Is Bild having second thoughts about Juncker?

If Angela Merkel had privately hoped to quietly ditch Jean-Claude Juncker after the European election, it all started to go wrong when Axel Springer, the media group that owns Bild, Germany's and Europe's biggest selling paper, added its substantial weight to the pro-Juncker/pro-spitzenkandidaten campaign. This severely restricted Merkel's room for manoeuvre.

While Bild's editorial line has not changed explicitly, today's coverage of the issue is notably less enthusiastic. The paper's Brussels correspondent Dirk Hoeren asks "Will the Juncker deal be a dirty one?", with his piece claiming that France and Italy have made their support for Juncker conditional on a relaxation of EU budgetary rules (unlike Cameron who has taken a principled stance).

In a separate op-ed entitled “Merkel’s dilemma”, Bild’s deputy editor in chief Béla Anda argues:

“that the Southern Europeans will make their vote for Juncker dependent on an agreement on their debt policies shows the shabby extent the haggling over the EU’s chief post has reached.”

“If Merkel supports the election of a euro-softener to the post of Commission President, she will have backed the wrong horse.”

“Jean-Claude Juncker should be warned and be made aware that he must not be a chief at the mercy of Southern Europe.”

If you believe in tight observance of budget rules, as most Germans do, the last thing you want is to have a Commission President, appointed on a 'pan-European democratic mandate', who supports relaxing German-inspired rules on budgetary stability and the introduction of eurobonds.

While Juncker might need French and Italian support, ultimately he is the EPP candidate and Merkel is likely to bring her influence to bear. But imagine if 'centre-left' parties with a more avowedly Socialist spitzenkandidat were to win in future. How would Germany respond then, particularly the 'centre-right'? Would it be a case of yes to pan-European democracy, but only if the 'right' candidate wins? It seems like some people are starting to wake up to this prospect.

Europe's most important political party hits the campaign trail: a sneak peak at the EU section of CDU/CSU's election manifesto

We've managed to get our hands on the CDU/CSU's draft manifesto for September's federal elections, which is not due to be officially presented until Sunday. Given that the CDU (which always runs jointly with its Bavarian sister party CSU) is the single most important party in European politics by a mile, this is definitely one to watch.

Interestingly, the first section of the manifesto is entitled "Germany's future in Europe", indicating how closely these two issues are linked.
Aside from the obligatory pro-European rhetoric, here are the key points we've picked out regarding what the parties will campaign for and against on the EU/eurozone:

CDU/CSU support:

-  More EU oversight over national budgets with sanctions for breaching the Growth and Stability Pact,
-  So-called ‘Competition Pacts’, i.e. enforceable contracts between the Commission and member states on economic reforms,
-  Increased labour mobility, including greater co-ordination on the recognition of academic degrees and professional qualifications, as well as on access to social security,
-  Retaining the Franco-German axis as the "motor" of European integration, while at the same time wanting to draw Poland - described as the most important partner among the new member states - closer into this fold,
-  Pushing German as one of the main EU languages (along with English and French).

CDU/CSU oppose:

-   Sovereign debt-pooling via 'eurobonds',
-   An EU-wide guarantee scheme for bank deposits,
-   A split between the eurozone and the wider EU (“We would prefer to progress with all EU partners”).

So broadly no big surprises, German support for economic reforms and budgetary restraint on one hand and opposition to debt-pooling on the other is well established, although we note the concept of giving the Commission greater powers was not included in the recent Franco-German proposals on the eurozone. The explicit commitment to pushing for greater use of German within the EU hints at a more assertive Germany that is more at ease with itself.

Tellingly, the UK is not mentioned explicitly in the EU section, although the co-operation between the two countries on tax transparency is mentioned elsewhere in the document. From a wider UK perspective, the focus on economic reform and competitiveness is welcome, although the UK would not want to give the Commission greater competence in this area. The UK would also welcome any moves to clarify the rules governing EU migrants' access to domestic welfare systems - though it's going to be very interesting to see more details on transferability of benefits, as that's something many in the UK are keen to limit.

We will of course keep you updated as the campaign progresses.

