Open Europe blog

A new year, the same old problems...

2012-01-27T15:08:00.016Z

Ahead of the first (full) EU summit of the new year, we've put together our thoughts on what progress to expect.

As per usual there are lots of topics to be discussed but we don’t expect too many concrete decisions. We’d expect a final draft of the euro fiscal pact to be completed, some progress on ESM - the eurozone's permanent bailout fund - and a commitment to "growth and jobs" (as opposed to recession and unemployment..?). Huge questions over Greece and size of bailout funds will probably remain. Below we outline the key issues to watch out for (take 2):

Fiscal pact: This should be last round of discussions on the new European treaty. The aim has always been to have the final draft completed by end of January. However, there are still a few issues which need to be resolved.

The key interaction is between how the rules will apply to those non-eurozone which sign the pact and how much influence they will have (i.e. how many meetings they get to attend and what decisions they will have an impact on). Sweden, Poland, Denmark and the Czech Republic will make their decision on whether to sign based on how this plays out. The final agreement won’t be finalised as the Czechs and Irish will still have to decide whether to hold a referendum on the treaty. Expect it all to be tied up at the March summit.

Our bet is on the Poles, Danes and Swedes signing up if they're guaranteed some sort of place at the table and if the rules of pact actually don't apply to them - creating a rather bizarre situation.

The UK and the use of EU institutions: We suspect that Cameron will reluctantly accept the formulation in the fourth draft of the fiscal compact which gives the ECJ the right to slap fines on member states for not implementing the pact's spending ceilings. Technically, this marks an overlap between the fiscal compact and the EU treaties - something which Cameron has argued against in the past.

ESM treaty: Behind the scenes negotiations have been on-going, so the draft should be fairly far along. The biggest sticking point was the use of Qualified Majority Voting (QMV) to make decisions within the ESM, which Finland objected to. There now looks to be a compromise. The Finnish Constitutional Committee announced today that it approves of the new wording in the ESM treaty, whereby QMV is used to disburse loans but for any change in the size of the ESM a unanimous decision is needed. The Grand Committee (representing the Finnish Parliament) will rule on Monday and is expected to support this position. This is pretty big.

Additionally, there should also be a discussion on the size of the ESM and whether the ESM and EFSF can run in parallel. It's hard to read Germany on this issue. There have been indications that Germany may be willing to let ESM and EFSF run together, but it would want the fiscal pact and Greece sorted before it is considered. It's likely the topic will be broached but final decision will be delayed until March.

Greek restructuring: EU leaders are unlikely to have a deal ready to present at the meeting so it may be more of a general discussion. Even if a deal is achieved, which reconciles the differences between Greece and its bondholders over the level of interest paid on the new bonds, there is still the huge question of holdouts and ECB. Expect these issues to be covered along with talk of increasing the size of the second Greek bailout and losses for public sector - but don't expect any big movements (at least not publicly).

Growth and jobs agenda: EU leaders have been pushing this 'new' agenda recently. After coming in for massive criticism for their undying commitment to austerity, they are keen to focus on boosting competitiveness, promoting growth, creating jobs and the like. Despite that, as of yet a coherent policy agenda to achieve this has not been formulated - most of the time there is just a broad commitment to ‘structural reforms’.

We expect much of the same from this meeting - leaders (David Cameron in particular) will play up the renewed focus on growth rather than just austerity but it remains unclear how much difference the EU can make on this front. Ultimately, national governments need to push ahead with long term changes to the structure of their economies (labour market reforms, increased education and training, investment in R&D, increased competition etc.) This will take time, money and political will, all of which the eurozone is short of at the moment.

What keeps central bankers in Frankfurt awake at night – and why should Britain care?

2012-01-27T11:18:00.002Z

In a blog post for the Telegraph, we argue,

In his speech in Davos yesterday, David Cameron outlined some very sensible proposals for how to deal with Europe's economic crisis. But, almost in passing, he also called for a eurozone “central bank that can comprehensively stand behind the currency and financial system”, implicitly suggesting that the ECB must be ready to provide more cash to struggling banks and governments around Europe. Unfortunately this statement completely misses the intricacies which the ECB and the eurozone face in the coming months.

The ECB’s balance sheet now stands at a pretty scary €2.7 trillion, higher than that of the money-printing Federal Reserve in the US. By buying government bonds and providing cheap cash to banks around the eurozone, the ECB is now leveraged 33 times – up from 24 times only last summer. This means that for every €1 the ECB holds in reserves and cash, it has €33 swirling around somewhere in the eurosystem.

But it isn’t the size of its balance sheet that keeps ECB officials awake at night – all central banks are leveraged – as much as the circa €60bn of (nominal) Greek bonds festering on its books. This (relatively) tiny item has become political dynamite, as Greece is set to default on its debt in March, either through a voluntary agreement with its creditors or by simply running out of money. As creditors and the Greek government are locked in to talks over which one it’ll be, big question is: will the ECB be forced to take a hit?

The question is crucial as the ECB has said in the past that it will not take losses on its eurozone exposure – ever. For the Germans, losses for the ECB would mark a huge betrayal of the Bundesbank-model, in which a central bank is trusted and prudent, and doesn't take on excessive risks – and therefore has the credibility to control inflation. Many German commentators have spent the past year grumbling about the ECB’s back-handed Quantitative Easing and illegal financing of state deficits. The ECB has got around this by purchasing the bonds on the secondary market, but if it took losses on Greek debt, this argument falls.

But at the same time, if “public” bodies, including the ECB, holding Greek debt don’t accept losses in a Greek default, the write-down may not be large enough to give the country even a hypothetical chance of bouncing back, meaning the EU/IMF cannot give it more loans. For the ECB, this amounts to a pretty awful catch-22: accept losses and see your credibility and rationale undermined or reject losses and at worst prompt a disorderly Greek default or possibly just massive distortions in eurozone bond markets.

So what’s the best solution? We’ve long argued for a full restructuring of Greece’s debt (now 60-70%) and reassessment of Greece’s position in the euro. But that looks unlikely right now. Instead, the ECB could be offered an escape route. It purchased its bonds at around a 30% discount. It could accept a 30% write down without taking any losses and would give Greece some additional debt relief. Another option would be for ECB-held bonds to be bought by the euro bailout fund, the EFSF (at cost price), and then submitted by the EFSF to the voluntary restructuring. The EFSF could absorb the losses, though it too may have to deal with some very uncomfortable questions from taxpayers who will have lost money. But arguably it’s better than sacrificing the credibility of the ECB.

Both options would still be a tacit admission of failure by the ECB, since it always claimed it would hold the government bonds it bought to maturity, but it may have little choice.

All of this should concern the British. Not only because the eurozone crisis is linked to the fate of the UK's economy. But also, as Anglo-Saxon commentators are coming out in droves – alongside the UK government itself – in calling for the ECB to load up on yet more eurozone government debt if need be, it should be a reminder: in the eurozone as in the UK there’s still no such thing as a free lunch.

In the end, someone has to pay – and if you want to keep the Germans fully on board, it best not be the ECB.

A crude agreement

2012-01-25T13:06:00.002Z

On Monday Brussels announced an EU-wide ban on oil contracts between Iran and member states. The hope is that these sanctions will choke the Islamic republic’s finances, and prevent its nuclear programme from progressing further. However, as with countless other EU foreign policy objectives, the goals look to have been undermined by the lack of consensus between EU member states.

Diplomats admitted that negotiating the embargo had been difficult. Quite an understatement given that the enforcement of the embargo has been delayed six months just to ensure that an agreement could be met. The key dispute comes from the fact that Greece, Italy and Spain are far more dependent on Iranian exports than their Northern neighbours. Greece imports up to a third of its oil from the Islamic state, with which it has negotiated a favourable rate. Italy and Spain buy 10% of their oil from Iran.

Forcing these countries to source such a large percentage of their oil from another producer in such a short time frame will undoubtedly put additional costs on their economies (not to mention the potential for higher prices which we discuss below). This seems slightly counterproductive to say the least when they are already struggling to stay afloat in the storm of the eurozone crisis. Not that you can abandon all policy goals on the basis of economics, but it highlights the breadth of impact which the eurozone crisis will continue to have until a lasting solution is found.

That said, fears of an impending energy crisis are alarmist. For one, Saudi Arabia has assured European governments that it will increase its production capacity to replace Iranian imports, which represent a fairly small share of overall EU oil consumption. Gaps in supply can also be met by Libya, which is set to boost exports after a year in remission.

A massive price hike is also unlikely, with refineries taking the hit more than consumers. Providing it does not switch to other Middle Easter suppliers, China will become the biggest consumer of Iranian oil, creating a monopsony through which it can drive down prices. Iran has shown itself willing to sell oil under the market price during previous embargoes. An interesting side effect then is that China could end up benefitting most from this ban by sucking up the excess Iranian supply at low prices. Not the EU’s fault, but it seems to undermine any prospect of the embargo having a huge financial impact on Iran.

Will Europe’s energy future be unaffected then?

Possibly, if two conditions hold:

- First, Iran must not blockade the Strait of Hormuz, through which Europe accesses Saudi oil. This seems unlikely since doing so would likely cause a full scale military conflict as the US has vowed to defend EU cargoes.
- Second, Iran must not throw a spanner in the works by cutting off oil supply immediately (something which Europe could not cope with as the delayed start of the embargo shows).

Will any of this bring Iran ‘back to the table’?

As EU High Representative on Foreign Affairs Catherine Ashton outlined, the aim is to “bring Iran back to the table”. It’s not clear this will be the case - Iran has survived previous embargoes, some of which have even hardened support for the regime. Without China and India joining the embargo (highly unlikely) Iran may not feel much of a squeeze. Even if they did, oil prices would skyrocket creating even more problems for the eurozone.

All in all then, this embargo has been a bit of a mess. Whether or not the aims are valid, it has once again highlighted the disparities in foreign policy goals within the EU, and therefore the limits of a combined foreign policy. It also brings home that, despite its size, the EU’s power is to some extent dwarfed by that of China and the US. Ultimately, their decisions will make or break this embargo, not the EU’s.

Off target: The case for bringing regional policy back home

2012-01-24T16:07:00.007Z

In a weighty new report published today we take a critical look at the EU’s structural funds which are the means through which the EU implements its regional policy. We estimate that over the course of the current 7 year EU budget, the UK will pay in around £30bn to the EU’s so-called structural and cohesion funds, but will get back just under £9bn.

In our press release, we argue that:

“Limiting EU regional spending to poorer countries would be a win-win situation for both Britain and Europe. It would channel more cash to the newest member states and allow the UK to spend exactly the same amount on its regions as it does now, with the option of adding the several billion that it would save from streamlining the structural funds. It would also eliminate a range of additional costs and allow the Government to radically improve the targeting of funds towards poorer areas and to viable projects.”

What exactly is the problem?

The EU aims to reduce regional disparities but under the current system, every region in every member state receives at least some financial support, regardless of how wealthy it is. This means a significant part of the UK’s contribution goes to member states with a comparable level of income. According to our calculations, of the UK’s overall contribution, 70% goes to other member states, 25% is redistributed within the same UK region in which the funds were raised, and only 5% is redistributed between richer and poorer regions within the UK.

This recycling exercise is fundamentally economically irrational, and even the Commission has recognised that it creates “considerable administrative and opportunity costs.”

It also means that most UK regions, even the most disadvantaged, are short-changed because they pay in more than they get out. For example, the West Midlands, which has the lowest disposable income per capita in the UK, pays £3.55 into the structural funds for every £1 it gets back. Other regions that do badly from the current set-up include the North-East, Merseyside, Lincolnshire, Northern Ireland and parts of inner London.

While there is a strong case for having an EU regional policy to assist the poorer member states that have joined the EU since 2004, there is literally no “added European value” – the criteria for justifying EU-level as opposed to national-level decision making – to keeping all member states locked in.

So what can be done?

Our proposal would see the implementation of an eligibility threshold of 90% of EU average income, above which member states would no longer receive any support. This would on one hand enable the remaining funds to be focussed exclusively on the poorer member states, while allowing richer member states to still make significant savings and regaining control over their regional policies and spending. This is broadly in keeping with the position adopted by the previous Labour Government.

What impact would this have?

Such a measure would create a whole range of winners, and a handful of ‘losers’. To illustrate, if this policy had been adopted for this EU budget period (2007-2013):

France would have emerged as the biggest winner from focussing the funds on the poorer states, cutting up to €12.8bn from its net contribution to the EU budget over seven years.
The UK comes second, with a net saving up to €5.1bn (£4.2bn) over seven years.
Importantly, all new Central and Eastern European member states would see a rise in the amount of subsidies they receive (except for Slovenia under one possible scenario), with Poland gaining the most.
Italy, Spain and Greece would all lose out substantially, but they are already set to get a smaller share of EU subsidies as recent enlargements continue to erode their net receipts. More importantly, to cope with the eurozone crisis, these countries need far more responsive and targeted support than is currently being offered by the structural funds.

The way ahead for the Coalition

It appears the Coalition has opted for a ‘safety first’ approach with regards to negotiations over the EU’s next long-term budget (focussing on keeping the overall amount down and protecting the UK rebate). However, pushing for a more ambitious reform along the lines of our proposal would see a significant reduction in the size of the budget and would be better suited to building alliances with like minded member states.

Devolving regional policy from the EU would be a good move for the Coalition if it is to come good on its commitment of ‘rebalancing’ the UK economy away form its reliance on the South-East and financial services, and place to start. The UK could then launch a revamped regional and re-generation policy which would start with the £8.7bn that the UK currently spends via the structural funds, and then re-invests the additional £4.2bn saving from the reform. This would mean virtually all UK regions would experience a rise in the amount of subsidies they receive by around 45%.

In 2003, then Chancellor Gordon Brown argued that:
“the economic and social, as well as democratic, arguments on structural funds now and for the future so clearly favour subsidiarity in action, there is no better place to start than by bringing regional policy back to Britain”
Almost a decade later, this statement still points out the path ahead for the UK.

Harsh

2012-01-24T13:19:00.003Z

Swedish Finance Minister Anders Borg - whose country is currently grappling with whether to sign up to the euro fiscal pact - is not impressed by Greece's implementation of its EU-led austerity programme.

This is what he reportendly told journalists in Brussels this morning:

“There are pretty obvious things that haven’t been achieved on the structural side and in terms of public finances. This is probably one of the worst programmes we’ve ever seen. There has to be a radical improvements in the implementation before there can be a discussion about additional programmes.”

Harsh.

So where does EU money come from?

2012-01-20T09:00:00.001Z

Ahead of our impending paper looking at the effectiveness or otherwise of the EU’s structural funds (watch this space) we came across this timely comment from Hungarian PM Viktor Orban - who has been subject to some (ehum) controversy over recent weeks (he took a roasting in the European Parliament on Wednesday).

During an interview with German tabloid Bild, he was asked that given Hungary’s economic crisis, with the country trying to obtain a “safety net” from the EU and IMF, was it right that Hungarians enjoyed a 16% tax rate on their income while Germans had to contribute up to 47% of theirs - which is sort of a silly question.

When Orban pointed out that Hungary didn't owe Germany any money, the interviewer asked about the €2 billion Hungary receives from the EU’s structural funds every year. Orban’s answer:

“Correct, but this money does not come from German taxpayers, but from the EU. This money is available to us as a member of the EU.”

Hello Mr Orban. Where does "EU money" come from?

Here at Open Europe we argue that less wealthy member states such as Hungary should continue to receive EU structural and cohesion funds (though the funds need serious reform). But the money doesn't come from the EU’s magic plant, but from taxpayers - and around 1/5 of the EU's budget just so happens to be financed by German ones.

Incidentally, in our forthcoming paper, we'll present a solution that will make both Hungary and Germany fare better from the EU budget.

Just to whet your appetite.

The Draft Euro Fiscal Pact - Episode IV

2012-01-19T20:00:00.004Z

We have just got our hands on the fourth draft of the European 'fiscal pact' (this time, the Telegraph's Bruno Waterfield - who is always quick off the blocks - beat us to it), which is being circulated among national delegations tonight. At a first glance, a very limited number of Articles have changed from the previous version - but all the changes look pretty significant:

At the request of Germany, the preamble of the agreement makes now clear that, as of 1 March 2013, struggling eurozone countries will be allowed to apply for a bailout under the eurozone's permanent bailout fund, the ESM, only if they have ratified the 'fiscal pact'. The previous version only required that countries incorporate the balanced budget rule.

The new draft gives the European Commission a greater role, compared with the previous version. In fact,

The Commission will set out "common principles" on the establishment of the national corrective mechanisms which, under the agreement, should be triggered automatically every time governments fail to comply with their deficit targets;

Furthermore, the Commission is now allowed to issue a report on whether governments have correctly transposed the balanced budget rule into national law on its own initiative (under the previous draft, it needed to be "invited" to do so by a member state);

More importantly, if the Commission's report concludes that a country has failed to transpose the balanced budget rule properly, "the matter will be brought to the ECJ by one or more of the Contracting Parties." In other words, a government can only be taken to the ECJ by its peers, at least formally. However, what the Commission says in its report plays a key role in the process.

In regards to the ECJ, its jurisdiction remains limited to Article 3(2), i.e. how national governments implement the balanced budget rule. But some very relevant changes have been made in Article 8, in particular:

If a member state fails to comply with the first ECJ ruling (see above), it can be taken to the ECJ again. If the ECJ confirms that the government concerned has actually ignored its previous ruling, it can now impose a fine (no more than 0.1% of the country's GDP);

Interestingly, under the latest draft, the fines "shall be payable" to the eurozone's permanent rescue fund, the ESM;

In addition, a new paragraph has been added, which makes clear that Article 8 "constitutes a special agreement between the Contracting Parties within the meaning of Article 273 of the Treaty on the Functioning of the European Union".

What does that mean in practice?

This new paragraph really reads like an insurance against any possible objections from the UK regarding the use of the ECJ outside the EU Treaties. For those who, unlike us, do not remember the Lisbon Treaty by heart, this is what Article 273 says,

"The Court of Justice shall have jurisdiction in any dispute between Member States which relates to the subject matter of the Treaties if the dispute is submitted to it under a special agreement between the parties."

Therefore, this small paragraph makes the use of the ECJ (albeit still limited to a legislative rather than enforcement role) 100% legal under the EU Treaties.

One last thing is worth noting. Following suggestions from the Polish government that Poland might decide to stay out of the agreement in the end, unless non-euro countries are allowed to be present at future meetings of euro leaders, the latest draft establishes that:

Non-euro countries that decide to sign up to the agreement must be kept "closely informed of the preparation and outcome" of eurozone summits;

The leaders of non-euro countries must be invited to eurozone summits at least once a year. However, the invites would be restricted to non-euro countries that not only signed and ratified the agreement, but also "declared their intention to be bound by some of its provisions."

Sounds like a tricky trade-off: the Poles are unlikely to take too kindly to having to institute the eurozone fiscal rules before they've joined the euro...

Fresh Trouble for the Fiscal Pact

2012-01-19T17:30:00.001Z

One week after we published the third draft of the new European 'fiscal treaty' setting out tougher deficit and debt rules for eurozone countries, and with a fourth draft imminent, a quick update on where negotiations are at the moment.

The big news today comes from Prague. We reported last week that Czech Deputy Prime Minister Karel Schwarzenberg had threatened to pull his party out of the ruling coalition if the government decided to stay out of the 'fiscal treaty', but Czech President Vaclav Klaus had insisted that he would not sign the agreement "under any circumstances."

Well, the Czech government has now decided to put the issue to a referendum after several rounds of "very bloody negotiations", in the words of Radek John, the leader of Public Affairs - the smallest party of the coalition (pictured). The Czech Republic is not part of the euro, meaning that eurozone countries could still go ahead with the adoption of the fiscal treaty, without having to wait for the outcome of the referendum (non-euro countries can join at a later stage).

However, the announcement is extremely relevant for at least two reasons. First, there's now a concrete possibility of the Czechs staying out of the 'fiscal treaty', which would be the coup de grâce for the 26-versus-1 scenario depicted by a large portion of UK and European media in the wake of Cameron's veto at last month's EU summit (we had a go at showing why these reports were rushed, to say the least, see here and here).

Second, the news of a Czech referendum may trigger public and political pressure for a referendum in Ireland. This would not necessarily destroy the treaty because if a referendum were held on Irish ratification of the treaty, rather than simply the government's agreement to it, the treaty could still enter into force in theory. The last draft required 12 ratifications among euro states to enter into force but, certainly, it would throw a major spanner in the works and thoroughly undermine the credibility of the treaty if Ireland (the recipient of a bailout package) were not fully signed up at an early stage.

But there could be another problem, and a quite surprising one. In fact, it looks like the Polish government is not happy with the latest draft, which (as the previous two) would exclude non-euro countries from attending meetings of eurozone leaders - a strong incentive for many of the non-euro countries to sign the treaty.

And sure enough, the Polish government is now suggesting that it might not join the 'fiscal treaty' unless its request is taken on board - Germany is thought to be rather keen on having the Poles signed up. This is what Polish Prime Minister Donald Tusk told the press yesterday,

"Our efforts aim at a fiscal agreement the shape of which does not make the division of Europe into two clubs - the eurozone and countries outside the club - more lasting than is safe in our opinion."

Meanwhile, a fourth draft of the agreement is being finalised, and should be made available ahead of the next meeting of finance ministers on 23-24 January. The way ahead still looks quite rocky...

More IMF contributions? conditionality is king

2012-01-18T16:05:00.011Z

The rumours were finally confirmed today as the IMF released a statement announcing its plans to increase its funding base by up to $500bn. There’s been a lot of talk in the British media in recent weeks about the potential increased UK contributions to the IMF, and not much of it positive. The coverage has painted any additional UK contributions as tantamount to a eurozone bailout – this is a tempting narrative but ultimately it may be too simplistic. When it comes to the IMF there are a few subtleties which need to be considered, as we outline below.

Firstly, no-one has lost money lending to the IMF…ever. It is always the most senior creditor, meaning it will be the first to be paid back. Therefore the potential risk of this lending is minimal, no matter where it goes. Moreover, as Cameron has pointed out, the contributions do not impact the UK’s debt or deficit, so it is not really a question of giving up other priorities to fund the IMF.

