Alexander Friedman, chief investment officer of UBS Wealth Management (who has close to $800 billion under management): 

“It felt different in the run up to this summit, as if the failed German auction had woken German policymakers up that this was approaching the end game. France has been downgraded by the markets, if not by the agencies themselves. And Germany has seen that even it is not safe. What we hoped for from the summit is sufficient agreement on fiscal consolidation to give the ECB cover to act as a lender of last resort.”

It remains to be seen if that has been delivered.

The ECB announced on Thursday further extraordinary steps to prop up euro area banks, with long-term funding against questionable collateral, so potentially propping up the banks that prop up the governments, while not lending to the governments directly. Is that enough? 

Friedman says: 

“There have been a lot of complex elements in previous summits. The markets don’t want complexity. They want simplicity. And they want to see a role for the ECB that lets investors know that, at the end of the day, there is a lender of last resort present. Unfortunately, the summit has not delivered the credible solution markets want. The ECB remains unwilling to act as a lender of last resort, and the steps toward fiscal sustainability are incremental rather than decisive"

The circuitous route to mutualizing the debt partially through increased funding to the IMF doesn’t impress.

”In the end, the IMF isn’t going to save Europe: China certainly isn’t when Europe is richer than China. Only Europe can save Europe.”

On Friday morning Italian and Spanish bond yields, having rallied hard in the run up to the summit were rising once more 

- Euromoney Skew Blog

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