Hollande goes on the offensive - two years to achieve political union in Europe

The French media called it François Hollande's "grand oral exam". The French President has just held a big press conference at the Elysée palace marking his first year in office. And he said a couple of very interesting things about his vision for the eurozone and Europe.

Hollande pledged to launch an "offensive" to "drag Europe out of its lethargy".

He called for an "economic government" for the eurozone,

"which would meet every month, with a real president appointed for a long term and who would be assigned this as his only task."

According to Hollande,

"This economic government would discuss the main economic policy decisions to be taken by the member states, would harmonise taxation, would start convergence in the social [policy] domain...and would launch a plan to fight tax fraud."

As if these remarks weren't controversial enough, Hollande re-stated his belief that the eurozone should have its own "budgetary capacity" and "the possibility to, gradually, borrow money". In the Q&A session he also suggested the ECB could be doing more on liquidity.

The French President concluded the EU-related part of his keynote speech by saying,

"Germany has said several times that it is ready to move to a political union, to a new stage of [European] integration. France is willing to provide the content to this political union."

With a real coup de théâtre, Hollande gave himself "two years to achieve" this political union. 

It will be extremely interesting to see what the response from Berlin will be. For the moment, Hollande's press conference is another reminder of how distant France and Germany are in the debate over the way ahead for the eurozone - with Paris sticking to its 'solidarity/integration first and supervision/discipline later' line, and Berlin insisting that things should evolve the other way around. 

Ten things that David Cameron should NOT say to Angela Merkel

UK PM David Cameron is today meeting German Chancellor Angela Merkel, as part of British efforts to explain to EU partners the thinking behind Cameron's recent EU speech. As we've argued repeatedly, this is the UK's most important bilateral relationship in Europe. So what could Cameron tell Merkel to convince her that his vision of Europe is worth investing in? Well, see here and here for some suggestions.

But knowing British diplomacy, equally important is what Cameron SHOULDN'T say. So after consulting our esteemed colleagues at Open Europe Berlin, we give you ten quips that most certainly wouldn't go down well with the Iron Chancellor - and that Cameron best stay well clear of. Here goes:

1. "How's that new exciting anti-euro party coming along?"

2. "Could you explain this ‘Target 2’ thingy…[pause]…how big!?” 

3. "We have formed this new ECR group in European Parliament - thought you might want to get involved?” 

4. "I always thought the ECB should become more activist."

5. "We’ve got some very clever people in the City who could design those Eurobonds for you. It's the 'inexorable logic' of a monetary union don't you know?" 

 6. "We’ve got a new central bank governor, he’s foreign, and he has stressed the need for ‘flexible inflation targeting’, why are you guys so uptight about Mario?" 

7. "Can you point me to that no-bailout clause in the EU treaties again?" 

8. "Have you been following Berlusconi’s political comeback? Very interesting…" 

9. "Those tweets of yours are hilarious – who says Germans don’t have a sense of humour?" 

10. "So Angela, Nick Clegg and Philipp Rösler - want to swap?" 

One of those is an actual Cameron quote - a free copy of an Open Europe report of choice for those who can figure out which....

Will the German Social Democracts come out in favour of debt pooling in the eurozone?

Last year we highlighted the German opposition’s somewhat ambiguous position on the hugely controversial proposition of debt mutualisation in the eurozone. However, with September’s elections rapidly approaching, it seems the SPD could have nailed their colours to the mast and have come out in favour, with their draft manifesto – launched yesterday by the party’s chancellor candidate Peer Steinbrück and party chairman Sigmar Gabriel (pictured) - claiming that the subject can “no longer remain taboo” according to Die Welt.

With the manifesto not yet publicly available (it has to be approved at the party’s national conference on April 14), we cannot be sure what form this would take – more limited mutualisation via a so-called debt-redemption fund or more extensive debt mutualisation via commonly issued eurobonds. With the German electorate reamining firmly against dept pooling, we suspect the former.

The party has also come out in favour of expanding the role of the European Commission into a ‘European government’ subject to control by the European Parliament and a second chamber where national governments would be represented, although it must be said that this concept has already been floated both by Angela Merkel and also by the ‘Future of Europe’ group chaired by Guido Westerwelle.