Additionally it seems as if the money will be paid into the IMF general reserve fund and not a specific eurozone fund. It is also likely that other members will contribute, so this moves the point away from being simply about the UK and the eurozone and becomes more about the UK's participation in the global economy. Being a member of the IMF is an important part of the UK’s global role and its foreign policy approach. Unilaterally declining to contribute funds and possibly removing the UK from the IMF would have an impact far beyond the UK’s role in the eurozone crisis.

Furthermore, given the failures of the EU in the eurozone crisis, shifting the balance of power towards the IMF would be no bad thing (in the right circumstances, of course). The IMF has conclusively argued for a large write down of debt in Greece (as we also have) and has the expertise and experience to deal with the challenges of restructuring struggling economies.

That said there are a few conditions which the Government should consider:

- The funds must go into a general fund not a eurozone specific one and must be matched proportionately by all other members of the IMF.
- Larger IMF contributions to the eurozone must be matched by a greater say in the crisis resolution. Generally, it should be made clear by the IMF and its members that the current approach is not working – the focus needs to switch to debt restructuring combined with increased competitiveness and growth.
- The funds must not be seen to impact on Cameron’s decision to veto the recent European treaty. Although IMF funding was mentioned, this is a separate issue since it is coming from a direct IMF request not the EU.

So, it comes down to this: The UK should not hand out further contributions to the IMF without conditions. With these conditions met, the result would not be the same as simply handing more money directly to the eurozone. Alas, in the end, even an extra $500bn at the IMF’s disposal may not make a huge difference the outcome of the crisis.

Which candidate has the most to gain from France's downgrade?

2012-01-18T09:30:00.005Z

The race to the Elysee took another turn on Friday when Standard & Poor’s downgraded French debt. The decision had been widely anticipated by the markets since December, when the ratings agency conducted a review of Eurozone finances. Although all three French parties called for reforms of the ratings agencies – Nicolas Sarkozy’s UMP called for central banks to establish rating criteria, while Socialist candidate Francois Hollande mooted the possibility of a European agency – some candidates reacted better to the downgrade than others.

However, what is the likely effect of the downgrade on the presidential race? A LH2 poll conducted on Friday and Saturday in partnership with Yahoo! and published on Sunday shows that, compared to a month ago, Sarkozy and Hollande saw their ratings slip while the Front National's Marine Le Pen saw her third-place position behind Hollande and Sarkozy boosted. Sarkozy's share of first round voting intentions fell to 23.5% from 26%, Hollande's fell to 30% from 31.5%, while Le Pen gained 3.5% points to 17%.

Le Pen – whom 26% of voters wish to see in the second round according to a separate TNF poll published Friday – used the announcement as an opportunity to justify her policies, which include a return to the franc and protectionist measures such as a 3% import tax to finance her proposed minimum wage and social spending increases. During a jubilant press conference at the weekend, she argued that S&P’s ruling was “validation of the analysis [she] had carried out for the last two years” and that Nicolas Sarkozy’s “boomerang of lies” would soon come flying back to hit him in the face.

Hollande was quick to blame Sarkozy’s economic record. During a conference in French Antilles on Saturday the Socialist candidate remarked that “it’s not France that was downgraded but a certain policy…a certain president”. But his pointedly delayed response to Moody’s decision to maintain its French AAA rating was seized upon by UMP officials as proof that he was rejoicing in France’s downgrade. “Is the Socialist Party more cheered up by bad news for France than good news?” asked the UMP secretary Jean-François Copé.

Hollande also appears aware of the limitations the new downgrade sets for his presidential programme, conceding at the weekend that “not everything will be possible” and his pledge to “re-enchant the French dream” at the beginning of his campaign has itself been downgraded to one of offering “lucid hope”. Hollande has announced that he will propose strong measures to combat France’s ailing economy by the end of the month, a move which commentators have – perhaps rather too quickly - likened to Sarkozy’s 2007 muscular campaign of economic reform.

Sarkozy was the candidate most exposed to the downgrade for obvious reasons. Having brought the question of the country’s debt rating to the forefront of the national consciousness during his campaign to reform pensions (justified on the basis that they would reduce public debt and therefore maintain France’s triple A) he had the most to lose. As he reportedly confided to allies in December, “si la France perd son triple A, je suis mort” (if France loses her triple A rating, I’m dead).

In a conference in Madrid yesterday, Sarkozy downplayed the relevance of the S&P judgment, refusing to answer journalists’ questions because “what happened Friday, is Friday”. Today Prime Minister François Fillon denounced the left’s “small media tsunami which was at times almost as indecent as it was irrelevant”. Sarkozy has instead preferred to focus on employment ahead of the election, organising a ‘social summit’ tomorrow, where he will unveil long-overdue plans to reform France’s labour market, less than one hundred days before the election.

Sarkozy looks like the biggest victim of the downgrade, but Francois Hollande shouldn’t count himself lucky just yet. The Socialist candidate has insisted that he – unlike Sarkozy - never pledged any specific debt rating for France (an admission of pessimism unlikely to win over many additional French voters one would suspect). His pledged reforms to be “tough on the dominance of finance, tough on growth policies, tough on new instruments…tough on tax” don’t appear to have convinced voters either. Le Pen should be able to benefit the most off the back of the downgrade, but her weak performance during a televised interview on Sunday exposed her shoddy grasp of basic macroeconomics (and maths) which has left her poll standing stagnate at 18% today.

In sum, none of the three leading candidates have been able to use the downgrade to their benefit just yet but the race still looks open with only three months before the polls start for real.

Friday the thirteenth in the eurozone…

2012-01-13T22:30:00.002Z

Over on the Telegraph blog, we look at today's euro developments:

It all looked so good in euroland after a market rally and successful Italian and Spanish bond auctions this week. However, on Friday the eurozone crisis again took a turn for the worse. Standard & Poor's – the increasingly unpopular credit rating agency – is set to downgrade France and Austria from their AAA ratings. At the same time talks broke down over what losses banks and other bondholders will be forced to accept when Greece writes down its massive debt, injecting another huge dose of uncertainty into the euro mix.

Euro policy geeks are already engaged in fierce debate about which of these two events constitute the worst news for the eurozone. Let’s have a look:

Downgrades: Friday the thirteenth jinx aside, this downgrade could be spotted a mile away with S&P putting the whole eurozone on negative watch before Christmas. Other eurozone downgrades are also taking place, notably of Italy, but the loss of AAA ratings are undoubtedly the most critical. In addition to the symbolism of having one of the EU’s big three economies downgraded, the eurozone’s €440bn temporary bailout fund (the EFSF) – aimed at backstopping fragile euro states – could be soon to follow. The EFSF needs its current AAA rating to continue to dish out cheap loans to Greece, Portugal and Ireland (and any other country that might need help). But as France is a major contributor to the EFSF, a downgrade for the country could result in a corresponding slash to the rating of the EFSF.

The effect would be higher borrowing costs for the struggling countries that tap the fund, reducing effectiveness of the ESFS as a backstop measure. In addition, an EFSF downgrade will make the fund – and the eurozone – even more reliant on German taxpayers. This would further expose the German economy to potentially bad eurozone debt and, at worst, even threaten the country's own credit rating.

It also raises even more questions about an EU plan, currently being negotiated, to increase the lending capacity of the EFSF through a complicated leveraging and insurance scheme (for details, see here). You simply cannot create money out of nothing – and even more so when one of your key players has just suffered injury.

So expect short term market jitters. But so far, we’re only looking at one credit rating agency, with the other two holding their fire – which is probably why the news coming out of Athens is more significant.

Greece: The negotiations over losses for investors in a voluntary restructuring of Greek debt are starting to look like a bad horror movie. For all the grand talk from EU leaders and officials, bondholders (especially smaller firms such as hedge funds) still have a massive incentive not to participate in the voluntary restructuring – either Greece pays back the money they owe them or there is a default, in which case their insurance on Greek debt (known as credit default swaps) are paid out and they recoup their losses at least.

The crux is that Germany and the IMF in particular have made a write down of Greek debt a precondition for paying out the next trance of bailout money, which Athens needs by March 20 to pay off €14 bn in debt due. If neither Greece, the bondholders nor Germany/IMF blink, we may be looking at a forced Greek restructuring (where Greece legally enforces losses on bondholders) or even a full default and, at worst, a eurozone exit. But there’s still plenty of negotiating time before March.

What’s clear is that both the downgrades and the break-down in the Greek restructuring talks could change the face of the eurozone crisis. Though the downgrades seem more dramatic now, the Greek problem could soon begin to hit home. An enforced write-down or uncontrolled default both essentially amount to the same thing in the eyes of the markets and investors will begin to have doubts about the future of other eurozone countries – if a default can happen in Greece, why not in other insolvent eurozone states?

Tags: bail-out, Credit Default Swaps, credit rating, default, eurozone, France,Germany, greece, Sarkozy, sovereign debt crisis

Wie Kent Olli Rehn?

2012-01-13T11:34:00.011Z

Not everyone in the newly formed (and long awaited) Belgian government seems to be happy with the new supervisory powers the European Commission has gained under the "Six-Pack" on economic governance.

As we reported here, Belgium was forced to withhold €1.3 billion of planned spending in its 2012 budget, after the Commission said that Belgium's estimates of its public deficit (2.8% of GDP at the end of this year) were "too optimistic."

Well, this is what Belgian Enterprise Minister Paul Magnette had to say about that (from today's interview with Flemish Belgian newspaper De Morgen),

"The Commission is today going too far with its measures. Who knows [EU Economic and Monetary Affairs Commissioner] Olli Rehn? Who has ever seen Olli Rehn's face? Who knows where he comes from and what he has done? Nobody. Yet he tells us how we should conduct economic policy. Europe has no democratic legitimacy to do this."

Incidentally, Magnette (see picture) is a fellow party member of Belgian Prime Minister Elio Di Rupo. Unsurprisingly, Di Rupo has promptly distanced himself from this statement. However, an important political message has been sent. Perhaps eurozone countries were not fully aware of the practical effects of the loss of sovereignty they were agreeing to when they rushed towards stricter economic governance - it wouldn't be the first time.

In light of Monsieur Magnette's reaction, we wonder what would happen if similar "recommendations" were made to France and/or Germany. You know things are changing when even Belgian Ministers resort to anti-Commission rhetoric...

What has the ECtHR done for the UK lately?

2012-01-12T16:32:00.002Z

A detailed report, written by veteran Parliamentary legal researcher Robert Broardhurst, and commissioned by a group of backbench Conservative MPs including Chris Heaton-Harris MP and Andrea Leadsom MP, has called for action on the European Court of Human Rights (ECtHR) to reinstate Parliamentary democracy.

This important report argues that we must radically change our relationship with the ECtHR so that it can no longer impose trivial notions of rights on the UK against the will of Parliament.

Among the findings the report discovered that:

Since Britain subscribed to the ECtHR’s jurisdiction in 1966 there have been more than 350 rulings on whether the UK has violated convention rights. The number of judgments made against the UK stands at 271, against only 86 that were successfully defended. This, added to the Human Rights Act's domestic rulings, has led to judgements that fly in the face of public opinion.

Areas looked at where the ECtHR has conflicted with public opinion:

Prisoner voting rights
Prevention of deportations
Extending rights to housing

Broardhurst believes that that the ECtHR's interpretation of human rights in these areas offends the British peoples' common understanding of those rights and that although parts of the Coalition are aware of this problem - the proposed UK Bill of Rights will not offer a full remedy to a growing problem.

Broardhurst's preferred solution offers a more far reaching solution. He argues that to solve the issue once and for all, the democratically accountable UK Parliament should be given the power to overturn ECtHR judgements directed at the UK.

The report suggests that if other signatories to the ECtHR do not agree to this step, the UK may have to withdraw from the Court's jurisdiction. This would also entail withdrawal from the Convention on Human Rights but, as the report notes, the UK could still enshrine the rights of the Convention in national law through a British Bill of Rights. After all, it is the way the rights have been interpreted by judges, rather then the rights themselves, that has been the source of most of the problems.

The UK took the Presidency of the Council of Europe in November 2011 and this will run until May 2012. If reform of the Court is not forthcoming, the number of people willing to consider the option of withdrawal is only likely to increase.

This is of course all complicated by the fact that the EU is set to join the ECtHR in its own right - but that's another story.

Would EU law introduce border controls with Scotland?

2012-01-11T15:21:00.000Z

The last time there was a formal English border with Scotland was under the Romans, although for some parts of the middle ages both England and Scotland may have wished for one. Since then, it's pretty much been come and go as you wish. Well, that may - at least hypothetically - soon change.

This week saw the debate over Scottish independence heating up again, in turn throwing up a number of questions about whether Scotland would have to negotiate new membership terms with the EU, and if so, how this would work. Most discussions have focussed on the euro - which all EU members that don't have an opt-out (which only the UK and Denmark have at the moment) - are required to join.

But there's another interesting twist. You might assume that if Scotland again became independent, the current open border would continue. Well, you could be wrong. This is because while the UK has a specific opt-out from the EU's common travel area (the Schengen agreement) under, the Amsterdam Treaty incorporated the Schengen agreement into EU law (Article 77, previously it was a stand alone agreement), meaning that whoever signs up to the full body of EU law, also signs up to Schengen. In other words, similarly to the euro, Scotland would not automatically have an opt out.

The EU considers that all states should join the borderless EU. This would pose a problem for an independent Scotland as the UK and Ireland have their own Common Travel Area and external borders - to help facilitate travel over the Northern Irish Border. If Scotland was in Schengen, England (and the rump UK and Ireland) would need to apply an external border and passport checks on the new frontier.

That is if Scotland was in the EU at all. The UK's membership does not extend to former members. Scotland would therefore have to negotiate for itself an opt-out from Schengen as a part of its accession process from outside the EU.

In addition to a Schengen opt-put, an independent Scotland would also have to negotiate:

Opt out from the Euro - so it could keep the English (or Scottish?) pound (the SNP says it want this option until the time is right to join the euro).
Possibly its own budget rebate so it is not unfairly penalised
A fair deal on fishing.

Plenty to play for in Europe, in other words, should Scotland wish to go down that path...

The Euro Fiscal Pact: The saga continues, now with better news for Cameron

2012-01-11T09:22:00.000Z

Following last Friday's meeting of negotiators from EU member states (including the UK), a third draft of the new European fiscal pact is now out. As with the version of the draft out last week, Open Europe has got hold of a copy of the revised draft (available here) and, yet again, we're the first in the Anglosphere to publish the draft.

From the UK's point of view, there are some significant changes, at this stage marking a victory for Cameron and Clegg. The controversial reference to the single market in Article 1 is no longer there - the UK has consistently said there should be no overlap between the euro fiscal compact and single market rules - and the role of EU institutions has been narrowed substantially.

From the eurozone's point of view, the draft may actually be worse news than the previous version, as the markets could judge the watering down of the enforcement mechanisms through the EU institutions as a weakness similar to those haunting the original Stability & Growth Pact. Looks as if the Germans have caved in a bit on an extensive role of the ECJ (which the French never were entirely happy about).

After a first glance, the following are the most significant changes from the previous version:

The reference to the single market which reportedly infuriated UK negotiators has gone;

A sentence in Article 2 establishing that "In accordance with the case law of the Court of Justice of the European Union, EU law has precedence over the provisions of this treaty" has also disappeared (this could be both good and bad news for the UK and other non-euro members - we'll return to that);

The expression "structural deficit" has been replaced by "structural balance", but details on what it means in practice are still lacking;

Article 6 on the coordination of debt issuance has been tweaked and now reads, "With a view to better coordinating the planning of their national debt issuance, the Contracting Parties shall report ex-ante on their public debt issuance plans to the European Commission and to the Council";

Under the revised draft, the Commission would not be allowed to submit proposals/recommendations to countries with an excessive public debt (something Italy is particularly concerned about, due to its large debt), but only to those running excessive deficits;

There seems to be a major backtrack on the role of the ECJ, as its jurisdiction is now again restricted to overseeing whether member states properly transpose the balanced budget rule into national legislation;

In addition, the European Commission no longer has the power to take governments to the ECJ. Under the revised draft, the Commission can be "invited" by member states to issue a report on a country which is thought to be in breach of Article 3(2) - the one on the balanced budget rule. If the Commission supports the breach, the concerned government can be taken to the ECJ, but only by another government;

The Economic and Monetary Affairs Commissioner would be excluded from the meetings of eurozone leaders, along with the Chairman of the Eurogroup (but Jean-Claude Juncker should not worry too much about this, given that he will attend as Luxembourg's Prime Minister);

The latest draft includes a specific date for the entry into force of the fiscal pact, 1 January 2013. The number of countries that need to ratify the treaty before it enters into force is now twelve (down from fifteen, which was probably too ambitious, given the problems that could potentially arise in Ireland, Slovakia and Finland);

A brand-new Article 15 has been added, which reads very much as an invitation to the UK and other non-euro members, "This Treaty shall be open to accession by Member States of the European Union other than the Contracting Parties upon application...The Contracting Parties shall approve the application by common agreement";

As regards the transposition of the fiscal pact into the EU Treaties, the wording has been slightly toughened up. The expression "an initiative shall be launched" has been replaced with "the necessary steps shall be taken...with the aim of incorporating the substance of this Treaty into the legal framework of the EU."

We doubt this is the last word though...

Greece-ing the wheels…?

2012-01-10T17:52:00.014Z

It would be a gross understatement to say that negotiations on the Greek voluntary restructuring/write-down/bond swap have been dragging on a bit. The initial idea was first proposed and adopted last July and has been the topic of almost permanent negotiations ever since. Recent reports have suggested that a deal is ‘close’, with Greek officials expecting it to be tied up by the end of the month.

However, given the headlines over the last couple of days, we’re not sure how close ‘close’ really is. We’re referring specifically to all the talk of a retroactive introduction of collective action clauses (CACs).

Excuse the jargon, but this essentially means that the Greek government is considering passing a law which will introduce a clause into outstanding Greek bonds which stipulates that if a certain percentage of the bondholders (usually 75%) agree to a restructuring deal, the remaining holdouts will, by law, also be forced to accept the deal. Seems like a strange move if a deal is just around the corner, doesn’t it?

The aim seems to be that by introducing the CACs the Greek government can ensure a high participation rate in the restructuring, increasing the chances of Greece returning to debt sustainability. This sounds like a reasonable idea on the surface but it raises a huge number of questions given the previous negotiations:

- Invoking CACs would surely constitute a credit event, meaning the restructuring would no longer be ‘voluntary’, leading to the pay-out of credit default swaps. We’ve long been advocates of a forced restructuring in Greece, but this is something which the EU and Greece have been trying to avoid since these negotiations began – it seems a strange turn of events to say the least.

- It has been suggested by some officials that the CACs will be put in place but not invoked, simply used as a negotiating tool or threat. This seems rather long winded (and feeds the idea that a deal is not imminent) but we’re fairly sure announcing it in advance is a poor negotiating tactic, even by EU standards.

However, by our reckoning, the most important issue it raises is over the bonds held by the ECB. As we have noted before, the ECB is now the largest single holder of Greek debt, having purchased a reported €45bn in Greek debt under its Securities Markets Programme (SMP). Up until now the ECB has been able to stay out of the restructuring discussions since they have been conducted on an ad hoc basis (the ECB has continually asserted that it will be holding these bonds to maturity).

Legally, though, the ECB is not a senior creditor and has the same standing as all other bondholders. If the CACs were introduced and invoked they would surely impact the ECB bonds as well. We have previously estimated that such write-downs could cost the ECB €12bn - €18bn, while Barclays recently put the figure as high as €20bn. Not the end of the world for the ECB, but it would be a huge blow to its overall approach to the eurozone crisis (particularly in terms of German support). Furthermore, resisting these losses could be more detrimental to the eurozone since it would essentially mark the ECB as a senior creditor, creating huge distortions in bond markets as investors become wary of the increased prospect of being the first ones to take losses.

So, the discussion surrounding CACs definitely brings a new element to the Greek restructuring issue. It’s very suggestion runs contrary to the claims, which all eurozone leaders have been making, that a deal is close. However, if it is a signal that Greece has realised that a voluntary restructuring may not be workable or be enough to make Greek debt sustainable then it could be a welcome turn of events towards a hard restructuring. As we have argued numerous times before, a Greek default is now unavoidable and will only become more expensive the longer it is put off - i.e. the sooner this is accepted and dealt with the better.

Et tu, technocrat

2012-01-10T15:00:00.003Z

According to the latest news from Italy, it looks like not even the country's technocrats are immune from scandals. Carlo Malinconico (whose surname means 'melancholic' in Italian, see picture), an EU Law Professor serving as Undersecretary to the Presidency in Mario Monti's cabinet, has resigned this morning following allegations that he had his holidays paid for by a dodgy Italian builder.

According to wiretaps analysed by Italian prosecutors, between 2007 and 2008 Malinconico spent a couple of weekends at the five-star luxurious Hotel Il Pellicano in Porto Ercole (part of Italy's glamorous Argentario peninsula in Tuscany) without paying a single cent. The roughly €20,000 bill was, it turned out, footed by Francesco De Vito Piscicelli, an Italian builder who, along with other Italian entrepreneurs, is involved in a scandal over several tenders illegally obtained at the time of the latest G8 summit held in Italy in 2009.

Malinconico decided to resign, but it is still unclear whether a specific investigation will be launched over his relationship with Piscicelli & co. He maintains that, at the time, he wanted to pay the entire bill and that, when he realised that he would not be allowed to do so, he was so annoyed that he immediately cancelled all future reservations at Hotel Il Pellicano. Malinconico also says that he had no clue about who had paid for his holidays and that he is now ready to pay his fair share, if need be (maybe a bit late now).

Given that Monti's technocratic government was put in place precisely to move away from the dysfunctional politics that has haunted Italy over recent years, this episode, reminiscent of the Berlusconi years, is concerning. On the positive side, at least the mis-step is being forcefully dealt with, showing that perhaps lessons are being learnt...

Et tu, technocrat - as the Romans might have put it.

What a ski slope 'in the world's flattest country' says about EU funding

2012-01-10T12:30:00.006Z

Fresh from giving Denmark some credit for prudent use of taxpayers' cash, here's a less flattering story:

Over at Open Europe we have issued periodic briefings on projects of dubious value which have wasted EU funds – in our 2008 report on ‘100 Examples of EU Fraud and Waste’, we picked out the particularly bizarre example of a ski slope constructed on a flat Danish island where snow rarely falls. By Scandinavian standards, the island is renowned for its mild climate, and there are no high hills.