It will be interesting to see what effect – if any – this has on the SPD's electoral fortunes (we can imagine that the new 'Alternative for Germany' anti-euro party making this a big issue). At the moment the party is struggling to break through the 30% barrier in opinion polls and has been as low as 23% in recent weeks.

In addition to the dynamics of German domestic politics, from the perspective of the UK, this debate is both interesting and relevant given that any of the changes proposed above would require changing the EU Treaties, thereby giving the UK the opportunity of putting forward some reform proposals of its own, as suggested by David Cameron in his recent speech.

Barroso's Christmas wish list

Christmas is approaching and, in that spirit, José Barroso, the President of the European Commission, has written himself a wish list of presents for the EU member states (and particularly the Eurozone) to hand over. The Christmas wish list, or as Barroso puts it "A Blueprint for a deep and genuine EMU" is as follows:

For the next 18 months:

Wish number one: the "rapid adoption of current Commission proposals such as the two-pack and the Single Supervisory Mechanism" - i.e giving the ECB powers over eurozone (and perhaps other) financial supervision.
Wish number two: a eurozone "rebalancing" budget in addition to the EU budget. - more money.
Wish number three: a "Convergence and Competitiveness Instrument" for the eurozone - mutual contracts to enforce bailouts and deficits.
Wish number four: "external representation of the euro area in international economic and financial organisations and fora." - some more foreign postings.

And thinking ahead for next Christmas (next 18 months to 5 years):

Wish number five: deeper [eurozone] coordination in the field of tax policy issues as well labour markets
Wish number six: an "autonomous" and enhanced eurozone fiscal capacity that will  "rely solely on own resources" - a eurozone tax, budget and treasury- perhaps a financial transaction tax?
Wish number seven: a "power of intervention in the design and implementation of national fiscal policies"
Wish number eight: "The common issuance... of so-called eurobills", requiring a treaty change - but will the German taxpayer want to underwrite (and perhaps lose) money lent to Greece?

For the Christmas after that (for 5 years time):

Wish number nine: "extend the competences of the Court of Justice, i.e. by deleting Art. 126 paragraph 10 TFEU and thus admitting infringement proceedings for Member States or by creating new, special competences" - i.e further power over national economies.
Wish number ten: "a commensurate involvement of the European Parliament in the EU procedures. The European Parliament, and only it, is that Parliament for the EU and hence for the euro."

And this would leave you with Barosso's ultimate wish: "a banking union, a fiscal union, an economic union [and] as a fourth element, appropriate  democratic legitimacy and accountability."

German Foreign Minister Guido Westerwelle's response to the proposals was: “It is good that the EU commission is putting forward proposals for a stronger co-operation in the eurozone. But eurobonds, bills or any other form of joint debt liability in Europe are going in the wrong direction."

To many the proposals may seem alarming, but in truth, most of these proposals have been floating around for a long time. The novel aspect was the proposed time frame outlined by the Commission and combining them in a single vision. Notably though, many similar proposals by the Commission have resulted in very little, especially since the eurozone crisis has put an increasing emphasis on the intergovernmental decision-making found in the European Council.

Herman Van Rompuy's own list (expected at the December summit) which will probably be more modest and less eye-catching is likely to be more important simply because it more closely reflects the views of the key decision makers in the process.

Germany's Summer of discontent?

Over the last few weeks, a range of German policymakers have fired broadsides against further German involvement in the eurozone crisis, and against further aid to Greece in particular. Referring to September’s troika report on Greece, Michael Fuchs – the deputy parliamentary leader of Angela Merkel’s CDU party – yesterday told Handelsblatt that:

“Even if the glass is half full, that won’t be sufficient for a new aid package. Germany cannot and will not agree to that. We reached the point where the Greeks must show they are capable of delivering a shift long ago.”

Last week, Horst Seehofer, Prime Minister of Bavaria and leader of the CSU, the Bavarian sister party and coalition partner of Angela Merkel's CDU (which has been getting increasingly agitated by the eurozone bailouts), proposed a series of referenda:

"We must involve the people... First of all: on the transfer of important competences to Brussels. Secondly: on the accession of new states to the European Union. And thirdly: on German financial aid to other EU states."