In 2006, the ski slope was given around €100,000, from the European Agricultural Fund which can provide financial support for various activities in rural areas (many have little to do with agriculture, incidentally). Following our list and reports in international media, Agriculture Minister Eva Kjer Hansen, whose ministry handled the grant, said in 2009 the "criteria for getting [EU] subsidies are not rigorous enough" and said that she would "tighten the screw". Then EU Agriculture Commissioner Mariann Fischer-Boel also promised more stringent tests.

Fast forward 2012 and where are we at? Have the EU funds been paid back since they failed to create any new jobs? There has been a radical overhaul of spending criteria? Not quite.

Die Welt last week reported that the organisation "Bornholm's Friends of Skiing" (Bornholm's Skivenner) is to receive a further €33,000 EU grant for the “expansion of the ski lifts”, leading to another round of protests and disbelief.

On average, the ski slope stays open three weeks a year, according to Swedish Television, though last winter - which saw exceptional snow fall - the slope managed to stay open between the end of December and March (hats off). It had a rocky start, however. According to some reports, in its first year of operation, the ski-slope was only open for one and a half days, and nine the year after. During a normal Bornholm winter, snow cannons are of little help, because the snow only remains if the temperature is at minus two degrees on at least two consecutive days.

Hans Jørgen Jensen, the head of "Bornholm's Friends of Skiing", calls the the project a "giant success" (en kæmpe succes), though admitting that "the ski slope isn't a commercial project but I don't have bad conscience. It's about quality of life and is focused on the young."

Now skiing is fun, and it may be that the slope has proven popular with the locals, but few would argue that this constitutes a good use of taxpayers' money. Fundamentally, at the last time of counting, the island registered a GDP per capita of €31,000 - significantly above the EU average of €24,900, posing the question of whether it really needed development geared funding in the first place.

And as German MEP Inge Grässle told Danish daily Politiken:

"it's pointless to give EU money to a ski slope in a place like Bornholm where extraordinary climate conditions are needed in order for the money to generate any type of value. [EU subsidies for downhill skiing] in "one of the world's flattest countries need to come to end."

No kiddin'. So whose responsibility is it for paying out the grant? As is symptomatic of EU-funding, accountability appears to fall into a black hole somewhere between member states and the European Commission.

EU Agriculture and Rural Development Commissioner Dacian Ciolos’s response to the grant is already a classic:

“This is fully in accordance with Article 56 of the Implementing Regulation 1698/2005, which provides support for recreational activities in rural areas…The individual projects are evaluated by the national authorities, because they know the local situation best.”

Ah, it's consistent with Article 56 of the Implementing Regulation 1698/2005. All must be well then. (And they wonder why the citizens find it increasingly difficult to both understand and support the EU).

The current Danish government (which took office last year) blames its predecessors, with Agriculture Minister Carsten Hansen pointing out that it was the previous centre-right government which signed off the grant for the skiing lift. He promises that "The whole administration of the subsidies will be streamlined" (sounds familiar).

Former Agriculture Minister Eva Kjer Hansen who was in charge when the grant was paid out despite pledging to "tighten the screws" is now an MP and member of the Danish Parliament's EU Scrutiny Committee. She defends herself, saying:

"My responsibility was to look at the rules in Denmark [as opposed to EU-level rules?]. And much was done to ensure that the the impact [of the projects] were more concrete and that the more thought-through projects were the ones receiving the money."

She adds,

"It's doubtful whether we get the most out of the subsidies. Therefore we always have this discussion about whether the projects are justified. Or if the money has been handed out merely because there was EU subsidies there which simply had to be used for this or that silly project."

Not exactly a ringing endorsement of the idea of having the EU involved in rural and regional development funding in the first place.

So if I think that taxpayers' cash shouldn't be spent on a 'development' project involving a ski slope on a mostly flat and largely snow-free island with a GDP of 24% above the EU average - who should I talk to?

The draft euro fiscal pact: not great news for the eurozone either...

2012-01-10T09:00:00.000Z

We’ve already reviewed what the latest draft version of the fiscal compact means for the UK (not much good) being the first in the UK to publish the draft of the compact (beating the Telegraph by a hair). But let’s not forget what the treaty is supposed to be about – saving the eurozone. There are still those out there, not least the ECB and the IMF, who believe that this treaty can form an integral part of the solution to the eurozone crisis (along with an increased firewall and structural reforms).

Looking at the latest version of the treaty it seems that not much has changed in the fiscal rules department. As always the 60% debt limit and 3% deficit limit provide the framework, while the 0.5% limit on ‘structural deficit’ is included as with the previous draft. There is no further detail provided on what exactly the ‘structural deficit’ is envisaged to be, although there are some qualifying statements which suggest such stringent rules could be waived in the case of “exceptional economic circumstances”. Still very vague with some key ideas not clearly defined. This doesn’t fill us with confidence. Remember this compact is meant to provide the original stability & growth pact with some teeth, by actually establishing some tools to enforce the fiscal rules.

Article 5 of the new draft suggests that the budgets of countries under excessive deficit procedure will be submitted to the European Commission and Council for “endorsement”. This isn’t much, if at all, different to the new six pack rules, while it again remains unclear what they mean by “endorsement” – will the Commission and/or Council retain a binding vote on national budget plans?

In terms of the overall debt level, the commitment for countries which exceed the 60% debt to GDP ratio to reduce their debt by one twentieth every year remains. However, this still raises lots of questions over implementation. Will this rule apply as soon as the treaty comes into force? Take Italy for example: if it was applied from this year, the government would have to potentially find a €108bn in savings or a 7% of GDP swing in the budget, in order to cut the debt by the required amount. This is more illustrative than anything, but the key point is the tension it represents. Realistically the rules cannot be enforced next year or possibly even the year after, otherwise too many countries would be sanctioned and be forced into ever greater austerity. However, to convince markets, there needs to be a clear plan for implementation and some signs that the immediate problems will be tackled. This latest version of the draft simply does not tackle these issues, nor do any of the wider discussions relating to the fiscal compact.

As we pointed out with our post on the draft’s impact on the UK, there is a widely increased role for the EU institutions. In particular, countries which are seen to have broken the fiscal rules can be taken to the ECJ by other members or the Commission. This gives the proposals significantly more teeth, but given the UK’s position it is far from a foregone conclusion that EU institutions will be able to play this role under the finalised new treaty. It also seems that much of the stuff in the compact can be done within the existing treaties anyway, begging the question why this, new over-lapping deal is necessary in the first place (and yes, we do appreciate German domestic concern).

Until the significant amount of uncertainty is removed from the fiscal compact – in terms of implementation, use of institutions, timeline, severity of sanctions and exceptions it is likely that markets will continue to be underwhelmed by it. Unfortunately, while these short comings persist eurozone leaders continue to meet and talk up their negotiations, which only seems to add to the eventual let-down.

Get ready for another rollercoaster ride

2012-01-09T11:30:00.002Z

As we noted last week, 2012 is going to be another incredibly messy year for the euro (hardly an earth-shattering prediction).

Everyone agrees that the next few months are going to be a crucial phase in the eurozone crisis. If a long term solution isn't found it is likely that one never will be and the window of opportunity for saving the eurozone in its current form may close for good (if it hasn't already). We've been here before of course (remember 'six weeks to save the euro'), but there needs to be, at least, some sort of settlement over Greece, to avoid a hard, uncontrolled default in the first half of 2012. Below are the key dates to watch, focusing on meetings and bond auctions - expect this list to increase substantially given the almost weekly meetings between eurozone leaders these days. It's going to be a busy first quarter for euro leaders - summits of various kinds are in bold:

--Monday, Jan. 9: Meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy in Berlin
--Tuesday, Jan. 10: Ireland's troika of lenders expected to start latest review of country's bailout program.
--Thursday, Jan. 12: ECB interest rate statement and press conference. Spanish (€3.5bn) bond auction.
--Friday, Jan. 13: Italian bond auction (€6bn).
--Monday, Jan. 16: Troika of international inspectors expected to return to Greece to resume talks on new bailout deal.
--Thursday, Jan. 19: Spanish (€3.5bn) and French (€8bn) bond auction.
--Friday, Jan. 20: Troika talks in Greece expected to end. Ireland's troika of lenders releases its latest quarterly review of the country's bailout.
--Sunday, Jan. 22: Finnish Presidential elections
--Monday, Jan. 23: Euro-zone finance ministers meeting. --Tuesday, Jan. 24: European Union finance ministers meeting.
--Thursday, Jan. 26: Italian bond auction (€4.5bn).
--Monday, Jan. 30: EU leaders summit. Italian (€7bn) and Belgian bond auctions (€4bn).
--Tuesday, Jan. 31: Greece aims to conclude talks detailing new EUR130 billion loan deal, debt-exchange program with private-sector creditors by this date.

--Thursday, Feb. 9: ECB interest rate statement and press conference.
--Wednesday, Feb. 15: eurozone Q4 2011 GDP estimate released.
--Friday, Feb. 17: EUR1.6 billion Greek T-bills maturing.
--Tuesday, Feb. 28: ECB three-month and three-year long-term refinancing operation. Italian bond auction.
--Wednesday, Feb. 29 to Thursday Mar. 1: Italy sees €46.5bn in debt maturing.

--Thursday, Mar. 1: EU leaders meet in Brussels for a two day summit.
--Thursday, Mar. 8: ECB holds monthly meeting
--Saturday, Mar. 10: Slovakia holds parliamentary election
--Monday, Mar. 12: eurozone finance ministers meet in Brussels --Tuesday, Mar. 13: EU finance ministers meet in Brussels
--Tuesday, Mar. 20: Potential Greek default? Greece sees €14.4bn in government debt mature, needs to have next tranche of bailout funds and second bailout in place to be able to cover this cost.
--Friday, Mar. 30: eurozone finance ministers meet in Copenhagen --Saturday, Mar. 31: EU finance ministers meet in Copenhagen; Deadline for new Spanish government to present 2012 budget to Spanish parliament

--Sunday, Apr. 22: French Presidential election

Leading by example...

2012-01-09T10:29:00.004Z

Danish daily Politiken today informs us that the ongoing Danish Presidency of the EU - the Danes took over the rotating six-month EU chair on January 1 - will aim to be "one of the cheapest yet", with a budget of around €35 million.

In comparison:

The Polish Presidency in 2011: €115 million
The Hungarian Presidency in 2011: €81 million
The Belgian Presidency in 2010: €74 million
The Swedish Presidency in 2009: €42 million
The Danish Presidency in 2002 (the last time the country was at the helm): €52 million (2011 prices)

Dannie Kjeldgaard, professor in branding and marketing at Syddansk University, commented,

"The big story is currently that we need to save because of the crisis. Everyone tells us that we must save, and even people who don't have to save, still do it. Therefore it is prudent that the government takes the lead as it takes over the presidency. The wasting of taxpayers' money could otherwise turn in to a good media story."

Are the EU institutions taking note?

Will the euro crack in 2012? It'll be turbulent but probably not...

2012-01-06T16:05:00.003Z

In a blog post for the Telegraph, we ask this simple and yet brutally complicated question. This is what we argue:

In truth, as the crisis is overwhelmingly about erratic domestic politics, it’s absolutely impossible to predict when the euro will bite the dust. What’s clear is that in the absence of some sort of fiscal union (likely to be collective borrowing amongst euro states in return for German-style budget rules), the single currency is doomed in the long-term. In the short term, however, there is still scope for plenty of muddling through – which is to say that there’s a strong chance that the euro survives 2012. So what is the likely good (an expression used loosely here) and bad news for the eurozone moving in 2012? And what would, to complete the phrase, an “ugly” scenario look like?

The “good”

The ECB stepping up: Arguably the biggest threat to the survival of the eurozone in 2012 is a deep freeze in the banking system. That is, banks get so incredibly nervous that they completely stop lending money to each other, leaving some banks bust. Governments would find it very hard to refinance themselves and credit to the wider economy would be choked off.

Now, for those who think short-term (which is most people), the good news is that the ECB has stepped in to offer ridiculously cheap loans to any bank in the eurozone that asks for it (under a new euro acronym known as the LTRO), giving them the cash and confidence to continue lending this year – at least in theory. There is a catch of course: as with all other ECB intervention, the LTRO serves to transfer more risks from private creditors to European taxpayers (as the ECB is ultimately taxpayer-backed) and there are little signs of a plan to wean banks’ off their growing reliance on public money. How all 523 banks that have taken loans so far will be able to rollover nearly €500bn in funds, all due for repayment in 2015 – when the ECB wants its money back – is a question few are asking at the moment.

There’s bailout cash left: Though not nearly enough to act as proper lender of last resort, there’s bailout money left in the pot for the eurozone to play with this year. Following a second Greek bailout, the temporary and permanent euro bailout funds (the EFSF and the ESM), set to run in parallel in 2012, have a combined lending capacity of between €500bn and €750bn with potentially another €170bn of IMF money to add. In addition, the ECB can still buy a limited amount of government bonds, albeit reluctantly. Compare this to the roughly €800bn that eurozone governments need to raise between them (including countries that are safe) this year, and it might just about add up – for 2012, that is.

The bad

Recession inevitable: No matter what happens, it will be an incredibly painful year for the eurozone, with recession plaguing several countries, exacerbated by a slowdown in the rest of the world. Low growth and poor competitiveness remain the euro's greatest curse.

The Greek factor: Without the next tranche of EU bailout cash, Greece will default in March, and is almost certain to default sooner or later anyway. Greece is currently in negotiations with private creditors over a ‘voluntary’ restructuring of its €360bn debt mountain – it remains uncertain whether it can remain inside the eurozone absent a deal, which would mean a ‘forced’ restructuring. However, both the Greek electorate and the political elite remain committed to the euro and I doubt eurozone leaders will have the nerve to force Greece out this year. But anything can happen should, say, the present Greek technocratic government fall (it's worth reading Paul Mason's take on it).

A French downgrade: Due to the large exposure of the country’s banks, France could well be downgraded at least one notch. Among other things, this would hit the creditworthiness of the euro bailout funds, meaning higher borrowing costs for those countries that tap them and even more reliance on German taxpayers’ cash.

Risk of unexpected bank collapse: Despite ECB liquidity, the sudden collapse of a large eurozone bank is an ever present risk. The radical increase in banks’ use of ECB cash (via the LTRO and other programmes) is an alarming sign that one or several banks are in serious trouble.

Europe stands alone: No one seems willing to come to Europe’s rescue, with international lenders from Beijing to Washington frustrated by the EU’s dithering.

The ugly

Though the risk is still small, there’s a possible perfect ‘storm scenario’ for the euro in 2012. As events are so incredibly intertwined, it’s impossible to tell which would come first. But the scary thing is that just one or two of the below factors may be enough to start a chain of events which would lead to the disorderly break-up of the eurozone:

• Widespread downgrades, including of the eurozone’s remaining Triple A countries, by credit rating agencies. Serious questions would be raised over the viability of the eurozone’s bailout funds as they rely on an ever thinner list of Triple A eurozone states, leaving the euro with little more than a paper tiger as a backstop.

• Spanish banks could hit the iceberg as households fail to pay their mortgages and the level of non-performing loans pile up. If it gets bad enough, the Spanish government wouldn't afford to recapitalise these banks on its own and must seek a potentially huge bailout from the EU/IMF.

• In addition to those in Spain, one or more banks in Italy or France could sink due to large exposure to weaker euro states - following a hard Greek default for example. As in Spain, there are doubts as to whether these governments could afford to bail out their banks without outside help.

In parallel to these economic concerns, the political tensions between what’s required to keep the euro together versus what citizens are willing to swallow could reach breaking point. A new French government might try to renegotiate the euro’s new budget and fiscal rules, causing uncertainty and delays, while Angela Merkel’s opposition to bailouts and ECB intervention could increase as national elections loom large in early 2013. Meanwhile, the push by unelected governments in Greece and Italy for ever more austerity, could trigger a fresh wave of political unrest. Though still unlikely, the Monti government in Italy could lose its support in Parliament, leading to fresh elections, more uncertainty and spiralling borrowing costs for Italy. The country remains too big to be bailed out.

Ultimately, it is how these political tensions are played out in various countries that is likely to determine the eurozone’s fate. My best bet is still on the euro surviving this year – we haven’t yet reached rock bottom. But make no mistake, this will be another incredibly messy year for the euro and the choice between what’s right for democracy in Europe and what’s right for the euro cannot be avoided forever.

The Draft Euro Fiscal Pact: Pretty Bad News for Cameron...

2012-01-06T11:31:00.022Z

As negotiations on the new European fiscal pact resume today, we have managed to get hold of a copy of the new draft prepared by European Council President Herman Van Rompuy's office, and it makes for interesting reading. First on the scene (at least amongst UK commentators), we'll give our take below:

On the Today Programme this morning, David Cameron said that countries which sign up to the euro+ fiscal pact,

"Shouldn't be doing things that are about the single market or about competitiveness, and we will be very clear that when it comes to that you cannot use the European institutions for those things because that would be wrong."

See here for the background to the legal scramble that has followed in the wake of Cameron's veto back in December of an EU 27 Treaty, with the crucial issue always being whether the EU institutions could be used by the 17+, despite Cameron's veto.

It's not entirely clear whether Cameron actually will try to block the use of the EU institutions in implementing and enforcing the fiscal pact, or merely insist on the EU institutions not being used for single market issues (which never was a concrete proposal but a general worry over the EU institutions, particularly the ECJ, being used to push a eurozone-specific agenda), but what's clear is that the EU institutions are all over this draft proposal.

The draft makes over 20 references to the EU institutions (seven to the ECJ and nine to the Commission).

Here are some of the most significant changes from the previous draft (we got hold of a copy of the revised draft, see here - changes from the previous version are highlighted):

The scope of the agreement is expanded, as it now involves "an enhanced governance to foster fiscal discipline and deeper integration in the internal market as well as stronger growth, enhanced competitiveness and social cohesion". Note here the references to the single market and social cohesion - a concession to the French and pretty bad news for Cameron.

The wording of Article 6 has changed, and now reads, "The Contracting Parties shall coordinate their national debt issuance," instead of "shall improve the reporting of their national debt issuance". This clearly gives the article more teeth.

Countries subject to an excessive deficit procedure should submit their structural reforms plans "to the European Commission and the Council for 'endorsement'";

The treaty would enter into force after fifteen (not nine) eurozone countries have ratified it.

Particularly interesting is the section on the role of the ECJ. In particular,

Article 8 stipulates that the ECJ would have jurisdiction over any violation of the entire Title III, i.e. on all the provisions of the so-called "fiscal compact". In the previous draft, the ECJ only had a say on Article 3(2), i.e. on whether national governments have correctly transposed the balanced budget rule into their national legislation;

Furthermore, according the revised text the Commission "may, on behalf of Contracting Parties, bring an action for an alleged infringement of Title III" before the ECJ.

Some subtle but significant changes, despite Commission claims that the previous agreement would form the basis for future discussions. There are three very interesting points from the UK's perspective:

1) EU institutions are playing a large role: In this draft the role of the ECJ and Commission is significantly expanded. Despite David Cameron's on-going insistence that EU institutions would not play a role in enforcing the rules of the treaty, Article 8 does just that. If the final version sticks to this definition it would likely be a defeat for Cameron, with his decision to veto being seen to have stopped very little (although this is far from finalised). On a side note this also seems to be a loss for France, since it had previously opposed such a wide role for the ECJ. Could a Franco-British alliance be in the offing at the next round of discussions? Something to watch for. For the record, we maintain that the use of the EU institutions in this way is a massive legal stretch (hello, EU law) - and that the aim of Cameron's veto was correct (it was an overall strategy and tactics that were lacking).

2) Focus on the internal market: Article 1 stipulates that the signatories of the treaty will work towards "deeper integration in the internal market". This is interesting given David Cameron's comment on the Today programme this morning, where he suggested that the treaty would not involve any discussions on the single market. Again the draft clearly directly contradicts this. The UK is understandably keen to avoid the new treaty along with its regular meetings becoming a talking shop for single market regulation which still has a huge impact on the UK economy.

3) Incorporate the treaty into EU law after five years: Lastly, Article 14 states -

"Within five years at most following the entry into force of this Treaty...an initiative shall be launched...with the aim of incorporating the substance of this Treaty into the legal framework of the European Union."

In other words, as demanded by the Commission and MEPs, it looks like that the new pact will have to be incorporated into the EU Treaties in the medium term, something which will require the UK's approval - suggesting that this argument will continue for sometime. Cameron's veto did not put the issue to bed by any stretch of the imagination.

At least two out of these three points almost directly contradicts what the UK government would have wanted, while the third one could potentially go either way. This is still a draft and much can change, but at the moment it has put the UK onto the back foot.

Further reading: "The ten lessons the UK government should draw from Cameron's EU veto".

For how long can Merkel have it both ways?

2012-01-05T12:30:00.003Z

As the escalating crisis in the eurozone has consistently frustrated politicians’ attempts to come up with adequate solutions, Germany, the block’s de-facto economic hegemon, has come under increased pressure to take charge of the situation both politically and economically in order to restore confidence in the single currency. Unsurprisingly, this has roused well established fears around Europe concerning German domination.

Are such fears well grounded?

Throughout the crisis, Germany has had to balance two of its percieved vital post WWII national interests: It's commitment to Europe on one hand, and its diehard comitment to 'price stability and hard money (the latter is percieved to be threatened by more bailouts, eurobonds, and massive ECB intervention which risk trigger high inflation at some point) on the other. It is not unfair to say that the government has been dragged kicking and screaming into the increasingly desperate bail-out efforts with Merkel pushing hard for stricter spending controls as a quid pro quo for the bailouts.

This has resulted in a 'worst of both worlds' scenario for Merkel; on one hand the domestic opposition, other EU member states and global players have accused her of insufficient commitment to the euro/European project (the two are often fallaciously used interchangeably). One notable example was Polish Foreign Minister Radoslaw Sikorski's speech in Berlin in which he said: "I fear German power less than I am beginning to fear German inactivity.” On the other hand however, the current crisis management measures backed by Merkel have already provoked significant anti-German sentiments, not least in Greece, where references are already being made to German past attempts to dominate Europe. To be fair, it didn't exactly help that Merkel ally Volker Kauder found it appropriate to claim that "Suddenly Europe is speaking German".