In particular Seehofer cited debt pooling such as eurobonds or a debt redemption fund, adding that "with the CSU there won't be any United States of Europe".

Merkel's other coalition partner, the liberal FDP, is also stepping up its rhetoric, with its leader and deputy Chancellor, Philipp Rösler and also its leader in the Bundestag, Rainer Brüderle, saying they were reconciled with a Greek euro exit. Bavarian Economy Minister Martin Zeil has gone even further arguing that: 

"...a country needs to leave the euro, when it doesn't fulfil its duties. If necessary, two or more [countries] could leave." 

From the other side of the political spectrum, former German Finance Minister Peer Steinbrück (SDP) last month stated that:

"in certain cases, I have increasing doubts whether all countries will be able to be kept inside the eurozone (...) I can see how certain countries will be unable to close their competitiveness gaps [with Germany]"

However, the SPD have also recently publicly come out in favour of eurozone debt pooling - albeit it with strict conditionality in terms of national financial policy-making.

Otmar Issing, former chief economist of the ECB, added his voice to the chorus, saying some eurozone member states might have to leave:

 "Everything speaks in favour of saving the euro area [however] how many countries will be able to be part of it in the long term remains to be seen."

The question is whether all of this is rethoric, or the beginning of something else.

Bavarians are getting increasingly restless over eurozone bailouts

Debt-pooling goes down less well in Munich

Its not just Spain that has a problem with its regions. Over in Germany, Bavaria is getting increasingly angry over the additional burdens imposed on Germany as a result of the eurozone crisis - both via the existing bailout funds and possible future burdens via eurozone debt pooling. This is because in addition to its strong regional identity, it is the wealthiest of Germany's 16 states; a bigger burden on German taxpayers therefore equals a bigger burden on Bavaria.




The day after Moody’s placed Germany as a whole on negative outlook, it placed Bavaria and five other German states on negative outlook as well. While the German government reacted quite stoically – saying it had “taken note” of the decision – the response from Bavaria to its 'outlook downgrade' was far more robust. The state’s Finance Minister Markus Söder told Süddeutsche that:

"The Bavarian finances are in top condition, we are paying back our debts. I would expect us to win a gold medal.”

The state’s Prime Minister, Horst Seehofer argued that the decision "ought to send a warning signal to the rest of Europe". Both politicians come from the CSU, the Bavarian sister party to Angela Merkel’s CDU, which governs Bavaria with the FDP as its junior coalition partner. In the German debate, the CSU has taken the hardest line on Europe’s so-called ‘debt sinners’; yesterday Söder became their latest senior politician to explicitly call for Greece to leave to eurozone – in contravention of the government’s official position, while in an interview last week the party’s General Secretary Alexander Dobrindt said that:

"With Greece we have reached the end of the road. There must not be any further aid. A country which does not have the will to fulfil the conditions, or is not able to do so, must get a chance outside the euro”. 

However, it is not just Greece that has attracted the ire of the CSU – in the same interview Dobrindt laid into the opposition SPD and Green parties, describing their positions on the eurozone crisis as a “betrayal of German interests”:

“We will defend the bastion that is Bavaria against the onslaught of the left… The [upcoming regional and federal] elections will be hard clashes with the opposition parties over major social issues: the SPD and Greens want German taxpayers’ money in exchange for eurobonds. They represent the interests of the Socialist International and not those of German citizens. They are preparing the ground – together with the French President [Hollande] – for a ‘eurosocialism’. Their egalitarianism comes at the expense of Europe’s top performers [and will] threaten the prosperity of Europe.”

Dobrindt’s intervention is noteworthy because it is the first time that a senior mainstream politician has explicitly called for the eurozone crisis - and longer term questions such as eurobonds - to be made into defining issues in next year's elections. Until now, despite accusing Merkel's government of poor political management, the SPD and Greens have broadly taken the same structural approach to the crisis - i.e. bailouts and savings/reform packages, albeit with additional emphasis on 'pro-growth' measures. It will be interesting to see if and to what extent Merkel and the CDU will heed Dobrint’s call to adopt a tougher tone.