Although Germany is going through a very dynamic internal debate at the moment, it's wrong to say that most Germans actually like what they see in front of them. In an interview with the German Bundestag’s weekly paper, Das Parliament, former German President and former Chairman of Germany’s Constitutional Court, Roman Herzog (a member of Merkel's CDU party), warned that the eurozone crisis could be a threat to democracy in the EU, and warned that the Bundestag had not been afforded sufficient opportunities to discuss the debt crisis.

Concerns about the corrosive effect on the democracy resulting from the eurozone are becoming widespread, and there is significant internal opposition to Germany taking on the role of the "irreplaceable yet reluctant hegemon", as Michael Stürmer, the editor of Die Welt, put it in an editorial a couple of weeks back.

Given the widespread prognosis that the eurozone's troubles are likely to deepen in 2012, this will further strain Merkel's attempts to have it both ways, i.e. more fiscal integration with credible sanctions but without Germany playing a leading role (with more German money on the table). Add to this the threat of France losing its Triple A rating - which would make that country look even more like the junior partner in the Franco-German relationship - and Berlin may have little choice but to shoulder even more of a leadership role in Europe.

But if Europeans are unhappy about such a development, the Germans themselves are probably just as unhappy. In fact, more reluctant leaders have rarely been seen...

Don't Put Those Scissors Away, Señor Rajoy...

2012-01-03T17:30:00.002Z

Spain's new centre-right government took office on 22 December, just in time to dump a veritable lump of coal into the Christmas stockings of people across Spain: a package of spending cuts and tax hikes worth around €16 billion for 2012. To be fair to Spanish Prime Minister Mariano Rajoy's cabinet, some of the measures adopted are quite bold.

In particular:

Both personal and capital income taxes will be subject to a temporary increase, depending on individual earnings. Spanish Treasury Minister Cristóbal Montoro (see picture) explained that the decision was taken in order to avoid raising VAT rates instead, an option which he said would have been more harmful for the country's growth;

Spanish public sector workers will see their salaries frozen this year, and will also be asked to work more (37.5 hours per week instead of the current 35). The salaries of those who refuse to do so will be cut accordingly;

Civil service will be significantly slimmed down, with the abolition of 30 Directorates-General;

State subsidies to political parties, trade unions and employers' associations will be cut by 20%.

Despite this landmark austerity package, another one could be along as soon as Thursday. In fact, the target of €16bn in cuts was based on Spain meeting its deficit target of 6% of GDP by the end of 2011.

Unfortunately, judging by what various Spanish ministers have been saying over the weekend, the target is going to be missed by at least 2% of GDP. Interior Minister Jorge Fernández Díaz, said yesterday that Spanish deficit could be 8.2% of GDP at the end of 2011. If this were the case, he added, the government would have to cut around €38 billion in order to stick to its commitment to bringing public deficit down to 4.4% of GDP by the end of this year.

In other words, tough sacrifices lie ahead, and they are not likely to be received particularly well in a country which spawned the indignados movement and one where, according to government figures published this morning, almost 4.5 million people did not have a job in 2011 (a 7.86% increase on 2010 figures).

One thing is certain: the biggest test for Rajoy remains the radical reform of the labour market, which he promised during the last electoral campaign. Trade unions - possibly with some support from the opposition Socialist Party - may take to the streets, with several demonstrations and general strikes taking place across the country. However, if Rajoy and his cabinet do not stick to their guns now and fail to deliver, the Spanish economy will miss a crucial opportunity to try and boost its competitiveness in the longer term - which in turn might raise questions about Spain's future within the eurozone.

Business support for Cameron's EU veto loud and clear

2011-12-23T11:20:00.014Z

Much was said about business' opinion of Cameron's EU veto in the immediate aftermath of this month's summit but, now that the dust has settled, the picture is starting to become much clearer.

Today, in a letter to the FT, orchestrated by Open Europe, 20 leading business figures express their support for Cameron's veto and his willingness to "stand up for an outward-looking and competitive Britain."

Here it is in full:

Sir, It is impossible to know just how European politics or economics will develop at this juncture. However, since the UK prime minister’s recent veto of a new European Union treaty, one major point of principle is clear: Britain does not want, or intend, to be dragged deeper into a more centralised and over-regulated EU with ambitions to become a political union.We therefore believe that David Cameron deserves the full support of the business community. On this occasion, he was seeking safeguards for the financial sector, still one of Britain’s biggest industries, employing more than 1m people and contributing more than £50bn in tax revenues, but the principle is applicable to many other sectors of our economy, including manufacturing, which employs more than 2.5m people.

Those who would portray Mr Cameron’s use of the veto as bad for jobs and growth or as leaving the UK “isolated” are mistaken. The real threat to employment is the euro crisis, which was unaffected by his veto and which the recent summit did little to address. Britain has great potential to compete across the globe, if freed from badly targeted and trade-hampering government intrusions, whether from London or Brussels. Irrespective of the fate of the euro or the ability of weakened southern European economies to prosper under severe austerity programmes, it is most welcome that the prime minister has shown himself willing to stand up for an outward-looking and competitive Britain.
Rodney Leach,
Chairman, Open Europe
Anthony Bamford,
Chairman, JCB
John Barton,
Chairman, Brit Insurance Holdings
Roger Bootle,
Economist, Capital Economics
Mark Darell-Brown,
Managing Partner, Brown Vanneck
Douglas Graham,
Chairman, Express & Star Midland News
Gerard Griffin,
Portfolio Manager, GLG Partners
Robert Hiscox,
Chairman, Hiscox Underwriting
John Hoerner,
Former Chief Executive, Tesco Clothing
Geoffrey Howe,
Chairman, Jardine Lloyd Thompson
Luke Johnson,
Chairman, Risk Capital Partners
Tim Martin,
Chairman, JD Wetherspoon
Nigel McNair Scott,
Finance Director, Helical Bar
David Ord,
Managing Director, Bristol Port Company
Neil Record,
Executive Chairman, Record Currency Management
Nigel Rich,
Chairman, Segro
Hugh Sloane,
Co-founder, Sloane Robinson
Brian Williamson,
Simon Wolfson,
Chief Executive, Next
Signed in a personal capacity

Meanwhile, an IoD poll has revealed that 77% of its members agree with the PM’s use of the veto, with only 19% disagreeing. The survey found that 63% of IoD members would like to see the UK in a looser relationship with the EU, including 42% who would like to see a repatriation of some powers.

Add to this our recent poll of financial services managers, before the summit, which showed that 69% supported the introduction of a British veto on EU financial rules even if it reduced access to the Single Market, and the picture is one of widespread business support not only for Cameron's veto but for a more liberal and competitive Europe.

Ten lessons David Cameron needs to learn from the EU veto

2011-12-22T13:07:00.005Z

Sir Humphrey it appears that "lessons need to be learnt” on how to negotiate EU Treaties

The Coalition has itself admitted that “lessons need to be learnt”. We would agree.

Open Europe has today published a new briefing setting out the ten lessons that should be learnt from David Cameron’s ‘veto’ of a proposed EU Treaty change at the summit of 8-9 December.

By accident or design, the UK Government has set down a marker for future negotiations. It is prepared to use the veto. It remains unclear what theconsequences of this initial veto will be. However, as moremember states show their reluctance to sign up to the new Franco-German-eurozone deal in its entirety, the initial dramatic portrayal of an isolated Britain was clearly premature.

Though Cameron left the negotiating table without any of his demands being met – which clearly wasn’t ideal – the broadly positive public reaction to Cameron’s veto should give him the confidence to set out what the UK wants from its relationship with Europe. But to make this vision a reality, it is vital that the UK uses the experience of this month’s summit to learn the lessons needed for future EU negotiations. Here they are:

Ten lessons in brief:

Lesson 1: Get in early
The Government was far too slow to react to the prospect of a series of EU Treaty changes to bolster the eurozone. The Government gave the impression that it left its requests to the last minute despite having over a year to prepare. The Coalition needs to start thinking now about not only the next potential opportunity but the one after that.

Lesson 2: If you fail to prepare, you prepare to fail
The UK failed to prepare potential allies and crucially failed tocorrectly gauge the likely reaction of German Chancellor Angela Merkel. There was clearly a breakdown in communication and understanding leading up to the summit with no time being given to explain the UK’s requests. The UK needs to improve its preparation for negotiations using all the resources available to it.

Lesson 3: Communicate intelligently and to persuade
The Coalition needs to set out a coherent narrative prior to summits in an easily understandable form. The UK was secretive and this made it easy for others to portray the UK’s requests as ‘special pleading’ for the City of London when in fact the UK was also seeking for the right to impose stricter regulation on banks than the EU standard. The UK should have emphasised its desire to protect the Single Market and the UK taxpayer.

Lesson 4: Listen and understand what the other side is thinking
There was clearly a failure to understand the changing mood in Berlin. Next time the UK will need to have a more intelligent method of understanding the thinking of key decision makers as well as natural allies so it can pitch its requests at the appropriate level and in the appropriate manner.

Lesson 5: Tailor your demands to the nature of the negotiations
The UK needs to ask for the right things at the right time. The UK’s requests at the summit were modest but some of the very technical demands were not appropriate for a discussion on EU Treaty change.

Lesson 6: Have a clear view of your own long-term interests
It is evident that the UK has for a long time failed to articulate a strategicplan to further its interests in the EU. The UK must develop a long termstrategy based on the realisation that it will not join the euro but that othereuro states might well seek to work more closely together.

Lesson 7: Don’t expend unnecessary political capital on lecturing others
The UK wasted a lot of goodwill and political capital lecturing EU leaderson how to solve the eurocrisis in the run up to the summit. As the UK was not going to contribute to a plan to ‘save the euro’, this advice was not welcome and merely wasted political goodwill. In particular, the UK’s public support for greater ECB intervention was always likely to antagonise Germany. The UK needs to do better at prioritising when to use its political capital andunderstand the sensitivities of other countries.

Lesson 8: Attempt to achieve a united front across the political parties
The UK political class, more than in any other EU state, uses the EU as a party political football. This creates a polarised debate at home and ties the hands of UK politicians abroad. The UK should do more to engage its MEPs and its staff in the EU institutions with a national strategy based around the UK’s strategic interests.

Lesson 9: Thereis no clear Coalition decision making process
It was not clear who was in charge of the UK negotiations, with officials from the Foreign and Commonwealth Office (FCO), Number 10, and the Treasury all keeping each other in the dark. The Coalition needs to make itsdecision making processes clearer.

Lesson 10: The Treasury and FCO are on the same side
The key UK institutional relationship in the negotiations was between the FCO and the Treasury. It is clear that this relationship broke down. This needs to be repaired so that all parts of the Government are signed up to the same strategy. The Treasury also needs to learn to engage with and better understandthe mechanics of the EU.

The ECB’s bazooka?

2011-12-21T16:15:00.014Z

This morning saw the first allotment of the new unlimited three year ECB loans - the much hyped mechanism that some hope will solve the eurozone crisis by actually providing cash to struggling eurozone banks with which they can then use to buy Portuguese, Italian, Irish, Greek and Spanish debt, giving these countries some breathing space.

Banks demand for these new loans shattered almost all expectations, coming in at €489bn (from 523 banks), compared to an average estimate of around €300bn beforehand. In the run up to the operation there had been much debate over whether this was a ‘back-door’ bailout by the ECB or its version of ‘Quantitative Easing’. Christian Noyer Governor of the Banque de France even termed it the ECB’s bazooka (for our recent briefing on this see here).

With all this in mind one would expect a euphoric reaction from financial markets – unfortunately that doesn’t seem to have been the case. There was naturally some initial boost, but stock markets have settled quickly with some European markets even down slightly, while peripheral bond yields have continued their upward rise.

There are a few key reasons why this might be the case:

- The actual boost in liquidity is only €210bn, since the rest is moved from some of the ECB’s other shorter lending operations, so any knock on effects it does have are likely to be limited.

- Banks face a huge task to reach the 9% capital requirements laid out by the European Banking Authority (EBA), even with this extra liquidity banks are still going to be tempted to undertake significant deleveraging (reducing lending) to meet these requirements.

- Banks face huge amounts of debt which needs to be rolled over or paid off, this is far from covered by this extra liquidity.

- It is unlikely that much of this money will be funnelled back into sovereign debt (thankfully) since banks still face huge scrutiny over their exposures to the eurozone crisis, while any such investments would have to be hedged (the risk would have to be accounted for) - both of which decrease the value of such investments.

- Some of this money may filter through to boost lending by banks to the wider economy, but given some of the constraints above this is far from certain.

- Reports suggest the ECB has already begun purchasing Italian and Spanish debt to keep yields down this afternoon, a role which many expected banks to be playing once they were flush with all this new liquidity.

So, still plenty of concerns and questions for financial markets to ponder despite the big uptake in this morning’s lending operation.

Even if all of this money were used to purchase sovereign debt by banks it would not help solve the crisis. Not just because it would load under capitalised banks with risky sovereign debt (hinged on huge political uncertainty) but also because it only represents a short term liquidity boost. Sure, it might help Italy and Spain rollover a few billion in debt a bit more cheaply, but it does nothing to tackle the underlying problems of the crisis (lack of competitiveness and growth to name but two) nor does it help the already insolvent bailed out states.

In the end, the pressure is still on for eurozone leaders to find a comprehensive intergovernmental solution, they must take the lead, the ECB and the banks cannot.

Sarkozy's outbursts reveal an insecurity

2011-12-20T11:08:00.031Z

A reconstruction by the Financial Times of what happened at the EU summit on 9 December reveals that it wasn't only a classic Franco-British dispute which raised the tensions of the discussions.

The newspaper discloses that following French President Nicolas Sarkozy's dismissal of David Cameron's demands, Denmark and its College of Europe-educated Prime Minister also came under fire:

Sarkozy went on to rebuke Helle Thorning-Schmidt, the freshly elected Danish prime minister, for the temerity to speak up for a deal at 27. “You’re an out, a small out, and you’re new. We don’t want to hear from you,” Mr Sarkozy said.

It's not a secret that France has never been too happy with either the EU's internal market or the 2004 enlargement, a view forever symbolised in the notion of the "Polish plumber." Sarkozy's latest outbursts suggest that the French government is not only once again looking to further its old agenda of a smaller, more centralised and more protectionist union but that he is personally starting to feel the heat.

The elephant in the room is the upcoming French presidential election. L'Express carried a headline recently noting that French far-right leader Marine "Le Pen is riding the wave of the debt crisis and the euro" with some polls putting her on 20% for the first round of the election, to be held in April. As opposed to her father, who made it to the second round of the Presidential election back in 2002, she's not just running with an anti-immigration message but also rallies very firmly against the euro, something that wasn't on the political agenda in 2002.

Polls show that Sarkozy is currently expected to gain around 25% of the vote in the first round, while the socialist candidate François Hollande is a few percentage points ahead.

Since April is still some time away and the euro crisis can still take many turns (including France losing its triple A rating) the French press is starting to realise that there is a serious danger that a Le Pen could again make it to the second round.

The Battle for the heart and soul of the ECB

2011-12-19T14:06:00.008Z

Open Europe has today published a briefing arguing that the ECB is unlikely to buy the hundreds of billions worth of government bonds required for it to properly backstop the eurozone, following an underwhelming agreement between EU leaders at the summit of 8 and 9 December.

However, Open Europe notes that, contrary to popular opinion, the ECB is already heavily intervening in markets. Through its government bond buying and liquidity provision to banks, we estimate that the ECB’s exposure to weaker eurozone economies has now reached €705bn, up from €444bn in early summer – an increase of over 50% in only six months, raising fresh questions about its credibility, independence and possible losses it may face in the case of future sovereign defaults.

The briefing also notes that other suggested options for boosting demand for sovereign debt – such as the newly announced three year long term refinancing operation (LTRO), due on Thursday – while helping to stem the short-term funding crisis, would also come with the risk of incentivising a weak banking sector to stock up on risky government debt. The ECB would also struggle to conduct ‘Quantitative Easing’ (QE) in the same vein as the Federal Reserve and the Bank of England as any QE would have to be spread proportionately around the eurozone, meaning that Germany would be subject to greater effects of any QE than Italy.

Open Europe concludes that there may come a day when the ECB has no choice but to intervene on a massive scale. However, if so, that will likely be a stop gap on the path to a new, slimmed-down eurozone, and probably following the default of at least one eurozone member.

Key points:

- As things stand the ECB should not, will not and cannot provide the unlimited financial backstop to the eurozone that financial markets seem to be clamouring for. The measures taken at the EU summit on 8 and 9 December are unlikely to supply adequate cover for the ECB to buy the hundreds of billions worth of Spanish and Italian government debt needed to fulfil this role.

- The ECB has taken on large amounts of low quality collateral in return for providing loans to banks, and has seen a massive surge in the number of asset-backed securities it has taken on to its balance-sheet. Though not all of these assets are bad or ‘toxic’, they are extremely difficult to value. At the same time, the number of banks which are becoming reliant on the ECB is alarming and hopes that the functioning of the European financial markets will ever return to normal are diminishing – creating a long-term threat to Europe’s economy.

- Through its government bond buying and liquidity provision to banks, the ECB’s exposure to the PIIGS has now reached €705bn, up from €444bn in early summer. This is an increase of over 50% in only six months and shows how, contrary to popular belief, the ECB is already intervening quite heavily in the markets. It also highlights how the eurozone crisis continues to transfer risks away from private creditors to taxpayer-backed institutions. It remains unclear how the ECB would cover losses in the event of a sovereign default.

- The ECB is likely to continue to keep interest rates low and continue to provide cheap credit to banks despite inflation fears in Germany. Currently, given the global slowdown, the different monetary policy needs of eurozone countries are small enough to paper over. However, this will not be the case for long and as German growth picks up the huge flaws in the one-size-fits-all monetary policy will again be horribly exposed.

- Moving forward, the ECB could offer a liquidity boost to Europe’s economy but little more. The term ‘lender of last resort’ is often misused or misunderstood – the ECB cannot fully backstop sovereign states or return them to solvency. At best it could ease the pressure on illiquid states, but even this depends on the legal constraints on the ECB’s defined role and being seen to give in to political demands that would hurt the ECB’s credibility and independence.

- Even if it can be achieved practically, Quantitative Easing (QE) by the ECB is unlikely to work. Even a €500bn bout of QE – as some have called for – would see only €90bn flow towards Italy, due to the need to spread QE evenly across the eurozone. This would not make a significant dent in Italy’s €1.9 trillion of sovereign debt.

- Alternative options such as the ECB lending to the IMF or lending to banks for them to stock up on sovereign debt, are preferable to direct ECB financing of states, since the IMF and banks can apply some conditions and maintain market pressure for reform, but create hazards and complications of their own without offering many additional benefits.

- Instead of arguing about the role of the ECB, EU leaders should focus on pushing ahead with debt restructurings in the eurozone, despite the ECB’s objections, and formulate a plan for how to mitigate the ensuing losses both on the ECB’s balance sheet and in the private sector. Ultimately, money would be far better used for these ends rather than flooding the eurozone with liquidity and recycling debt – both of which have failed so far.

- The time may come when greater ECB intervention in the sovereign debt markets is unavoidable, but at this point it would be a mechanism to help ease the transition to a new eurozone structure, probably with fewer members and a more clearly defined role for the ECB.

To read full briefing, click here.

How will the UK judge the role of the ECJ?

2011-12-16T18:31:00.009Z

A draft of the new European treaty proposed by France and Germany has been leaked and attention has immediately turned to the thorny issue of the role of the EU institutions in enforcing or policing the new deal – remember the UK's line is broadly that they can't, a key source of potential leverage in future talks.

The proposed document would see a role for the European Court of Justice in judging whether national governments have transposed a new “balanced budget” obligation and, if this is breached, an automatic “correction mechanism” into national law. The new treaty states:

NOTING that compliance with the obligation to transpose the "Balanced Budget Rule" into national legal systems at constitutional or equivalent level should be subject to the jurisdiction of the Court of Justice of the European Union, in accordance with Article 273 of the Treaty on the Functioning of the European Union.

The question is whether this is allowed under EU law, can the ECJ be used for this? (NB, the draft foresees no role for the ECJ in enforcing any sanctions but simply judging whether the new rules have been adequately transposed into national law.)

Article 273 of the EU Treaties, cited by the new treaty, states that:

The Court of Justice shall have jurisdiction in any dispute between Member States which relates to the subject matter of the Treaties if the dispute is submitted to it under a special agreement between the parties.

So this EU Treaty article clearly provides the new group with a hook on which to try and hang the new arrangement and get the ECJ involved. Article 273 would allow the ECJ to be used to judge a dispute (in this case whether the “balanced budget” rule has been adequately transposed), as long as the subject of the dispute is “related” to the EU Treaties. The question is whether this 0.5% rule can reasonably be seen as “related” to the Treaties. This is where the legal grey area begins and where it seems that the justification for ECJ involvement is iffy to say the least.

The existing EU Treaties contain obligations for governments to remain within a 3% deficit limit and a 60% debt to GDP limit. But there is no mention of the new 0.5% “structural deficit” limit proposed by the new treaty.

The 0.5% limit is a new obligation. It is therefore a legal stretch to say that this falls under the category of things to which the EU Treaty “relates”. Using the ECJ to judge whether this new obligation has been transposed properly is therefore also a huge legal stretch and one that the UK would be well advised to investigate and possibly challenge. If Cameron does wave the proposal through it will certainly raise political questions about what his veto actually achieved.

Polarised Poles unite in fear of Franco-German run EU

2011-12-15T18:02:00.017Z

Yesterday witnessed a heated and fractious debate (a former Foreign Minister walked out in protest) in the Polish Sejm concerning the conclusion of the Polish Presidency of the EU and last week’s EU summit. Polish PM Donald Tusk kicked off the proceedings by stating that there is still a long way before the future of the euro, and consequently the EU, will be any clearer:

"I would be a happy person if I know the answer to the following question: What is the future of the European Union?"

Tusk added:

“The attempted steps taken in Europe reveal not only the dysfunctionality of certain institutions and European principles, but how strong the disintegrative tendencies in Europe are…Poland can not become a part of the second or third ring… The biggest risk for Poland is the silent division of Europe…that the eurozone fixes itself and turns inward forgetting about the 27, soon to be 28."

Tusk also emphasised that the decision about the new shape of the Union must not be a result forced through by three European capitals (he said it was not necessary to specify the capitals concerned, because everyone knew which ones he had in mind), but a decision made by the community as a whole.

The Law and Justice and Solidarity Poland parties accused the government, and in particular Foreign Minister Radoslaw Sikorski (following his controversial speech calling on Germany to play a more active role in Europe) of betraying Polish interests and sovereignty. They were also very critical about the possibility of Poland offering financial assistance via the IMF to countries with a higher standard of living than that enjoyed by Poland.

The clash of approaches was perfectly captured by the fact that Law and Justice MPs wore badges with the Polish flag, while MPs from the pro-integrationist Palikot’s Movement wore badges with the EU flag (pictured). Janusz Palikot, the flamboyant leader of Palikot’s Movement (yes he really did name his party after himself) well known in Poland for his use of props to illustrate his political arguments, want as far as to present Sikorski with the pen used by late President Kaczynski to sign the Lisbon Treaty in order to keep him on the path towards European Integration.

Looking at the bigger picture, it is clear that, on both sides of the debate, Poland sees the main challenge as one of avoiding Franco-German dominance of the EU, which circumvents the EU institutions and crowds out smaller member states. Polish daily Rzeczpospolita featured an analysis of the Polish Presidency which concluded it had been a “façade”, given that:

“as a result of the crisis, not only was the EU’s centre of leadership not in the country holding the Presidency, but not even in the EU Council, the European Commission or the European Parliament, but in two capitals – Berlin and Paris.”

The unease about the future direction of Europe is spreading fast.

Wise Men Flee Europe…

2011-12-15T15:42:00.005Z

H/T Eric Worall

Why the 26 vs 1 narrative is simplistic (Part 2)

2011-12-15T11:50:00.003Z

On Tuesday, we set out a country by country guide looking at the limited support in cabinets and parliaments around Europe for the main points of the deal agreed last week highlighting that the European match-up is far more complicated than "26 vs 1". The FT had a similar piece on its front page yesterday, and the Independent featured almost the exact same story on its front page today (which goes to show that you should sign up to our press summary if you want to stay ahead of the curve).

So what about reactions from politicans and media around Europe to the veto? To be honest, there's been quite a bit of Cameron-bashing in the European press - some justified, but there's been plenty of ranting too. It's almost as if politicans and commentators finally saw a chance to divert some attention away from the constant fire that eurozone leaders have been under since the crisis started two years ago.

But there have been a lot of more nuanced reactions. For example, as you will have heard, speaking to the Bundestag yesterday, Chancellor Merkel said that the UK will remain a strong EU partner, despite its decision not to sign up to an EU summit deal. In an interview with Rheinische Post, Frank-Walter Steinmeier, former German Foreign Minister and current parliamentary leader of the opposition SDP party said that he feared that the decisive step towards a British exit had already happened, but warned this would be a damaging scenario:

“I too am often annoyed by Britain’s special interests! But we must be aware that with the loss of Great Britain we would give up a historical element of the European integration story. I do not want to imagine writing the future of Europe without such a strong partner as the UK.”

Even Nicolas Sarkozy, who it is alleged could not even bring himself to acknowledge Cameron at the summit, struck a more concilliatory tone this week, emphasising that:

“We need Great Britain! It would be a big impoverishment to see its departure which, very happily, is not the actuality”

Unsurprisingly, the Swedish and Irish Prime Ministers, have also both indicated that there are still plenty to discuss regarding the future of Europe, and that they expected the UK to be involved in this process.

And here are some other reactions from around Europe that you won't hear on tomorrow's Today Programme:

In Poland, Arkadiusz Mularczyk, a senior MP for the Conservative Solidarna Polska party, went as far as to argue that:

"[Polish PM] Tusk should learn from Cameron's diplomacy"

A leader in Welt am Sonntag entitled: “Britain: Please come back!” argued that:

“Should the UK actually leave the EU, the Union would lose not only the cradle of European democracy, but also one of its founding members - and the most important financial centre of the old continent”.

On Monday, in Sweden's main daily Svenska Dagbladet, EU-expert Roger Älmberg wrote that:

"[Sarkozy and Merkel] Needed to identify Cameron as a scapegoat to paper over their own conflicts...the details that will emerge [from the EU deal in March] will most likely lead to more than the UK feeling excluded.”

A leader in Sweden’s largest tabloid, Expressen, noted that Cameron may have ended up outside the EU’s core structure, but that it was also “hard to find arguments” for Sweden to join Merkozy’s pact, since:

“There are no plans or political majority for joining the euro. Besides, Sweden doesn’t like that the euro countries go off on their own outside the Treaties.”

Meanwhile in Belgium, Baroness Mia Doornaert, a well-known Belgian commentator and former advisor to the former Belgian PM, Yves Leterme, argued in De Standaard:

"David Cameron says no to a new European treaty, while listening to his English voters, and is accused of being someone who "blackmails" Europe. Twenty six other government leaders and heads of state don't give their parliaments but European bureaucrats control over their budgets...this kind of top down integration carries the risk that democratic support for the Union shrinks. Europe and democracy: for now they don't seem together. Unless you consider it democracy that elected leaders in Brussels agree upon common measures which they can't or don't dare to push through in their own countries."

There was also nuanced remarks from Dutch magazine Elsevier’s EU correspondent Carla Joosten, who commented that:

"[Cameron's] fear of European rules which would hit the heart of the British economy, the financial sector in London... isn't unjustified. It wouldn't be the first time that France and Germany are trying to get rid of competition elsewhere in the Union. French President Nicolas Sarkozy keeps on repeating that the City of London is at the heart of the crisis. It isn't of course that simple. The British have already cleaned up their banking sector better than the French and the Germans together."

The Irish Independent's chief critic, Bruce Arnold yesterday wrote a piece somewhat dramatically entitled "We need to strengthen UK ties before EU strangles us", in which he argued:

"That is now overshadowed by the darker figures of Angela Merkel protecting German interests, Sarkozy protecting French interests, and doing so with greater skill and duplicity than we have seen before. David Cameron has seen what this would do to British interests and backed away. We should do the same."

This theme continued this week, with Tuesday's Handelsblatt's editorial arguing that:

"Even under normal circumstances it would have been hopeless to expect Cameron to approve the EU's conversion into a fiscal union as a first step towards political union without receiving anything to show for it at home. But given that the justification for this step was the rescue of a currency the logic of which the British still doubt today it was utterly impossible…It would be better now to focus on what the two sides still have in common and what can serve both their interests instead of ranting against the Britsh. And a functioning common market is right at the top of the list here."

While worrying about the UK’s ‘departure’ an editorial in El Pais claimed that:

"From development cooperation to a European research area, many European projects would look very different today without the UK's influence. And it's difficult to imagine that without the UK the EU would have dared to break up hugely influential national monopolies like the telephone companies or airlines. If the UK leaves, the EU will lose not only military, academic and financial clout but also a country that has demonstrated that it is much better able to renew its public administration and policies than continental Europe"

Spanish regional paper Las Provincias argued that:

“Despite doubts, the UK contributes much to the EU in economic and political reforms, and one should avoid reading the pact as a new battle between Europeans, with winners and losers.”

In this week's Spiegel magazine, London correspondent Marco Evers criticises Cameron’s decision to veto EU Treaty change, but concludes that:

“Despite all the anger, [the British] might soon be missed… ironically enough, it might just be the Germans who regret losing the United Kingdom. London's dedication to free trade, to the rule of law and to having things run in an orderly manner is not so easy to replace. Berlin is losing a partner who was a dependable counterweight to the club of those slack states in southern Europe whose freewheeling financial policies the restrained Germans have always abhorred.”

All in all then, to paraphrase Mark Twain slightly, it could be said that reports of the UK’s death in Europe have been greatly exaggerated.

FrAAAnce misses the point...

2011-12-15T09:00:00.003Z

For all those who think that French President Nicolas Sarkozy will be sitting in the Élysée plotting some form of retaliation against Cameron, it has quickly become clear that he has much bigger things to worry about.

Rumours have once again been flying around that France’s triple-A rating is under threat and could be facing an imminent downgrade. These have become all the more serious by the numerous French government ministers that have publicly played down the gravity of any downgrade.

On Monday Sarkozy said that a downgrade would be “one more difficulty, but not insurmountable.” On Tuesday Valerie Percresse, French Budget Minister, made similar remarks saying, "The fundamentals of the [French] economy are good, and investors don't doubt France will pay back its debts," thereby playing down the impact of any downgrade. Finally, yesterday French Foreign Minister Alain Juppe said, “[A downgrade] wouldn't be good news, but it wouldn't be a cataclysm either. The United States lost their triple-A and still manage to borrow on the markets in good conditions.”

This public onslaught by the government on the cost of France losing its triple-A rating is widely being seen as a way of softening up the public and the markets for what’s coming. Ultimately, the impact of a downgrade on France will depend on numerous factors, not least: whether other countries are also downgraded, whether it is a one or two notch downgrade and the level of upcoming public and private financing which France faces immediately after the decision.

Our concern though is not about the impact on France. In fact the French government seem to be missing the bigger picture – the impact it will have on the eurozone bailout funds. The eurozone is already running short on money, at least in terms of providing a financial firewall to stop the crisis. As we noted in our ‘No Way Out' report a downgrade would not be good:

Since the EFSF’s Triple-A rating relies on Triple-A countries, a French downgrade would also mean a downgrade for the EFSF itself. For such a downgrade to be avoided, the remaining Triple-A countries would need to substantially increase their share of the guarantees, transferring even more of the burden on the already reluctant German taxpayer – while also threatening Germany’s own rating. In all likelihood, under the increased EFSF scenario, a downgrade of France would trigger a downward spiral of ratings cuts due to the extra EFSF liabilities which would make the entire fund completely unworkable.

So a French downgrade would be bad for the EFSF, the eurozone’s temporary bailout fund, while numerous downgrades could spell the end of its ability to borrow, and therefore lend, at low cost. It could also spell trouble for the ESM, the eurozone’s permanent bailout fund, which, despite some paid in capital, also largely relies on guarantees from its members.

In any case, the French government may be softening up its population for a downgrade, but who’s going to soften up markets for the realisation that the eurozone bailout funds could be rendered close to useless (more useless?)….

Update 15/12/11 12:20pm:

Christian Noyer, Governor of the Bank of France, today launched an attack on the rating agencies (and the UK), suggesting that they are not basing their decisions on economic fundamentals and if they were the UK would/should be downgraded before France.

Noyer raises some valid concerns about the level of the UK's debt, deficit, inflation and the dwindling credit availability - but he, like his colleagues mentioned above, misses the key point. The UK has full control over its own monetary policy and can balance it with its fiscal approach in any way desired. France however faces: a central bank whose thinking runs completely contrary to the government's desires, an overvalued currency, increasing fiscal constraints due to its exposure to the eurozone crisis and a looming election (along with potential political divisions over the eurozone crisis). All in all, the UK may economically be in just as bad a position as France, but the UK has the tools to deal with its problems, the French government is, on the contrary, massively constrained.

So what does business really think of Cameron's veto?

2011-12-14T16:45:00.011Z

Cameron's use of the veto at last week's summit, in order to seek a level playing field in the single market, allow for stricter bank capital rules and unanimity on the transfer of powers to the EU's financial supervisors, has been followed by the usual arguments that the business community is concerned that the UK will be isolated (see here why the issue is slightly more complicated than that) and that it fears for the UK's place in the single market.

This 'argument by anecdote' is one that we've heard so many times before, and the last few days has seen a number of exponents of it.

Monday's FT reported that:

"while others within the banking community and beyond said the decision risked destroying the country’s position as Europe’s pre-eminent financial centre."

The Observer added:

"It was hard to find many business voices supporting the decision this weekend"

Michel Barnier, the European Commission for the Internal Market and Services had a piece in the Telegraph today, in which he argued that:

"It seems clear to me that the City's interest is in a truly single European market, not a fragmented patchwork."

Hosting a breakfast for Nick Clegg this morning, Philip Souta, BNE's genial Director, said he believed Cameron "did the wrong thing in using the veto" and BNE chairman Roland Rudd chimed in:

"Business clearly wants a deepening and widening of the single market and that is what our message is in terms of wanting to see greater reforms. We are not defending the status quo, we are trying to see a changed and reformed Europe."

Yes, of course we're all in favour of trade and growth, but let's think a bit deeper about this. Cameron's efforts last week, whatever you make of the tactics and if he asked for the right thing, were an attempt to achieve reform in Europe, through more local ownership of supervision and capital rules for banks, for example.

So surely, what's interesting is what business really thinks about the basic aims. And what does it actually think about the single market? Well, you're in luck, because this morning we published a new ComRes poll designed to inject some substance into a debate that has so far been based on hearsay.

Now, as we know how the following 'inconvenient' findings tend to rub some people the wrong way, a couple of qualifications:

500 financial services professionals were polled between 28 November and 7 December, before last week’s EU summit. So this poll is about the general sentiments on the EU negotiations, a UK 'veto' over financial services and attitudes to the cost/benefits of EU rules and market access.

At Open Europe we maintain that access to the single market has by and large been beneficial for UK businesses, which is why we were very surprised to see such a large share in the business community expressing such qualified support for it.

We were keen to qualify our key 'veto' question by flagging up that such a tactic could compromise market access. This point is vital, as a substantial chunk of the media narrative in the last few days has been that the business community now perceives itself as worse off than before the summit (again, this is the narrative not necessarily the reality). But our poll would suggest that this is a risk that businesses are actually willing to take - which again, surprised even us.

With that out of the way, here are the main findings:

- Overwhelming support for a UK veto on EU financial regulation even if it reduced market access to the EU: The ComRes survey finds that 69% of financial services professionals say that they would support the UK having a veto on future EU financial regulation and other financial measures, even if it risked reducing their firm’s market access to one or more EU countries.

- Concerns about the cost of EU regulation: The poll finds that 56% of financial services professionals think that, on balance, the costs of EU financial regulation currently outweigh the benefits of the Single Market to the City, while 31% disagree. Over the next five years, 62% expect the costs of EU regulation to outweigh the benefits of the Single Market, while only 24% disagree.

- 70% think the UK should renegotiate the EU Treaties to safeguard the City: While the Single Market is seen as important, surprisingly, a full 70% think that the UK Government needs to renegotiate the existing EU Treaties to safeguard the City of London, limiting agreements to trade and association only.

- Eurozone-only financial transaction tax (FTT) would have a negative effect on finance firm’s UK operations: Given that the UK and other non-euro countries are opposed to an EU-wide FTT, the likelihood of a eurozone-only FTT being proposed has increased. If the eurozone went ahead with its own FTT, without the UK, finance professionals think this would still have a negative effect on UK firms. 55% say it would have a “negative effect” on their UK operations. If an EU-wide FTT, including the UK, was introduced, 48% of financial services professionals say they would consider moving some of their activities to outside the EU.

- UK regulators are perceived to have a better understanding of financial markets than EU regulators: In contrast to EU-level regulation, financial services professionals are less likely to agree (40%) that the costs of UK-derived Financial Services Authority (FSA) regulation outweigh the benefits, than disagree (47%). Only 22% of respondents agreed that the EU institutions have a better understanding of how financial markets operate than the UK’s FSA, while 62% disagree.

As our survey and the graph above clearly demonstrate, in financial services in particular, a key sector of the UK economy, a majority already believes that the cost of complying with existing and new EU regulations outweighs the benefits of access to the single market. And even more are concerned that this will be the case in five years time.

See a full summary of the poll here.

Why the 26 vs 1 narrative is simplistic

2011-12-14T09:46:00.004Z

In our press summary yesterday, we flagged up how Sarkozy's and Merkel's pact is far from a done deal (if anyone for a second thought so) as Parliaments and governments around Europe continue to struggle to come to terms with its details and content. On their respective front pages today, the FT and the WSJ are picking up on this theme as well (which goes to show that if you have not yet done so, you may want to sign up to our daily press summary featuring the key stories from all around Europe).

Over on the Spectator's Coffee House blog, we take a closer look at the state of play in various EU countries in the context of the "26 vs 1" narrative and the UK isolation hysteria that have swept the UK media over the last few days, following Cameron's veto (the isolation hysteria is sort of the equivalent of the scare story - peddled by some eurosceptics - that Germany is set on becoming the 'fourth reich').

Here's the post:

Judging from much of the coverage in UK media, you would be forgiven for thinking that Britain is on the fast track to becoming the North Korea of Europe — eccentric and completely isolated from the rest of the world. Indeed, the media narrative over the past couple of days has largely treated the agreement reached at the summit as concrete, supported in full by everyone apart from Britain. Or ‘27-minus’, as Commission President Jose Manuel Barroso put it.

The reality, of course, is quite different. Leaving aside whether Cameron could have played his cards better (he could have), as Gideon Rachman pointed out in yesterday’s FT, ‘the picture of an isolated Britain’ will become blurred as the rest of Europe grapples with the Merkozy deal.

So let’s have a look at the level of support in cabinets and parliaments around Europe, for the deal’s main points: fiscal integration, stricter EU budget rules and sanctions, new rules for the euro’s permanent bailout fund (the ESM) and fresh cash contributions to the IMF.

France. For all the Sarkozy rhetoric, his main rival, the Socialist candidate Francois Hollande, leading him by 18 per cent in a hypothetical second round clash, has said that: ‘If I'm elected president, I'll renegotiate this deal...to add to it what it lacks today’, being particularly critical of constitutional limits on budget deficits.

Germany. Scratch the surface and the Germans aren’t overwhelmed either. In addition to the deal being seen as an insufficient to solve the crisis, the Bundesbank has warned that the proposed new IMF contributions could take Germany above the ‘bailout’ ceiling established by the Bundestag.

Denmark. The Merkozy deal appears to have split the newly-elected Danish centre-left coalition. Danish Foreign Minister Villy Søvndal (of junior coalition partners the Socialist People's Party), and PM Helle Thorning-Schmidt ( Social Democrats) have been accused of contradicting each other over whether the pact could restrict the government from pushing through its economic programme. The agreement is now pending analysis and approval in Folketinget, which will also consider whether a referendum is required (it’ll most certainly be avoided). A poll this week found that 54 per cent of Danes want the pact to go to a public vote.

Sweden. The Swedish minority government looks unlikely to get the necessary majority to get the package, as it stands, through the Riksdag. The leader of the opposition Håkan Jurholt has warned against becoming euro members ‘via the backdoor’. The centre-right coalition remains split on the issue, with PM Fredrik Reinfeldt saying that it would be a ‘bit strange’ for the country to join. Meanwhile, Swedes are becoming increasingly sceptical. A fresh poll out this week shows that over 80 per cent of Swedes would vote ‘No’ to the euro in a referendum, compared to 42 per cent two years ago, while support for EU membership has dropped from 55 per cent to 47 per cent in a year.

Poland. Opposition parties Democratic Left Alliance and the Law and Justice parties have warned that the deal would violate the Polish Constitution, and therefore needs a two-thirds majority in both houses of the Polish Parliament, which is far from guaranteed. Law and Justice has even threatened to over-turn the agreement once in power (which, it should be said, can be a while). The government maintains that the pact actually won’t impact on Poland until it joins the euro.

Finland. The Grand Committee in the Finnish Parliament has launched an inquiry into whether the country’s Prime Minister Jyrki Katainen potentially over-stepped his mandate in the negotiations in Brussels last week. In its current form, the deal is unlikely to pass Parliament as the majority rule for the activation of the ESM (meaning Helsinki will be stripped of its veto over future bailouts) will require a two-thirds majority in the Parliament to be compatible with the country’s Constitution. Such super-majority looks unlikely since the main opposition parties the Centre Party and the Finns (previously ‘True Finns’) both oppose the deal.

Czech Republic. Prime Minister Petr Necas told the Czech press, ‘It wasn't possible to sign up to this international agreement for a number of reasons. But the main reason was this – nobody knows what's in it’, saying that the deal will need approval form his Parliament. In addition, the Czech Finance Minister Miroslav Kalousek yesterday said that the suggested additional IMF contribution is ‘extremely high,’ estimated by the Czech Central Bank to be equal to 10 per cent of official Czech reserves, something echoed by Czech President Vaclav Klaus.

Hungary. Hungarian PM Viktor Orban will let the Hungarian parliament decide whether to agree to the deal, although with his Fidesz party enjoying a solid two-thirds majority, he could in theory easily push it through should he want to.

Netherlands. The situation is not fully clear, with the Social Democrats appearing to have backtracked on their previous request for early elections to be called if further transfers of sovereignty to the EU were to take place under last week’s agreement. With the Social Democrats, the government would have the majority needed to push through the agreement.

Ireland. Ireland will decide whether it needs to be put the agreement to a referendum when the details of the agreement are clearer (probably March), with chances for a vote seen as 50-50. Deputy PM Eamon Gilmore also said that ‘I believe there will be a lot of discussion on that between now and March. I will be surprised if Britain is not involved in that discussion’.

Estonia. The Finance Ministry has said that the country will not contribute to the agreed €200 billion IMF capitalisation, even though the country is a member of the eurozone.

So is it fair to reduce this myriad of opinions and political positions to a 26 versus 1 discussion? You decide.

Barroso's failed attempt to single out Cameron

2011-12-13T12:03:00.024Z

There seems to be some continuing confusion over David Cameron’s demands at last week’s EU summit, specifically in reference to their impact on the 'integrity' of the single market. Unfortunately, European Commission President Jose Manuel Barroso, who should know better, is also doing his bit to propagate these misconceptions in a speech to the European Parliament this morning, in which he said:

“The United Kingdom, in exchange for giving its agreement, asked for a specific protocol on financial services which, as presented, was a risk to the integrity of the internal market. This made compromise impossible.

All other heads of government were left with the choice between paying this price or moving ahead without the UK's participation and accepting an internal agreement among them."

As we mentioned in passing yesterday (see here), this simply wasn’t the case.