Bavaria’s position in Germany can be seen as a microcosm of the eurozone as a whole – together with neighbouring Baden-Württemberg they largely subsidise public expenditure in the Western Länder and the former DDR – the latter via a statutory ‘Solidarity payment’ on top of general taxation. Given that many Bavarians are unhappy with this arrangement - the state government recently launched a legal challenge - their resistance to funding another ‘solidarity payment’ – this time for the Mediterranean bloc – should not be underestimated. Earlier this month, Seehofer warned that:

“Eventually, a point will be reached when the Bavarian government and the CSU can no longer say 'yes' any more [and] the coalition has no majority without the CSU's seats.” 

While this is unlikely to happen any time soon, the CSU’s resistance will severely restrict Merkel’s ability to place further eurozone rescue related burden on the German taxpayers in the remainder of the current parliamentary session and beyond.

As Germany as a whole faces the question of how it will respond to the crisis in the longer term – with a range of options running from a break-up to more political and economic integration – expect Bavaria to be at the forefront of the resistance to the latter option.

A great way to run down a bailout fund?

Ahead of the summit today the proposals for the EFSF/ESM to start purchasing sovereign debt began rearing its muddled head again, with some indication that this is actually one of the few things that could be agreed at the summit. We hate to be party poopers but as we have already noted (at length) this is a confused idea and will likely provide little help relief to those countries embroiled in the eurozone crisis. Below we outline some of our key concerns with the plan:

• The capacity will be tested: this role was previously filled by the ECB. Markets know that the ECB can provide an unlimited backstop and will rarely test its resolve in keeping yields down. However the EFSF only has around €250bn left, while the ESM has a lending cap of €500bn (as we have shown though this will also not be fully operational for some time). In any case markets are likely to test the resolve of these funds, meaning they may spend more than is needed and may be less effective than the ECB was. 
• Will deplete the funds of the EFSF/ESM: further to the point above, the money in the bailout funds will be severely depleted reducing the capacity for them to fully backstop countries which may need full bailouts. Particularly a worry if Portugal needs a second bailout, Greece a third and Spain possibly a full one on top of its bank rescue package. 
• Subordination: if ESM purchases bonds other debt of the recipient countries will become junior. This increases market jitters. Would be less of a concern if these purchases solved any of the issues but they only simply delay them at best.
• Secondary market purchases: if the buying is on the secondary market, the benefit is limited in terms of countries actually being able to issue debt. Still rely on domestic markets and the sovereign-banking-loop in problem countries may become more entrenched. 
• Primary market purchases: if done in primary market, then this will be a direct transfer between countries and could lay the groundwork for debt pooling, something which could cause political outcries across northern Europe. 
• Risk transfer: holders of peripheral sovereign debt will likely see this as an opportunity to sell off their holdings at a higher than expected price, shifting risk to the eurozone level. 
• De facto Eurobonds: the funds will issue bonds to raise money to buy debt off struggling countries. Building on the two points above, this means that investors will sell national debt and buy European backed debt, again essentially creating a de facto European bond and debt union. 
• Conditions: must come with clear conditions otherwise could be self-defeating (removes incentive to reform). Furthermore, if, as is currently the case, countries must enter an adjustment programme to allow the EFSF/ESM to buy its bonds, there could be significant stigma attached (again reducing the benefit).  It could also mean other countries picking up the slack if a government does not properly implement its own fiscal policy (however, without a clear say on the spending programmes).

All in all then, a very mixed bag. At best this plan could provide some temporary relief to high yields but the side effects could be large and frankly these funds just aren’t big enough to fulfil this role (and their other roles) on a consistent basis. Besides, even if some time is bought they are still yet to outline to what end it would be used – better then to agree on this before starting to run down the one of the few backstops still in place to the eurozone crisis.

What will proposals for a fiscal and banking union mean for the Eurozone and the UK?

Ahead of this week’s EU summit, Open Europe has published a briefing note summarising the various ideas floated for a fiscal and banking union in the wake of the eurozone crisis, analysing their potential impact on the UK and the eurozone. Given the embryonic nature of many of the ideas, Open Europe concludes that none constitutes a realistic short-term, or even medium-term, solution to the crisis. In particular, Germany’s insistence on an effective veto over other member states’ spending over a certain level as a precondition for fiscal burden sharing is itself a huge political obstacle that may not be overcome anytime soon.

The briefing also notes that it’s virtually impossible to separate a fiscal union from a banking union, as they are interdependent. Open Europe estimates that, taken together, an EU bank resolution fund and deposit guarantee scheme will need to be worth at least €600bn to be credible, with a direct credit line to either ECB or national treasuries. However, in a crisis situation, this amount could be far higher. Since 2008, for example, the EU has approved €4.5 trillion in national state aid to financial institutions in Europe – an EU banking resolution fund must be prepared to inject similar amounts. This fund could initially be built upon the existing ESM framework, although it would require a substantial rewriting of the ESM treaty and a large increase in its lending capacity.

We’d note that a banking union in the eurozone does come with merits, but it is effectively a fiscal union via the backdoor given that eurozone governments will ultimately have to jointly stand behind all the banks in currency union. Therefore, there is a very real risk of banks in one country free-riding off the backs of taxpayers in another is therefore huge and the Germans are absolutely right in insisting on fiscal safeguards to avoid this happening. But this is also why banking union, even in an optimistic scenario, is years away.

For better or worse, a banking union will inevitably have an impact on the UK’s place in Europe and add pressure on the Coalition to seek safeguards ensuring that a more integrated Eurozone is compatible with the UK’s economic and political interests. A key question for the UK is whether it really wants the ECB tasked with supervising a banking union in which cannot take part itself, and how to avoid barriers to financial trade in the Eurozone for UK firms if this happens.

For the full report see here.

Merkel comes out swinging against debt pooling

Debt pooling in practice? (h/t Phil's Stock World)

In recent weeks Chancellor Merkel has come under ever-increasing pressure to “do what is necessary” and take the plunge on debt pooling within the eurozone. This pressure has been applied from a wide of actors including the other big eurozone countries (France, Italy and Spain), the EU institutions (Commission President Barroso, Council President van Rompuy, Eurogroup chief Juncker and ECB head Draghi), the IMF and last but not least UK Prime Minister David Cameron and US President Barack Obama.

However, Merkel - who in her time has crossed a fair few ‘red lines’ - has come out swinging ahead of Thursday’s summit of EU leaders, with Handelsblatt reporting that she is has lashed out at discussions ahead of the for focusing "far too much on all kinds of common liability [including] eurobonds, eurobills and a European common deposit guarantee fund with common liability". She described the proposals as "economically false and counterproductive" and asked Van Rompuy, to rework the report he published ahead of the summit to shift the focus from debt pooling to budget discipline.

According to Reuters, at a meeting today with representatives from the FDP, her junior coalition partner, she went even further, claiming that: 

“Europe will not have shared total debt liability as long as I live” 

If accurate, this is strong stuff and - though intended for a very domestic audience - certainly a departure from the measured and stoic tone Merkel usually adopts. Likewise Merkel’s reaction to suggestions that Germans would be getting a referendum on a new constitution allowing for greater EU integration in the immediate future – after Finance Minister Schäuble had suggested this in an interview with Der Spiegel –suggest that she does not anticipate full debt pooling as an immediate possibility, with FT Deutschland citing her spokesman as saying “clearly we are not there yet.”

However, to split some pretty big hairs, the qualification of “shared total liability” hints that Merkel is not ruling out all forms of eurobonds during her lifetime, such as debt redemption fund as favoured by the SPD and Green opposition. Likewise she could offer other concessions, something hinted at by the news that Germany could be prepared to drop the provision that ESM loans are senior to other debt, something which has been perceived to have contributed to rising Spanish debt yields on the assumption private creditors would take the biggest hit.

However, nothing will happen on any form of debt pooling before the German elections in the autumn 2013.

Are the rumours of a new(ish) eurozone backstop true?

The press have got very excited over suggestions from European leaders at the G20 meeting in Los Cabos, Mexico, that they will activate the EFSF to buy eurozone government bonds from the secondary market in an attempt to reduce borrowing costs for Italy and Spain - a function which the fund has always had but has never been used (since the ECB has filled this role with its bond buying programme). Berlin has already moved to deny this, but there could be truth in it - not least because it's legally possible but also because we've seen over the past few weeks that the ECB has refused to buy bonds despite the persistent rise of Spanish borrowing costs. It has become increasingly clear that Spain cannot withstand these interest rates for long - something needs to  be done.