Cameron’s first set of demands were to ensure that unanimity applies on decisions relating to: transfer of powers to EU supervisory agencies, the use of 'maximum harmonisation', issues impacting on fiscal interests of member states (taxes & levies) and the location of EU Supervisory Authorities (ESAs). In actual fact, Cameron's demands did not relate to the level of financial supervision but the rules governing the transfer of powers from member states to those EU supervisors. This is quite different to the functioning of the single market.

As is also instantly clear, there were no UK-specific demands, especially not for some form of opt-out as Barroso seems to imply. So, whether you agree with Cameron’s demands or not, it is clear that he was not seeking special treatment for the UK, these rules would allow unanimity for all EU members.

The case can, and should, also be made that, in terms of content, Cameron was defending the single market, particularly on the location of ESAs (i.e. they can't all be in the eurozone) and in defending the UK against the ECB's insistence that sizeable euro-denominated transactions only be cleared within the eurozone.

The source of the confusion seems to be that many people are conflating trying to protect a vital UK industry with seeking special treatment for the UK – these are clearly not the same thing legally or practically when it comes to the EU. All governments in EU negotiations try to protect their vital industries, for example: France with agriculture, Spain with fishing and Germany with manufacturing exports, and in some cases these countries have more protection than the UK does on financial services despite it representing a bigger share of the UK economy (see our recent report for a full discussion of this issue).

The other major misconception is that the UK's demands were to shield the City from all regulation - one major demand would have allowed the UK to impose tougher capital requirements on banks than permitted by the EU's desire for 'maximum harmonisation', for example. This was protection for taxpayers, not bankers. The Commission's logic that maximum harmonisation is necessary for the functioning of the single market is flawed and not one that it applies in other areas of EU policy. For example, on cutting carbon emissions, member states are free to go beyond the EU-agreed minimum.

Overall then, the UK did not seek any special treatment or specific opt-outs. Cameron asked for safeguards relating partly to an industry which is of importance to the UK (and other countries), but safeguards which could be accessed by all EU members. Neither the structure nor content of his demands were in anyway designed to hamper the single market, but in fact to bolster it. It can only be damaging to the integrity of the EU that the Commission President should openly encourage such a misconception.

Capital Requirements

2011-12-12T14:25:00.016Z

There has been a lot of speculation and a fair few misconceptions about what Cameron asked for at the EU summit - we addressed many of them here. One key point we want to flag up is his demand on bank capital requirements. According to the document obtained by the Telegraph, Cameron's demand was for unanimity to be applied to any plans for "maximum harmonisation provisions which prevent member states imposing additional requirements".

This clearly relates to the current EU proposals implementing the Basel III requirements. Here the UK is keen to push ahead, imposing stricter capital requirements on UK banks. However, the Commission could block this by stating that all member states must adhere to their minimum and maximum levels, to avoid distortions to the Single Market. This difference raises a few key points to keep in mind during the debates over Cameron's veto:

1) The UK government is not pushing for more or less regulation on financial services, merely more suitable regulation and smarter control. The EU is keen to punish practices which it sees as problematic, such as short selling and the use of credit default swaps, but when it comes to tackling a fundamental problem in the make up of the financial system it dodges the issue. This is mostly because the eurozone states fear excessive deleveraging, while they cannot afford to recapitalise the banks using public money. Valid fears, but it highlights the differing needs for the UK and European financial sectors.

2) Leading on, the UK has a much larger financial sector - solvency is therefore paramount. This point is clearly highlighted by the FSA report into the failure of RBS which was released today. The UK cannot afford another crisis and another series of bank bailouts. This is a concern and problem which the many in Brussels and in some national capitals seem to not fully appreciate. The lack of scope for allowing the UK to deal with what it sees as a key issue is hypocritical given the number of times which the UK has been tagged as an 'awkward partner'.

3) Cameron wasn't asking for a UK specific opt-out. He asked for unanimity to be applied allowing all countries the option to veto maximum requirements. This highlights how the myth of 'special treatment' seems to be unfounded.

Leaving aside whether he asked for the right thing and the viability of his negotiation strategy (and here there are clearly lessons that need to be learnt), the demand highlights the crux of the issue for the UK. It is not about stopping regulation on the city but about realising that in some areas the UK may see a need to tailor its regulatory system in a way that better suits its economic and financial circumstances - but under general provisions of EU law, rather than special UK 'opt outs'. Much of the media coverage and comments relating to this point have left much to be desired in the accuracy department.

Cameron must persist with EU reform strategy

2011-12-12T11:39:00.004Z

We've got a piece in City AM today, assessing what the EU summit conclusions really mean for the UK financial services sector. Despite much of the noise in the media not all that much has changed. That said it is vital that Cameron pushes forward with his strategy for EU renegotiation in order for his veto approach not to be in vain. See below for the full piece:

NOW that the dust is beginning to settle on last week’s tumultuous EU summit, where Prime Minister David Cameron blocked a change in the EU treaty, we can start to assess the consequences of his decision. So, what could the summit outcome actually mean for UK financial services?

Despite the clamour in much of the media, structurally it doesn’t change that much for the City. The UK would never have actually taken part in the proposals that were on the table to shore up the euro – for example, the monthly meetings among Eurozone leaders – so Cameron has not lost a seat at the table as some have incorrectly reported. The UK may not have gained any additional safeguards, but it isn’t visibly any worse off on financial services. That said, there are a couple of valid background concerns.

Firstly, since there are no safeguards in place, there’s still a risk of Eurozone caucusing, with the 17+ countries deciding for all 27. Some have argued that this risk is now greater since Cameron lost a lot of good will, which could lead to retaliation from EU partners, particularly with regard to financial regulation. Let’s be honest though, the Eurozone has much bigger problems to worry about for now and doesn’t have the time to punish the UK, nor can it afford self-defeating regulation.

Second, there is a concern over a Eurozone financial transaction tax (FTT) – an EU-wide FTT is still a non-starter and the UK retains its veto. The impact of a Eurozone only FTT on the City is unclear. It could be positive, as businesses relocate from the Eurozone to London to avoid the impact of the FTT – they would still have to pay the FTT to access the Eurozone, but would not have to do so with international trade. As such, London would have a competitive advantage. At the same time, it may have a negative impact by reducing financial transactions in Europe generally – something which the City would lose from since it is often seen as a gateway to European markets. The overall impact is unclear though and the same points can be made for any Eurozone specific financial regulation.

So, if Cameron didn’t gain or lose much, what was this all about? Fundamentally, it was about announcing a new strategy in the UK’s negotiations with the EU and flagging up the City as an area of vital interest. Perhaps Cameron’s demands were too detailed, so didn’t lend themselves to EU treaty negotiations, while his timing wasn’t ideal. Perhaps he also failed to link his arguments to wider efforts to develop a more competitive and outward-looking EU. But, due to domestic political pressure and the looming threat to the City from EU regulation, Cameron may have had little choice but to take the approach he did.

There is no doubt that Cameron expended substantial political capital with this move. For this not to be in vain he must continue to push a reformist line, ensuring sound and proportionate regulation. The agreement formed at the summit does not solve the Eurozone crisis and throws up huge legal questions, not least over whether the Eurozone will be able to use EU institutions to enforce decisions. There could be instances in the near future of the Eurozone needing the approval of the UK. Cameron should stick to his guns, but needs to do a better job of communicating his overall strategy and why the City is important to the UK economy. This is not over by a long shot.

Ten myths about Cameron’s EU veto

2011-12-10T19:17:00.003Z

Over on the Spectator's Coffee House blog, we set out ten myths about Cameron's veto. This is the post:

The EU veto that Cameron pulled in the early hours of Thursday morning has been widely misunderstood on all sides. Here are the ten most common myths:

1. Because of Cameron’s veto, Britain lost a seat at the negotiating table. Not true. The UK was never itself going to take part in the Merkozy pact (and potentially be subject to EU sanctions), and therefore not in the monthly, parallel EU meetings that will begin in January, either. Even if he had approved the Treaty changes, Cameron still would not have had a seat at the table. Wider political challenges aside, the veto didn’t change anything structurally in terms of UK influence.

2. Cameron’s veto created a two-tier Europe. A two-tier (or, rather, multi-tier) Europe was a consequence of the formation of the euro, which would inevitably force its members closer together. Cameron’s veto was a reflection of a multi-tier Europe, not the cause of it.

3. The UK is now completely isolated. Define isolated. Yes, Cameron expended a lot of political capital and frustrated many EU leaders — and he could have done some things differently, including sequenced his demands in a smarter way. But as Fraser pointed out earlier, the UK remains an open economy plugged into the global network. And given the state of the euro Britain is — as Terry Smith of brokerage firm Tullett Prebon told the BBC — ‘as isolated as someone left on the dock in Southampton as the Titanic sailed away.’

4. Cameron used his veto to protect a ‘tiny part of our economy’. This claim slipped into the BBC’s Stephanie Flanders’ reports on Friday and is incorrect. Financial services accounted for a £35bn trade surplus last year — one of the few sectors that generated a surplus, as well almost 2 million jobs and it contributed £54bn in taxes.

5. Merkel got what she wanted. This claim was also part of most broadcast reports and is equally untrue. Merkel got something, but, as Spiegel noted, she also ‘paid a high cost’ — compromising on ECJ budget powers and private sector involvement in future bailouts, for example — without achieving a lasting solution to the crisis. As yesterday’s FT Deutschland put it, ‘The next rescue summit is guaranteed to come.’

6. The UK is alone in expressing reservations about Merkozy’s deal. Cameron was clearly all alone on the veto, but others are far from enthusiastic about what’s on offer. Part of the deal hit the wall in the Finnish Parliament, while the Swedish opposition parties are opposed to Sweden signing up, meaning that the deal may not make it through the Riksdag. Håkan Juholt, the leader of the Social Democrats, said, ‘The Swedish people rejected the single currency in a referendum and we have to respect that. We have no intention of becoming members through the backdoor.’

7. The UK asked for ‘special exemptions’. Whether or not he asked for the right things, Cameron did not demand UK-specific ‘opt outs’ from regulations, but for the reinstatement of general vetoes over transfers of power to the EU’s financial supervisors and a guarantee that business and trading activities won’t be pushed inside the eurozone through regulation. The closest he got to an opt-out was a proposal to exempt certain types of businesses that only operate in one country from certain aspects of EU regulation.

8. Cameron went to Europe to protect greedy bankers. One of his demands was to be able to impose stricter rules on banks (capital requirements) in order to avoid future taxpayer-backed bailouts of bankers.

9. The 17+ can easily use the EU institutions to enforce their decisions, making Cameron’s veto pointless. ECJ case law clearly states that an ad hoc group of countries can use the EU institutions but only subject to an agreement by all EU member states sharing and paying for the institutions. This means that the UK still has a veto. Some EU leaders are now set on manipulating EU law to get around the UK veto (we’ve been here before). It’s not easy, but they may succeed. However, to criticise Cameron for this is to blame someone for losing in poker because the rules changed mid-way through the game.

To be fair, there have also been some misconceptions among those who would defend Cameron:

10. The veto was about blocking the financial transaction tax and specific financial regulations. Not quite. Cameron already had a separate veto over the FTT, and the Treaty changes were merely about tightening the eurozone’s budget rules (from which the UK already has an opt-out). The veto was always a lever to push for safeguards against the UK being sidelined on key economic issues (i.e. financial regulation) in future as the eurozone integrated further. It was not a protective measure in itself.

So leaving misconceptions and domestic politics aside, did Cameron ‘trip over his own red line’ by spending a veto without actually getting any specific safeguards in return? There is a risk. But the truth is that it all depends on what happens next. As dramatic as Cameron’s veto may seem now, I suspect it is merely one of many acts.

Hail the all-conquering Iron Chancellor? Not Quite

2011-12-09T17:59:00.005Z

Earlier this week (although so much as happened it feels a lot longer than that) we scored Merkel and Sarkozy’s pre-summit meeting in which they plotted their course of action. We decided Merkel had just shaded it in terms what was agreed.

However, in addition to giving up her stance on extensive private sector involvement in any activation of the ESM (the eurozone's forthcoming permanent bailout fund) - a key German negotiation position over the last few years - one of her key demands was to push for Treaty change at 27 (Sarko always favoured a more inter-governmental approach), and many of her other ‘wins’ were also premised on getting that agreement (e.g. the right to take other member states to the ECJ in the event of breaches of the new agreement on fiscal integration and budgetary discipline). This has now been blown out of the water for the foreseeable future, following David Cameron’s veto.

For all the predictable talk of the end of an era and the UK’s permanent isolation in Europe henceforth (we argue Cameron had little choice) did Merkel actually come out a winner in all of this? Clearly, Sarkazy if the one leaving Brussels the happiest (not minding doing business at 17, albeit now with the 'help' of some euro outs as well).

But Merkel didn't fare that well. This is not for lack of trying; Merkel has arguing that: “I am very pleased with the outcome”, and that the agreement on fiscal integration was a “breakthrough” in the debt crisis. The reality is that Merkel has no legal guarantee (despite her argument to the contrary) that the EU institutions, in particular the Commission and the ECJ will be allowed to play an active role in implementing and policing the agreement. Instead, the measures in the agreement will be subject to long-winded political wrangling and horse-trading, precisely the sort of scenario that Merkel wanted to avoid.

It is not surprising therefore that Merkel has acknowledged the need to transplant the agreement on fiscal integration into the Treaties as soon as it is possible to do so. This means the UK has not exhausted its veto quite yet (though, as we've noted, there's a complex legal discussion over whether a group of countries formed outside the EU treaties can use the EU institutions to facilitate and enforce its decisions), and Merkel will still have to accommodate British concerns on the single market and financial services if she wants to get around this amicably; any attempt to override do so would be highly acrimonious and subject to legal challenge, which would take time to resolve.

This has been noted back home, with Foreign Minister and former FDP leader Guido Westerwelle acknowledged the deal was "not great", while Der Spiegel wrote that Merkel “paid a high cost” in order to secure the agreement, noting that she had maintained all along that an intergovernmental agreement would be second best vis-à-vis Treaty change. For all the “UK is isolated” stories in the German press, SPD party leader Sigmar Gabriel struck a sober note when he pointed out that the agreement is "insufficient" and will remain so until Britain joins up.

Meanwhile Die Welt wrote a piece which examined Merkel’s reputation for toughness and consistence in Europe, i.e. “Madame Non”, pointing out that throughout the crisis, Merkel has already crossed plenty of what had initially been “red line issues”.

Politics aside, the German media are also sceptical that the agreement on further fiscal integration, and also the agreement on an additional €200bn in funding for the IMF, will be enough to arrest the economics crisis - an editorial in FTD argues that:

"For all the understandable anger both sides should not obstruct the possibility of one day making a fresh start under new governments. In summary: The euro will not go under. But the crisis is not over. The AAA rating of the Euro-zone remains at risk. The next rescue summit is guaranteed to come.
All in all, still plenty to play for…

The summit to end all summits

2011-12-09T15:47:00.007Z

At least that was how it was being seen beforehand. Unfortunately, in the aftermath it seems to have fallen short of expectations (although admittedly the dust is yet to fully settle). Nevertheless, it was an interesting summit, especially for the UK. Below we outline the key outcomes of the summit giving our assessment of the economic, political and legal impact which the decisions may have (read our full press release here).

1) Treaty change

Summary: Failed to agree to a treaty change involving all 27 member states. Eurozone members will push ahead with a new treaty for the 17, plus a possible 9 other EU states, pending consultation with national parliaments. Aim to incorporate the measures into the EU Treaties as soon as possible.

Open Europe’s take: The legal basis for the new intergovernmental treaty is still not clear. It will be very legally complex for the new group to use EU institutions to enforce the new treaty without the consent of the UK. As such, the negotiations are far from over, particularly since eurozone leaders are still keen to incorporate the measures into the Treaties and push further in the future in terms of integration.

Was Cameron right to use his veto? How might it impact on UK – EU relations in the future?

- Cameron had little choice but to exercise his veto given the importance of financial services to the UK economy and his need to balance domestic party concerns. His demands were not excessive, particularly given that other EU members have issued similar national demands during this crisis, e.g. Germany over Eurobonds and the ECB’s role, France over using the European Court of Justice (ECJ) to enforce fiscal sanctions and now Finland over the use of QMV in the ESM.

- There was never any discussion of the UK taking part in the new ‘fiscal compact’ but merely whether it would approve the treaty change or not. As such, the UK’s position has not changed within the EU itself. The political dynamics may have changed but whether this will turn out to be better or worse for the UK remains to be seen.

- There is still a huge legal mess to sort out. Whether the new treaty will be enforced by EU institutions or not remains unclear, as is the UK’s role in future proceedings, but it looks likely to be a massive legal stretch to use the existing EU institutions for this new treaty.

- There are valid concerns that Cameron received no clear safeguards while spending a lot of political capital. In order for this to be a sound investment, it needs to be followed up with a concerted push for a more flexible, adaptable and competitive EU in which the UK can feel at home. In the wake of the eurozone crisis, Europe will need a new grand political settlement, which can take years and in which the UK, like all other EU countries, will push their interests.

2) Fiscal compact

Summary: Commitment to balanced budgets, with an annual structural deficit limit of 0.5% enshrined in law and a clear, automatic correction mechanism for when this is broken. Legal enforcement judged by the European Court of Justice (ECJ). The Excessive Deficit Procedure will be strengthened; any country which breaks the 3% threshold will be subject to Commission sanctions unless a qualified majority of eurozone states oppose them. Examine new Commission rules on economic governance and increase surveillance.

Open Europe’s take: Only difference from the stability and growth pact is that qualified majority voting is reversed. Not a particularly credible or strong fiscal compact. There are significant concerns that if countries such as Germany and France struggle to meet the requirements, they will be watered down. Missing out on strong ECJ enforcement and European level automatic sanctions reduces the impact of these measures, unlikely to be enough to convince markets or the ECB that fiscal discipline will be maintained in the long term. Not clear what a national automatic mechanism for correcting budget deficits would be. This seems to be the start of a process, installing fiscal straight jackets on struggling eurozone countries if they wish to stay in the eurozone long term – not clear where their growth and competitiveness will come from.

3) European Stability Mechanism (ESM)

Summary: Move up entry into force to July 2012 or as soon as members representing 90% of capital commitments have ratified it. EFSF will run until mid-2013 as expected, although deciding how the two will run at the same time (given current restrictions in the ESM treaty) will be delayed until March 2012. ESM wording on private sector involvement in future bailouts will be watered down, highlighting that Greece is “unique and exceptional”. An emergency procedure will be added to ESM voting rules, which states that 85% QMV threshold can be used to make decisions if the Commission and the ECB believe the financial and economic sustainability of the euro is threatened.

Open Europe’s take: Moving up the ESM is broadly positive from a market perspective, although the key issues about its implementation have been delayed. One concern is that the sped up timeline for paying in capital resulting from this move will increase pressure on the funding needs for eurozone states. Removing private sector involvement may calm markets in the short term but could be a mistake in the long term. Takes us back to where we were with EFSF bailouts, simply recycling debt around the eurozone with no clear goal for tackling solvency. Although the QMV rule has to be approved by the Finnish parliament, the “emergency procedure” seems misleading – in what instance would giving a bailout not be seen as an emergency?

4) IMF

Summary: Decide within 10 days whether to provide €200bn in bilateral loans to the IMF general resources fund, via national central banks.

Open Europe’s take: The IMF can apply more conditionality on lending, so it is preferable to the central banks doing it themselves. Still only offers a short term liquidity boost to countries, unless IMF is able to enforce broader economic restructuring which the eurozone looks set dead against. Raises questions over the independence of central banks, since they are giving up money to a general fund to be controlled by an institution with completely separate aims. May be opposed by the ECB and/or Germany depending on format. Even with this additional funding the IMF capacity for bailing out Italy and/or Spain still falls well short.

The legal scramble for the EU institutions

2011-12-09T09:33:00.011Z

So, following the news this morning that the eurozone plus six more countries want to go ahead with their own treaty, where are we? David Cameron vetoed a treaty of 27 because of a refusal to insert a protocol safeguarding the City and other key economic interests (Sarkozy called Cameron's demands for safeguards on financial services "unacceptable").

Well. the EU now looks set for an almighty legal battle. Cameron has warned the new bloc of 23 (the UK has been joined by Sweden, Hungary and the Czech Republic so far but that group is fluid) that it would not be able to use the resources of the EU (the Commission or the ECJ), raising real doubts as to whether the eurozone would be able to enforce its fiscal rules in order to calm the markets.

Last night Spiegel was reporting that the European Council's legal service had advised that a smaller group of member states could not amend articles in the EU Treaties (e.g. the articles on budget deficits etc) without agreement of the 27. So, the UK has a veto over this.

The draft summit conclusions state that:

"This will require a new deal between euro area Member States to be enshrined in common, ambitious rules that translate their strong political commitment into a new legal framework."

This leaves the group of 23 pursuing a new treaty outside the EU framework. The next, and now most important, issue is whether they will be able to use the EU institutions to enforce the commitments set out in this new non-EU treaty.

The UK is clearly of the belief that they can't. Cameron said last night, "Clearly, the institutions of the European Union belong to the union, they belong to the 27. They are there to do the things that are in treaties that we have all signed up to over the years. That is an important protection for Britain."

As Bruno Waterfield tweeted last night an ECJ ruling from 1993 set a precedent that the EU institutions can be used by ad-hoc groups of member states, but only after unanimous agreement of the 27. This still gives the UK a veto.

The FT today reports that

José Manuel Barroso, the Commission president, said he believed there were ways to work around such legal prohibitions, but senior EU officials acknowledged it would be difficult to give Brussels new powers over eurozone national budgets outside the EU treaties, and diplomats expressed concern financial markets would not see the new pact as credible.

So Barroso may throw his hat in with the new group and support them in their desire to use the EU institutions - a key German demand. It all looks set for a legal standoff but, given the past history of EU law (the new interpretation of "no bailout" clauses and so on), where there's a will there's usually a way.

Everyone now naturally has their own take on the situation, ranging from "victory" to leaving the UK completely isolated. Clearly, few EU leaders expected this. The Germans thought that Cameron was bluffing, and possibly vice-versa. But remember, a treaty change not involving the UK was always a possibility - and it was never on the cards that Britian itself should participate in the new 'compact', only whether it would approve it at the level of all 27. The political dynamics have changed, and not being able to do this at 27 has made the situation a lot messier. Eurozone leaders now have to work out a non-EU treaty, based on Merkozy's letter but otherwise very little substance to work with.