If true, this could prove a important change. Despite always being possible, bond buying from the EFSF has up until now only been theoretical. When it comes to the unenviable task of backstopping Spanish and Italian government debt, the ECB has now officially passed the buck to eurozone governments. Over the last two years, the ECB has effectively managed to manipulate government bond yields by buying a limited amount of government bonds – some tens of billions a month at its peak (although with mixed success). In August last year, for example, the mere willingness of the ECB to buy Italian government debt may have prevented a full-scale run on that country as political uncertainty ran wild. But there’s a key difference between the ECB and the EFSF – while the former has deep enough pockets to move markets, the EFSF’s lending capacity is inevitably limited, meaning that making it into a lender of last resort for a country the size of Spain (let alone Italy) could prove risky. The ECB could stand behind Spain and Italy with, at least in theory, the ability to massively expand its balance sheet and thereby quarantine these problem countries. But the EFSF only has €250bn left to lend – to top up its lending capacity, it will need to pass 17 hostile national parliaments, which ain’t gonna happen anytime soon.

This is to say that, if the buck has indeed been passed from ECB to the EFSF, then the Eurozone’s firewall just became a lot weaker - many have rightly previously questioned its capacity to purchase bonds and fund lending programmes to struggling countries simultaneously. Furthermore, the EFSF treaty states that secondary market intervention can only take place at the request of the recipient country and will come with some conditions (although probably not a full reform programme). Clearly this will come with significant stigma (once you go down the path of any external aid it is hard to return, as Spain is now finding out), while it is hard to imagine a country signing up to extra conditions just to manage its secondary bond market (especially since the ECB was previously doing this without any clear conditionality).

There are additional questions over what this means for the permanent eurozone bailout fund, the ESM, which is meant to be up and running this summer. Presumably, it will have to take over this bond buying role once it comes into force. The same problems apply here as do with the EFSF, but the ESM is also senior to other debt, meaning that as it buys up debt of a country other holders of this country's debt become subordinated - this can result in further market uncertainty making it counter productive. Ultimately, if the ESM is to serve as a lender of last resort in any way, it almost has to be equipped with a banking license in order to allow it to lend and borrow freely, without being hostage to national parliamentary politics or very limited in size. Giving the ESM a banking license is a hot potato in Germany, but will Berlin have any choice if the markets start to question the firepower of the fund?

On the current path, presenting the EFSF/ ESM as lender of last resort – for Spain in particular – but without equipping it with the cash to actually allow it to fulfil this function, could set the stage for a showdown between markets and the funds - in that scenario we can only see one winner.

Referendum confusion: Is Cameron protecting Britain from British plans for a eurozone superstate?

The eurozone crisis alone is complicated enough. Add in UK domestic politics and calls for a referendum on EU membership, and this stuff becomes maddening.

Today's Europe coverage in the UK press was a wonderful cocktail of a euro Armageddon, EU-UK relations and a huge dose of British domestic politics.

The Telegraph reported that:

"The Prime Minister dismissed as 'nonsense' a suggestion from Angela Merkel, the German chancellor, that the European Union should eventually have a single national identity and described as 'nonsense' the idea of loyalty to a common European flag."

It also noted that Merkel said yesterday, “We need more Europe, a budget union, and we need a political union first and foremost”, which led the paper to proclaim that "David Cameron promises to 'protect' Britain from German plans for a eurozone superstate with common banking and political systems".

But is that really what's going on here? It's true that both Cameron and Osborne have floated the idea of "safeguards" if the eurozone presses ahead with a banking union and further integration. But here's the thing: Germany's default position remains strongly anti-fiscal burden sharing, meaning that Merkel's 'budget union' is still based on exporting German fiscal discipline to the eurozone-level by introducing stronger budget oversight and enforcement mechanisms - only then could some form of debt mutualisation be considered. A German-led superstate still seems years off - if it ever will be agreed (no matter how much other parts of the eurozone or markets might like to see it right now).