Without the use of the EU institutions to enforce them, the new rules will have limited credibility (to be honest, they don't have a lot of credibility as it is).

However, if the new group does gain access to the EU institutions - which to us would be another example of a massive legal stretch of the EU treaties - this could clearly have a negative impact on the UK, possibly increasing the risk of the European Commission for example being colonised by eurozone interests. But that risk has been there since the very formation of the euro.

EU vs eurozone: Who has said what ahead of the summit?

2011-12-08T19:32:00.002Z

Much has been said about David Cameron’s thinly veiled threat to veto Treaty change at 27 if he is unable to obtain satisfactory safeguards to protect UK financial services from overzealous EU regulation (as we have argued for), and also his determination to protect the single market from fragmentation. This is clearly a worry if the eurozone proceeds with closer integration and implements its own measures on issues such as financial regulation, labour markets, harmonisation of corporate tax base, and the introduction of a FTT at the eurozone level, as proposed by Merkel and Sarkozy in their recent letter to Council President van Rompuy.

However, amidst this Cameron vs Merkozy narrative, it is important to remember there are another 24 member states attending the summit, and they all have specific views on what they want to achieve, and crucially, how prepared they are to see a separate eurozone agreement. It is the stance adopted by these countries that will determine what, if anything, Cameron is able to bring back from Brussels.

While there is not much explicit support for Cameron’s position, the determination for Treaty change at 27 comes through strongly, suggesting that as we have argued, Cameron may have more leverage than widely acknowledged. Anyway, you can judge for yourselves:

Polish PM Donald Tusk criticised those trying to save their own money and further their own national interests at the expense of the community, arguing that this could “lead to the ruin of the European community… this is a devilish alternative”, adding that: “We can only protect our national interests by maintaining and strengthening a community of 27 countries”, although he acknowledged there was a "real threat" the summit could fail.

Finnish PM Jyrki Katainen said that: "It will be a very tough meeting I don't know how long it will take. It is always better if you change the current treaty of 27 because it's important to get a strong, united Europe and not to divide it. The situation seems to be quite tricky and now we all must be cooperative and ready for compromise. Hopefully we only have one common treaty for everybody."

Dutch PM Mark Rutte said that: "We also have to make sure that we keep the union of 27 together. It is not just a union of 17 euro countries. It is of great importance for a country such as the Netherlands, which is growth-orientated and believes in importance of jobs, that we keep countries such as the UK, Sweden and the Baltic countries and Poland in."

Danish PM Helle Thorning-Schmidt said that "I come with a mandate to negotiate this, and we're very open. We think that if the euro countries see treaty change as part of the solution, we are able to back that treaty change. What is most important right now is that we show a willingness to compromise and a willingness to find solutions in common, and then it is very important for all of us that we keep the 27 member states together. This is what has worked in other times of crisis for Europe, and that is what we will be working (for) now as well."

Romanian PM Traian Basescu warned that: “Any decision in Brussels will affect the everyday lives of all Romanians [therefore] Romania can not accept a Europe with two categories of members”.

Hungarian PM Viktor Orban said that: “The question today is whether the current two-speed Europe will develop into a three or four-speed Europe… Hungary’s national interest is that the euro zone members should find a solution that does not strain the framework of the 27-member EU. This compromise is somewhere in the direction of Germany’s position, that’s where we’d like to get to by Friday afternoon”.

Austria’s Chancellor Werner Faymann is more pessimistic, saying that the basis for agreement on EU treaty change at 27 was not very good.

Martin Shultz MEP, leader of the Socialists and Democrats in the EP, said that: "If there is too much insistence on treaty change there is a danger of backroom deals and trade-offs, which we do not want to see. I want clarity and transparency. I understand those who refuse to engage in horse-trading with a non-euro country. But we cannot allow the division of Europe into a 17-10 structure. Maybe, we should think about a 26-1 solution."

Separately but significantly, Spain’s incoming Prime Minister Mariano Rajoy (not yet allowed to attend EU summits, since his government will only enter office on 22 December), has allegedly urged outgoing Prime Minister José Luis Rodríguez Zapatero to demand that the QMV threshold on future euro bailouts via the European Stability Mechanism be raised to 90%, so that Spain can also have a veto.

What could Cameron hope for?

2011-12-08T18:18:00.015Z

As has been repeated, and repeated again, in the UK media over the last few days, David Cameron isn't in the easiest spot as he attempts to square off a number of circles with EU leaders today and tomorrow. The referendum debate has taken on a life of its own (not so much driven by backbenchers as by media and high-profile interventions by two ministers and a mayor).

Cameron's squeezed position stems from an unusually complicated mix of domestic pressure, an economic crisis running out of control and an EU negotiation cobweb of massive proportions. But, we all know this. The question now is, what can he realistically hope for?

As Bruno Waterfield explained on the Telegraph live blog earlier today, Cameron is fighting to insert language in tomorrow's (or the weekend's - it might be a long session) conclusions that would commit EU leaders, on paper at least, to "consider and develop concrete and effective mechanisms" to ensure the integrity of the internal market at 27 and that the essential economic interests of non-euro members are fully protected (i.e. for the UK, the City).

The thing to remember is that the Treaty changes will not be agreed tomorrow - what this summit is designed to do is to lay the groundwork for a deal (and possible finalised Treaty changes) at the summit of EU leaders that will take place in March. So if Cameron managed to insert this kind of language in a political declaration attached to the summit conclusions, though it may on the surface seem like nothing, it could actually set Cameron up for negotiations to achieve some sort of "emergency brake" over new EU financial regulation - which we have called for.

Is it doable? It depends on a number of factors.

1) Treaty changes involving 17 or 27 (or 17+ or 17- ) - Berlin is set on 27, and for Merkel it will be difficult legally to achieve a eurozone-only Treaty, for reasons we've discussed before and though several countries have expressed reservations about the Merkozy proposals, they could well be adopted in some form at the end of the day and trasnlated into Treaty changes. As it has been over the last few weeks, our money is on a Treaty at 27.

2) A limited or even more limited Treaty change: The changes that the Germans want require a proper Treaty change (although often described as "limited") through what's known as the 'simplified revision procedure'. As these changes would involve the EU institutions, which as Cameron rightly pointed out are the property of all 27 member states, that would give the UK a veto over the Treaty change. But there's also a second way to change the Treaties, proposed by Herman Van Rompuy, which would only involve tweaking protocol 12, which is the protocol governing the eurozone. This would still give Cameron the right to veto the changes as they require unanimity in the European Council - but it would be a relatively small change to a protocol (a protocol which doesn't impact in the UK as it's not in the euro).

3) Will Cameron have any allies? Several countries are worried about fragmentation of the EU, including the Poles, Romanians, Swedes as well as eurozone 'ins' such as the Netherlands, so any moderate measure Cameron takes to counter such a trend could draw some support from these countries. However, many countries are fed up with the whole Treaty business, and see it as unnecessary (merely designed to cater to German domestic concerns) and the quicker they can move on from these talks, the better. Most EU leaders are unlikely to be too patient with additional demands.

However, as one of the EU's big three and given the importance of financial services to the UK economy and the domestic pressure Cameron is under, few EU leaders are out to get Cameron. He's still well liked among many. Question is if they feel it's politically possible to meet any of Cameron's demands.

And to say, as some have, that financial regulation is "not on the agenda" is pretty silly. It is on the agenda. And it wasn't put there first by the UK, but by France and Germany which are pushing for a Financial Transaction Tax and increased regulation of financial markets.

So Cameron's best hope is:

1) Insert a political declaration in the summit conclusions tomorrow that calls for concrete measures to protect non-euro member states' economic interests
2) Work out concrete protocol language amounting to a UK safeguard over EU financial services (see here for how it could work), which can then be inserted via Treaty changes
3) Insert such a protocol at the first possible opportunity (it's unclear to us whether this can be achieved legally under a limited treaty change - but political will and expendiency is king in EU law).

In combination, this would amount to establishing an effective veto over a key UK national industry - and would be a massive achievement.

However, what is more likely to happen is some sort of language in the text of the summit conclusions which makes no mention of 'concrete measures'. It would rather be a general formulation of the importance of the single market at 27. At the March summit, this could possibly be turned into a political declaration, which would be useful but would have no legal force.

In terms of 'safeguards', this wouldn't be perceived as enough, and Cameron would potentially have a grave party management problem on his hands...

Draghi's Den

2011-12-08T18:16:00.010Z

It’s been a whirlwind entrance for Mario Draghi as ECB President and today’s meeting of the Governing Council was seemingly no exception. The key decisions which came out of the meeting were much what we expected, although with a few twists, while more importantly Draghi tackled some of the interesting problems facing Europe fairly bluntly (for a central banker anyway).

Key decisions

1) 0.25% interest rate cut: Essentially needed to be done since markets had come to expect it and the prospects of a eurozone recession next year are looming large. Probably highlights previous rate rises as a mistake, at least in retrospect, has been shown up by eurozone leaders failure to tackle the crisis. The failure of a single monetary policy looks to have been papered over while eurozone contraction sets in, but when/if Germany starts growing quickly again (relative to the rest of the eurozone) Draghi will have some much tougher decisions.

2) Long term liquidity to banks (3yr loans): Widely reported that banks would struggle to secure long term financing without such a move (have €230bn in debt maturing in Q1 2012). Not ideal given the ever increasing dependence from the banking sector on the ECB, but should be seen as a one off. Hopefully will increase lending in the broader economy but this is not assured, especially since unlimited short term liquidity has failed to do so.

3) Easing collateral rules: Greater acceptance of asset backed securities (ABS) – sounds ominous. Not ideal but does come with clear criteria and conditions. There have been indications that banks are running short of viable collateral. Without such a move, this could cause deleveraging or force banks to shift to Emergency Liquidity Assistance (ELA) which accepts even worse collateral and is more secretive. This could, however, potentially propagate the movement of poor quality assets onto the ECB’s balance sheet.

Interesting comments by Draghi

- “The ECB is not a member of the IMF”: Draghi went to some lengths to stress that the plan for eurozone national central banks (NCBs) to lend to the IMF so that the IMF could lend “exclusively” to struggling eurozone countries would not be possible. One point which has been raised is that IMF money is fungible, so the NCBs could contribute to the IMF general reserve account which could then lend to eurozone members. In any case, Draghi made it clear he’s not keen on ECB or NCBs lending to the IMF and may try to stop any proposal, even if it isn’t de jure illegal.

- “We shouldn’t circumvent the spirit of the treaty”: Draghi said this countless times. He reiterated his opposition to increasing bond purchases. He also seemed to suggest he would reject similar ideas of ECB lending to states even if they could be justified as de jure legal if they were de facto illegal and broke the principles of the treaty.

- ‘Other elements will follow’ fiscal compact comment was misinterpreted: Interestingly, Draghi highlighted his surprise that his comments last week had been taken as an indication of increased bond buying, stating that he did not mean that in anyway. He suggested that he was merely highlighting the sequence of events, in that fiscal consolidation needs to come first and can then be followed by a backstop but only through the EFSF or the ESM, the eurozone bailout funds.

So, a strong expansion of monetary policy to help the banking sector a promote growth and stability. We may not be onside with all of his measures, since they may raise long term questions over what gets put onto the ECB’s balance sheet, but they are clearly within the realms of monetary policy. Using these mechanisms is always preferable to the ECB wading into the murky world of fiscal policy.

Despite this boost, markets are likely to be unnerved by his comments during the Q&A session. Draghi essentially ruled out any ECB or NCB lending to the IMF or at least suggested he would oppose the process. He also put pay to this ‘quid pro quo’ theory that the ECB will step in and increase its bond purchases if eurozone leaders agree some fiscal integration or discipline. We have to commend Draghi for his firmness on these issues, although we still fear he could wilt in the face of the increasing clamour from eurozone leaders and their reliable inability to find any solution. But at least for now it puts the ball firmly back into EU leaders’ court ahead of tomorrow’s summit.

Now Turkey is raising concern over democracy in the EU

2011-12-08T11:20:00.012Z

This is a sign of the times.

In an interview with EUobserver, Turkey's permanent representative to the EU, Selim Kuneralp, made some interesting comments on the future of the eurozone . In particular, he said that, although the Franco-German proposals to strengthen central control over national budgets, which could steer the eurozone "in the right direction", they also risk undermining democracy.

He argued,

"In an election campaign, you have one party that says, 'I'm going to reduce taxes and invest in this or that, to build nuclear power plants or spend money on renewable energy, build more schools and better hospitals.' And the other party says, 'I'm going to do everything this guy is promising, but more.' So you have a race on who is going to spend more. But if you have this kind of mechanism [of central control] they won't be able to do it. That means you would have such a loss of sovereignty as to make election campaigns meaningless."

Clearly, Mr. Kuneralp does have a strong point. Perhaps EU leaders should rememebr the 'Copenhagen criteria' - the rules on democracy (and various other things) that countries wishing to accede to the EU have to fulfill - as they're trying to deal with the eurozone crisis...

30 MPs and Lords back our proposal for "emergency brake" on financial services

2011-12-08T11:11:00.008Z

In a letter to the Telegraph today 30 MPs and Lords back Open Europe’s recommendations that David Cameron seek, at the very least, a new Single Market protocol or an “emergency brake” on EU financial services laws at this week’s EU summit.

Here it is in full:

SIR – European Union proposals pose a grave threat to Britain’s financial services industry, which employs nearly two million people, accounts for 10 per cent of GDP, and generates over £50 billion in tax receipts annually.

Although there have undoubtedly been regulatory failures in recent years, future policy should primarily be decided by Britain, not the EU.

There are nearly 50 proposals under consideration by the EU. The most troubling include a unilateral, EU-wide financial transactions tax which would inflict enormous damage on Britain’s economic interests, a ban on some short-selling and a European Central Bank proposal that transactions on euro-denominated financial products are only cleared in the eurozone.

From 2014, Britain will have only 12 per cent of the votes in the Council of Ministers and 10 per cent in the European Parliament, yet it accounts for 36 per cent of the EU’s wholesale finance industry and enjoys a 61 per cent share of the EU’s net exports of international transactions in financial services.

It is imperative that the Government fights our corner by arguing either for a new EU protocol or a Britain-specific legal safeguard. Without strong action, the present drift seriously threatens both British jobs and Exchequer revenues.

Andrea Leadsom MP
Chris Heaton-Harris MP
George Eustice MP
Desmond Swayne MP
Sajid Javid MP
Nicholas Soames MP
Ben Gummer MP
Margot James MP
Nadhim Zahawi MP
Harriett Baldwin MP
Karen Bradley MP
James Gray MP
Amber Rudd MP
Anne-Marie Morris MP
Bernard Jenkin MP
Dominic Raab MP
Lord Trimble
Steve Brine MP
Lord Risby
Mike Weatherley MP
Geoffrey Clifton-Brown MP
Mark Garnier MP
Esther McVey MP
Caroline Dinenage MP
Andrew Bridgen MP
Michael Fallon MP
Matthew Hancock MP
David Ruffley MP
Lord Flight
Viscount Trenchard

London SW1

Significantly, the letter is signed by Cameron and George Osborne's Parliamentary Private Secretaries, Desmond Swayne MP and Sajid Javid MP, potentially a sign that the Government is sympathetic to the idea of UK veto over financial services.

There's a long way to go until close of play on Friday night when the dust will settle for a short while on this week's summit (there will be more like it before too long) but there are some encouraging signs that the Government is starting to get the message.

A busy day in Euroland

2011-12-07T19:56:00.009Z

It’s been another busy day in the eurozone crisis, with European Council President Herman van Rompuy putting out his report on the prospects for treaty change and greater eurozone fiscal integration and then German Chancellor Angela Merkel and French President Nicolas Sarkozy sending a letter to Van Rompuy with their take on the issue. That’s just the formal announcements, not to mention the usual rumour mill of giant bailout funds, ECB and IMF intervention and a UK referendum.

To help digest this mass of info, we’ve picked out some of the key points from each text along with our thoughts on them.

Van Rompuy report:

- Need to enhance credibility of debt and deficit rules and ensure full compliance. Greater budgetary discipline to move euro area to true economic union. Commitment to balanced budgets.
- All introduced into national law – the ECJ would judge whether these rules had been correctly implemented.
- Two processes for achieving this: revise Protocol No 12 (in annex of treaty) or full treaty change with amendment to Article 48.
- Changing protocol 12, which relates to excessive deficit procedure, has the advantage of only requiring unanimous approval in the Council, therefore does not need national ratification and avoids triggering an Irish referendum.
- Amending article 48 would be a lengthy process but reforms could be much more far reaching including – automatic sanctions using EU institutions, specifically enhanced Commission oversight of budgets.
- Longer term move towards common debt issuance.
- Adhere to “well established IMF principles and practices” with regards to private sector involvement in future bailouts. Basically, rewrite the ESM treaty so that private sector losses are not encouraged. Also make most ESM decisions QMV.
- Allow ESM to recapitalise banks directly and have the “features of a credit institution”. This likely means that it should be able to borrow from the ECB.
- Review the clause which limits lending capacity of EFSF and ESM jointly – to allow them to run in parallel.

Merkel and Sarkozy letter:

- Commitment to push ahead with broad treaty changes although willingness to work with just 17 eurozone members.
- Regular eurozone summits (twice a year usually but once a month in the crisis). Focus on policies to foster growth, competitiveness and fiscal stability. “Ministerial Eurogroup” to prepare for meetings and enforce decisions.
- Framework of prevention using ECJ to ensure that fiscal rules are correctly transposed in national framework.
- Foster growth and competitiveness through eurozone convergence and integration on: financial regulation, labour markets, harmonisation of corporate tax base, introduction of eurozone FTT and more efficient use of European funds.
- Automatic sanctions for states which breach 3% deficit rule (can be reversed by QMV vote). Continuous failings will result in increasing interventions.
- Move forward ESM to 2012, rewrite clauses so it’s clear PSI in Greece was an exceptional occurrence. Decisions on ESM made by 85% QMV (based on ECB capital shares).

So, all in all a lot of words without saying much we didn’t already know. It is clear though that both documents line up fairly closely on many key issues. One area where they don’t agree, and where Merkel is apparently annoyed by Van Rompuy’s proposal, is the plan for the ESM and EFSF to run in tandem offering a boosted bailout fund.

Other things that caught our eye include: common corporate tax base - good luck getting Ireland to agree that, especially after all the austerity they have successfully introduced - and the plan for the eurozone FTT, which they seem determined to push ahead with, no matter how much havoc it would wreak on the European financial system.

In any case, as always, this doesn’t fill us with hope for the summit. If anything these plans are likely to be watered down through the negotiations, despite already looking relatively similar to the toothless stability and growth pact. Even if finalised in their current form the plans will only provide more austerity and take some time to implement. The (misguided) hope still remains that they will encourage the ECB to step up its bond buying – although if we were the ECB the commitment doesn’t seem large enough or credible enough for us to put our independence and principles on the line.

And the question would be....?

2011-12-07T10:15:00.025Z

This week has seen the mandatory flare-up over the question of an EU referendum, following a remark by Ian Duncan Smith that any major EU Treaty would need to go to a referendum in Britain. For the Coalition it was most unfortunate that Nick Clegg, on the same day, was seen to say the opposite. Only thing was of course that he didn’t quite do that.

Both were actually expressing merely what was in the EU Act or referendum lock – and government policy - though IDS clearly failed to qualify his remarks. That is, any major new Treaty that has an impact on the UK will be subject to a referendum. There’s a lot one can say about the Treaty changes that Sarkozy and Merkel are pushing for, but one thing is for certain: they won’t have an impact on the UK in the sense that new powers will flow from London to Brussels, in contrast to what happened under the Lisbon Treaty or treaties before it. It merely creates a new set of arrangements for the eurozone.

Now, before you start to jump up and down, hear us out. The Treaty changes in combination with the ongoing eurozone crisis, do have an impact on Britain’s position in Europe in that they will create a more tightly knit eurozone bloc, to which Britain’s interests could become secondary. It’s this point that should and does concern most Tory backbenchers - very few of them are actually actively calling for a referendum at this point. And think about it: what would the question be? Something like:

"Do you think that the UK should accept EU Treaty changes which would allow the eurozone to integrate further and introduce measures to enhance budget discipline, which will not impact legally on Britain in the sense that new powers will be transferred from the UK to Brussels, but which could potentially lead to the eurozone voting as a caucus to the detriment of UK influence in Europe?" Yes/No

Hardly credible. Instead, the referendum would, in effect, be on membership of the EU (as it effectively asks voters to consider the current structure and direction of the EU as nothing has changed legally or institutionally for the UK, albeit a very significant political change). Option 2 would be to attach specific demands on EU reform and re-negotiation. The latter option could involve, say, the UK Government putting in a series of demands for repatriation or for vetoes to be restored. Subject to a successful conclusion of the negotiations involving those demands, the package, including the new budget rules for the eurozone, would be put to the British people in a validating referendum. It wouldn't exactly be a swift process but, minus all the complications involved in lengthy negotiations over Treaty changes at a time when the eurozone is on its knees, it could generate the kind of EU that the UK wants.

Now, there are a whole range of reasons why people might want to support one of those two paths - including the fact that people are understandably fed up about not having had a say on Europe for so long - but we need to be honest about what the consequences and political implications are. Either the exit door, or fundamental re-negotiations - that's probably what a lot of people want - but it wouldn't merely be a vote on the Treaty change per se. But for all the shouting in the press over a referendum over the last few days, it's absolutely amazing that no one has bothered to ask the question, what should the referendum actually be on.

This is not to say that the UK Government should not ask for concessions in Europe and start to embark on a reform programme aimed at reversing the flow of powers - we've been arguing that case for years. But if Britain wants to turn the EU into a 'network rather than a bloc' as Cameron reiterated in the Times today (which is the right vision), it needs, collectively, to be a bit smarter and think a bit deeper about the way forward.

* Update 1.16pm: Apparently, both London Mayor Boris Johnson and Northern Ireland Secretary Owen Paterson have now called for a referendum on Treaty changes involving all 27 member states - this is clearly becoming increasingly difficult for Cameron to manage. As ever, the nature of the referendum in question remains unclear, which is also what makes the issue so hard to manage...

Scoring today's Merkozy summit

2011-12-05T15:29:00.012Z

Today's meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy is over and they have announced their proposal for treaty change and tackling the sovereign debt crisis in the eurozone. To give them credit its more substantial than we, and many others were expecting, with some clear agreement on key points. However, it is still an early stage - France and Germany need to gain the support of the other EU members at this week's summit.

In our view these are the key points (our reaction in bold):

- Automatic sanctions for eurozone countries running deficit above 3% of GDP. Only a qualified majority vote can block the sanctions. Merkel looks to have got her way on the automatic sanctions, although the QMV block does reduce the power to enforce them slightly, but most countries committed to austerity approach and Germany still wields substantial influence as largest guarantor.
Verdict: Merkel 2 - 0 Sarkozy

- Sarkozy said that the ECJ "will not be allowed to rule national budgets void", but will have the power to judge if the required fiscal rules (including the need for a 'golden rule' against persistent deficits) are being properly enforced by national law. Definitely a plus for Sarkozy, keeps hold of national sovereignty and keeps ECJ focused on legal not political matters. Also shifts focus towards intergovernmental procedures.
Verdict: Sarkozy 1 - 0 Merkel

- Permanent eurozone bailout fund will be brought forward to 2012, decisions on the ESM will be made by qualified majority. This move will help calm markets since it brings forward a significant amount of bailout money. Neither argued strongly for this in the run up, but had been considered by Merkel previously.
Verdict: Draw 1 - 1 (markets the real winner)

- Under the ESM no more losses for private bondholders (no more restructuring or private sector involvement clauses placed into ESM bailout agreements). Big and surprising win for Sarkozy. Had been touted in run up to meeting but slapped down by Germany before. Huge point for Germany previously when ESM was put together. Pledged to German electorate that private sector would take its fair share of pain under future bailouts. Merkel did hint she would consider a rule change last week, but never went as far as suggesting this was in the offing. Will have very positive impact for markets, hugely reduced likelihood of future losses, however, may be large political cost. From our perspective this may be a mistake, simply because the aversion to restructuring has not served the eurozone well so far. Ultimately, just recycling debt around the eurozone with no significant reduction, which many countries need, will not help in the long run.
Verdict: Sarkozy 2 - 0 Merkel (and markets again)

- Sarkozy said that France and Germany agree that "under no circumstances" can Eurobonds be considered a solution to the crisis. Expected, but Sakozy's openness to admitting that eurobonds won't come into force any time soon is a win for Merkel.
Verdict: Merkel 1 - 0 Sarkozy

- France and Germany will continue to abstain from making comments on how the ECB operates. Germany was keen to see this continue, although they didn't really stick to the agreement anyway so will make little difference. Keeping ECB out altogether is a plus for Merkel.
Verdict: Merkel 1 - 0 Sarkozy

- Eurozone heads of state and government will meet on a monthly basis until the crisis is sorted out. Sarkozy was keen to have this in place, although it was far from something which Merkel objected to. Does keep the intergovernmental slant which Sarkozy wanted.
Verdict: Sarkozy 1 - 0 Merkel

- To achieve all this, a new treaty is needed. The clear preference from both is for a Treaty change involving all 27 member states but a eurozone-only solution would be chosen if there is significant opposition from non-eurozone countries (read UK). The phrasing and focus here is a big win for Merkel. She's said all along that a eurozone only treaty is an option but not her first one. Statements here line up exactly with Merkel's earlier thinking. Does provide potential for UK negotiation although there is still a limit on how far Cameron can push his demands.
Verdict: Merkel 2 - 0 Sarkozy

Final Score: Merkel 7 - 5 Sarkozy

So, closer than many may have been expecting, but fair play to Sarkozy he managed to land a heavy blow in there with the removal of restructuring clauses from the ESM. The slant is surprisingly intergovernmental as Sarkozy would have wanted it to be, so another plus point for him there. But on the overall picture, we still have to say Merkel edges it, particularly with the focus on treaty change at 27.

All that said, this isn't a solution. Huge questions still remain over how countries will return to growth and competitiveness as well as how the divergent needs in terms of monetary policy and currency value will be overcome. We also suspect some of the positive market reaction will be from expectations that the ECB will step up its bond buying in response to these rules, but that is far from a given.

Super Mario Shows His Hand

2011-12-05T14:15:00.001Z

The new Italian government has been in office for less than 20 days. That must have seemed an eternity given the record interest rates Italy has been forced to pay by the markets over the past few weeks, while uncertainty remained over what Mario Monti and his cabinet of technocrats were actually planning to do to get Italy out of the crisis.

A new package of austerity measures, tax hikes and economic reforms worth a gross €30 billion over the next three years was finally unveiled yesterday (it is becoming a habit for Italian politicians to work and announce measures during the weekend, when the markets are closed), during an exhausting 2-hour press conference. Monti will make an official presentation in both houses of the Italian parliament this afternoon, with a view to having the new package adopted before Christmas.

Some of the proposals (especially those affecting the pension system) are undeniably ambitious, and are therefore likely to face resistance from both political parties and workers' associations. Here are the most relevant measures announced yesterday:

An in-depth reform of the pension system, which will effectively (although not formally) abolish early retirement pensions. Italians will be required to work for longer, and all pensions will be calculated exclusively on the basis of what each worker paid into social security during his working life (pensions for some professions are today calculated as a percentage of the latest average monthly salary);

Retirement age will be raised to 66 years old by 2018 for men and women without distinction between public and private sector workers (the previous Italian government committed to 67 years old by 2026);

As for the short-term, in 2012-2013 adjustments in line with inflation will be suspended for all pensions worth €1,000+ per month. Italian Labour Minister Elsa Fornero literally burst into tears while presenting this specific 'solidarity contribution' from pensioners at yesterday's press conference (see picture);

The package also involves a number of tax hikes. VAT will increase by 2% in the second half of 2012, and a local council property tax will be re-introduced. In addition, people who used the 'fiscal shield' initiative launched by Berlusconi's government in 2009 to pay lower taxes on capital repatriated from non-EU bank accounts, will have to pay an extra 1.5% on that capital. Special levies are also envisaged for people owning certain 'luxury goods', such as yachts, private jets or high-capacity-engine cars - still not a fully-fledged tax on wealth, though;

A new push to fight tax evasion was also unveiled. Under the new rules all payments in cash will be forbidden above a €1,000 threshold. The threshold was previously fixed at €2,500, surely a bit too high for a country struggling with endemic tax evasion like Italy;

The package unveiled yesterday also includes the first concrete pro-growth measures, something which seemed to be off the radar of previous Italian governments. Tax reliefs for small and medium-sized businesses are envisaged, as well as a strong push on the liberalisation of certain professions. This is certainly not enough, but it is a start and more labour market reforms are expected.

At a first glance, the measures seem to go in the right direction, as it is quite clear that Italy needs some austerity to convince markets of its credibility and for the new government to establish its credentials. As expected, the markets have warmly welcomed Monti's proposals, with the spread between Italian and German ten-year bonds plummeting below 400bps (although this was probably aided by ECB bond purchases and talk of it stepping up its financial support). Widespread approval has also been voiced by the European Commission and some foreign leaders.

However, at least three big questions remain unanswered. First, as we previously noted here, what will Italian citizens' reaction be when the new measures - which, at the end of the day, are being imposed by an unelected government - really start to bite? Second, will Italian political parties give unconditional support to the package, even if it contains measures which are not in line with their electoral manifestos? To give an example, it was Berlusconi's government, when it took office in 2008, who scrapped the local council property tax. On the other side, the leader of Italy's main centre-left party, Pier Luigi Bersani, has already expressed doubts over the 'social equity' of Monti's proposals.

But, most importantly, will these measures be enough to tackle Italy's (but also Greece, Spain and Portugal's) real problem - i.e. the loss of competitiveness experienced since the introduction of the single currency? The answer, at least for the moment, seems to be a 'no'. The measures will certainly help address the markets' lack of confidence in Italy in the short term, but ultimately without any hope for growth and a boost in international competitiveness the future for Italy in the eurozone remains bleak.

P.S.: Credit where credit is due. At yesterday's press conference, Italian Prime Minister Mario Monti announced that, in his personal capacity, he had decided to give up his salary as Prime Minister and Economy Minister in exchange for the sacrifices that his government is asking to Italian citizens. Not expected to have any significant financial impact, but still you don't hear that every day.

P.P.S.: It went almost unnoticed in the press, but it looks like the UK has lost another ally in its opposition to an EU-wide financial transactions tax. In fact, Monti (who, by the way, took lectures from James Tobin, the father of the FTT, during his years at Yale) yesterday said that his government will have a "more favourable" attitude towards an EU FTT than its predecessor.

Summiting the mountain that is the eurozone crisis

2011-12-05T12:59:00.009Z

The perpetual rolling meetings which have characterised this eurozone crisis look to be reaching a head this week. The EU summit which kicks off on Thursday evening will undoubtedly be preceded by a series of smaller meetings between European officials and bilateral meetings with foreign leaders keen to see a solution to the crisis found (and in town to apply the suitable amount of public pressure).

Below we flag up a few key points of discussion to look out for, and outline some of the key issues which still need to be resolved:

- Today’s meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy must produce a united front on the plans for budgetary integration. If they fail to produce a set of concrete and workable proposals from the summit, planning will already be behind schedule and markets will begin to expect another failure. That said, given outstanding areas of disagreement (see here) some broad political agreement short on detail looks likely as always.

- The role of the ECB. Reports over the weekend suggested that the ECB was ready to step in once an agreement on strict fiscal discipline is reached. Whether or not eurozone leaders’ commitments will satisfy the ECB's idea of austerity remains to be seen, and the unlimited backstop which markets want still looks unlikely. A plan involving the ECB lending to the IMF has been touted again.

- A greater role for the IMF. Germany agreed to explore the possibility of greater contributions to the IMF last week, although where these will come from is unclear. US opposition to expanding the IMF’s resources is significant (it requires congressional approval), but reports suggest financing could come from central banks in an attempt to circumvent political opposition.

- The UK’s approach to negotiations. Whether Prime Minister David Cameron will look to repatriate powers will depend on the details of any proposal Merkel and Sarkozy put forward, but it’s increasingly looking like he will keep his powder dry regarding his desired bigger push for retrieving powers from the EU. (For some of our recommendations see here and here).

- Italy unveiled a new set of controversial austerity measures yesterday, which look to have been well received so far. An important debate on the measures will take place in the Italian parliament today, while the reception which Italian Prime Minister Mario Monti gets at the summit will be a good gauge of what Italy can expect in the coming months. If the pressure is instantly for even more austerity, it could set the tone for a torrid few months for the interim Italian government.

- Other issues which still need to be ironed out include the leveraging of the EFSF, the eurozone bailout fund, and the second Greek bailout. Discussions over the extent of private sector involvement in the Greek package were put on hold last week – the package just looks too complex and will always be held up while it is voluntary. We would argue that the plan should be scrapped and a simpler, cleaner restructuring put in place for Greece, although that looks very unlikely.

All in all, plenty to keep an eye on.

ECB lending to the IMF

2011-12-02T14:17:00.009Z

This is the third time the prospect of the ECB lending to the IMF has been brought up as a potential solution to the eurozone crisis. As such it might seem like old hat, but this time round it may have a bit more substance to it. Bloomberg reports that at Tuesday's meeting of eurozone finance ministers the ECB President Mario Draghi, who was also in attendance, approved the creation of a plan to allow the ECB to lend to the IMF, and then the IMF to use these funds to lend to struggling eurozone countries.

Very much an initial stage, but more than the recycling rumour which we had before. The report suggests the lending could top €200bn, so not pocket change but not enough to stem the crisis. The likely plan would see the IMF using the funds to provide precautionary lending programmes to the likes of Italy and Spain.

So could such a plan work? As you may expect, we think probably not. Here are a few of our initial thoughts on why:

- Ultimately, this proposal doesn’t change much may allow a small boost of liquidity but doesn’t solve the underlying competitiveness problems and structural flaws in eurozone. Italy and Spain need devaluation to become competitive again.

- IMF can impose conditions, so does circumvent the moral hazard problem posed by direct ECB lending. It does seem that ECB lending to the IMF is preferable to the ECB funding states directly with bond buying, due to this added conditionality.

- Although, may be conflict between ECB and IMF over best practice and use of money. Already disagreed over Greek restructuring (to the point where the ECB added a footnote into the troika report stating it did not agree with the level of write downs).

- ECB will essentially be ceding control over a large amount of funds, does again raise questions over its independence.

- Will not de jure break the ECB statute (Article 23 allows it) but definitely de facto against the fundamental principles of the ECB. The legal basis for it was never intended to sustain large bailouts. Will not be supported in Germany generally.

- German government has suggested it would support bilateral loans to the IMF. Not clear if this involves the ECB, unlikely, probably more in favour of countries boosting their IMF contributions.

- Where would the funds come from? The ECB would basically just create new money and lend it to the IMF. No indication that collateral would be taken on (not needed from IMF really, but separates it from usual lending options) or that this would be sterilised in anyway. Seems a big abandonment of ECB principles.

- Impossible to justify this as monetary policy (as ECB has done with SMP etc.) just direct lending to IMF to finance states.

- Still stigma attached to asking for IMF help. Not clear Italy and Spain are ready to cross that line yet. Once it is crossed will be more pressure for funding to continue if initial bout is not successful (which it looks unlikely to be – both countries need huge reforms which cannot happen overnight, yet have huge funding needs).

- Not clear who would take losses, should any occur. IMF is always senior so unlikely to take any losses. But existing debt holders may not like the introduction of €200bn in senior debt, especially if it originates at an equal creditor (the ECB).

- ECB exposure to PIIGS is around €630bn now, adding another €200bn to that, even through the IMF, cannot be seen as desirable.

All in all then, many of the same problems as with any massive ECB intervention. Legally and economically this plan could be preferable to the direct ECB financing of states (but then almost anything would be) but politically, it still raises a huge number of problems.

Sarko Has Spoken

2011-12-01T20:00:00.013Z

The day after French President Nicolas Sarkozy's keynote speech (available here) on the state of French economy and the future of the eurozone, those who (like us) were expecting a bit more details on what exactly France is planning to change in the EU Treaties have been disappointed. Sarkozy made some general remarks on his vision of the future of the eurozone, but then announced that the specific proposals for Treaty change would be finalised at a bilateral meeting with German Chancellor Angela Merkel on Monday.

So have all the divergences between Paris and Berlin (which we discussed here) magically disappeared? Not quite. Here are some interesting quotes from Sarkozy's speech,

France and Germany have "their institutions, their political culture and their idea of nation. One [Germany's] is federal, the other one [France's] is unitary. One needs to understand this difference. One needs to respect it."

"France and Germany have chosen convergence...This doesn't mean that one is trailing behind the other, or that both want to give up their identities so that they confuse with each other."

"Europe needs more democracy...A more democratic Europe is a Europe where it is the [national] political leaders who decide."

"Europe’s re-foundation is not a march towards more supra-nationality."

"The crisis pushed heads of state and government to take on growing responsibilities, because, at the end of the day, they were the ones who had the democratic legitimacy that allowed them to decide."

"European integration will go the inter-governmental way because Europe will have to make strategic choices, political choices."

As expected, a clear political message to Berlin and Brussels. France also has its red lines on Treaty change: more coordination of economic and budgetary policies among eurozone countries is welcome, but the important decisions must remain with national governments. The European Commission (or the ECJ) should not be given the power to enforce the rules on member states.

As we said, Sarkozy didn't go into too much detail on specific proposals to strengthen economic governance in the eurozone. However, he did give a couple of interesting indications about what he thinks should be done to sort out the crisis,

"Every eurozone country must adopt a 'golden rule' enshrining the balanced budget target in its juridical order."

"We need to decide to move without fear towards having more decisions taken by qualified majority" within the eurozone.

"Let's examine our budgets jointly, let's establish quicker, tougher sanctions for those who don't live up to their commitments."

"The ECB obviously has a decisive role to play. There is debate over what it is allowed to do under its statute. I don't want to weigh into that debate. The ECB is independent. It will stay independent. I'm convinced that...the ECB will act. It's up to the ECB to decide when and with what means."

Meanwhile, the reactions to the speech in the French press were mixed. Centre-right Le Figaro argues that Sarkozy has substantially done his bit in terms of commitments, and therefore "it’s now up to the [German] Chancellor to decide if she also wants to accept a compromise to save the euro, through the mutualisation of national debts." However, Arnaud Leparmentier, the Élysée correspondent for centre-left Le Monde, accuses the French President of "intellectual incoherence", noting that he "imagines a French veto in Europe, but considers that smaller countries must accept the majority principle."

Indeed, Sarkozy knows that if the plans are seen as an excessive abandonment of France's souveraineté, that would almost certainly be the last nail in the coffin for his chances of winning another mandate.

The Creaking Axis?

2011-12-01T15:35:00.002Z

French President Nicolas Sarkozy is due to unveil France's plans to amend the EU Treaties and make yet another step towards his cherished gouvernement économique for the eurozone in a keynote speech on the state of French economy this evening (which we will follow live on Twitter @OpenEurope). However, German Chancellor Angela Merkel isn't expected to show her hand until tomorrow, at least according to what French Economy Minister François Baroin said (which could contain proposals we highlight here).

Say what? Only one week ago, during the joint press conference with Merkel and Italian Prime Minister Mario Monti in Strasbourg, Sarkozy announced,

"In the forthcoming days, France and Germany will put forward common proposals to amend the [EU] Treaties in order to improve [economic] governance in the eurozone and increase the level of integration and convergence of economic policies."

So why has 'Merkozy' eventually decided to make proposals separately? Well, according to reports in the French press today, the reason is that Germany's plans (or at least what has been leaked so far, which we discuss here) are too far-reaching for France's taste. As French Budget Minister Valérie Pécresse explained to the press yesterday,

"What we want is greater budgetary discipline, but a budgetary discipline enforced by the states, with a real participation by national parliaments. This question of sovereignty does not arise for us."

She went on,

"We want a règle d'or [golden rule, i.e. a deficit brake in the Constitution, in French political jargon]...which binds the states, but is adopted by national parliaments...It is in the full respect of its sovereignty that France wants to stick to its commitments on deficit and debt reduction."

Madame Pécresse's words are a perfect illustration of how - when you scratch the surface - deep the divide is between France and Germany's ideas of how stronger economic governance in the eurozone should be achieved. So how important are these divergences, emerging only a few days ahead of a make-or-break EU summit?

Sarkozy is, after all, a Gaulliste (General Charles de Gaulle triggered the well-known 'empty chair crisis' in reaction to the introduction of Qualified Majority Voting in the then European Economic Community). Hence, he could only support stricter supervision of national budgets if governments are allowed the last word on key decisions, especially when it comes to sanctions. In other words, giving the Commission (or the ECJ) the power to enforce budgetary discipline directly on eurozone countries is a non-starter as long as Sarko remains the occupier of the Élysée.

And the French Socialists aren't too keen on the idea of involving EU judges either. François Hollande, the Socialist presidential candidate, said yesterday at a press conference in Brussels,

"I will never accept the fact that, in the name of control over national budgets, in the name of budgetary policies coordination, the European Court of Justice can be the judge of the expenses and revenues of a sovereign state."

Oh-la-la! But there's more,

"Europe's [economic] revival can't happen without a project. Now, sanctions and authoritarian policies are not a project."

And also,

"When Mrs Merkel demands that the Bundestag be convened ahead of the European Council, I respect this procedure. But I want the choices made by the French people to be respected too."

Needless to say, this makes things extremely interesting, not least in light of next week's meeting of EU leaders as Germany is unlikely to agree to the ECB intervening or even to a leveraged EFSF in the absence of much stronger supervision of national budgets and economic policies. But, just as for every single eurozone country, the question is: how much of its souveraineté is France really willing to give up in the name of Franco-German cooperation and, more in general, to save the euro?

It should be said, however, that we've been here many times before, with Berlin and Paris with different starting positions and then ending up with a common stance, which is then rolled out to the EU as a whole.

And let's remember the French do know how to play the diplomatic game...

A disturbing glance into the future of Europe?

2011-12-01T11:19:00.016Z

As Europe waits for Germany and France to present their plans for EU treaty change - Bild has today published a rather disturbing photo of what a combination of Merkel and Sarkozy, i.e. 'Merkozy' might actually look like (it was only a matter of time before someone did it).

Bild notes that according to sources in Berlin, during summits, the pair are so in tune with one another that they require only the distance from the car to the meeting room, to clarify what they intend to do (note: that's sarcasm).

Meanwhile, more on the substantive side, Die Welt has managed to get hold of a plan by the leader of the FDP and German Economy Minister Pilipp Rösler, which, allegedly sets out the course for EU Treaty changes and the creation of a 'European Stability Union'. The document, which is called "Stability and Competitiveness in Europe", consists of several points that require Treaty change:

A stability board of experts should be created, whose job would be to make recommendations to improve competitiveness, examine the national budget plans and to participate in the monitoring process of the EU's competitiveness and fiscal policy. In addition, the board should assess whether the eurozone countries comply with their obligations under the Euro Plus Pact.
Furthermore, the document proposes a reduction in the current budget deficit limit allowed in the Stability and Growth Pact - from 3% down to a 2% (good luck!).
The familar idea of semi-automoatic santions also re-appear: where eurozone countries exceed the limit, there will be automatic sanctions imposed on them as opposed to the present sanctions regime which is basically discretionary, and reprimands aside, has never been applied in concrete form. So instead of requiring a majority in order to impose sanctions, a majority will be required to block sanctions. According to the document, this "reversed qualified majority voting" would also be applicable in event of preventive decisions, i.e. if it becomes clear that a eurozone member will soon be unable to meet its commitments under the Pact.

Sarkozy will tonight present his views on Treaty change, while Merkel will deliver hers tomorrow, although it is not entirely clear how similar her proposals will be to Rösler's. Interestingly, the Welt write-up of Rösler's document does not mention a potential role for the ECJ (which was raised in a list of proposals leaked earlier from the German Foreign Ministry), or the creation of an economic government for the eurozone members only.

As ever we'll keep you posted...