In contrast, David Cameron last month called for a bigger bailout fund, shared eurozone bonds and a more active monetary policy from the ECB - in other words, the eurozone quickly moving to "joint and several liabilities" with stronger states indefinitely underwriting weaker ones. That would really be a German-led super state.

So, who's plans are Cameron and Osborne really trying to 'safeguard' themselves against? Of course, Cameron is right to stay well clear and seek safeguards in return for nodding through treaty changes designed to achieve a fiscal or a banking union, for example for UK financial services. But this discussion leaves the impression that Cameron is actually seeking safeguards against his own plans for eurozone integration. Not necessarily a contradiction, but not a good starting point for future negotiations over EU treaty changes either.

There's also a second confusion: an EU referendum.

In response to questions about the impact on Britain of more eurozone integration, Osborne yesterday told the BBC Today Programme that:

“I think what the public are concerned about, the British people would be concerned about, would be if there was any transfer of power...A reshaped relationship with Europe would imply, would involve, a transfer of sovereignty or powers from the UK to Brussels.” 

In reality, Osborne merely re-stated what's in the 'referendum lock', i.e. a substantial transfer of powers to the EU will, by law, trigger a public vote. But the context is confusing. In all likelihood any eurozone focused treaty change would not legally and constitutionally impact the UK enough to trigger a referendum. Furthermore, the government's talk of safeguards suggests that, if none are present, the UK would veto any treaty change before it actually gets to a referendum. So a referendum still looks unlikely, at least on the back of the eurozone crisis.

Osborne and Cameron are in an unenviable position - the eurozone crisis threatens to send Britain into a deeper recession, and remains a fundamental threat not only to the UK economy but also now to the Conservatives' 2015 election prospects. Tory backbenchers and UKIP are both breathing down the necks of the Conservative leadership over an EU referendum. All factors considered, Osborne and Cameron are doing a decent job balancing all these interests.

At the same time though, as we hint at in today's Telegraph, the UK government could end up in a rather strange position by sending all these political hares running at the same time. Is it going to veto the same Treaty changes (to establish a fiscal / banking union) that it is now effectively calling for? If it's deemed that these treaty changes de facto transfer powers away from the UK - i.e. by shifting the institutional balance of power towards the eurozone at the UK's expense - will it then also call a referendum on those treaty changes? What would the question be?

This may all work out both in the polls at home and in talks in Europe. But given the unrealistic expectations it raises - and how very difficult it will be to square all these various factors - it may well come back to haunt the Tory leadership, at home as well as abroad.

The UK should throw its weight behind a Europe based on sound money

In today's Telegraph, we argue:

Whatever the future of the single currency – and the entire European project – it will largely be decided in Berlin. The most important relationship for David Cameron is therefore with the German Chancellor, Angela Merkel. But there is a risk that the Prime Minister will miss a vital chance to cement a new Anglo-German deal on the future of the European Union.

For years, the UK’s European diplomacy has been defined by its relations with the Élysée, but the eurozone crisis has demonstrated that Germany now stands alone as Europe’s leader, however reluctantly. Despite there being a great deal of cultural and political overlap, however, the basic problem is that Britain does not really understand Germany, and vice versa. Britain perceives itself as a seafaring country of traders, Germany as a continental land of engineers.

Much like the UK, Germany is undertaking a highly charged internal debate about its place in Europe. For the first time, the twin pillars of Germany’s extraordinarily successful post-war settlement are in conflict: its commitment to Europe, and its belief in sound money and stable budgets. Whatever the outcome of this debate, it will have a defining impact on the future of the EU.

The UK, however, risks ending up on the wrong side of the debate. To the great annoyance of Berlin, Cameron and George Osborne have developed a fondness for calling on the eurozone to move towards fiscal union, including eurobonds, and for the ECB to effectively start the printing presses. Britain has a right to voice its opinion – a full-scale crisis would have implications well beyond the eurozone – but its advice is misguided.

Eurobonds and cheap money create huge incentives for more spending, which is exactly what the Coalition is arguing against at home, and feel awfully like solving a debt crisis with more debt. Cameron has also stressed that “Europe’s lack of competitiveness remains its Achilles’ heel”. But, as Merkel has rightly countered, eurobonds do nothing to address this. If anything, allowing countries to piggyback on Germany’s credit rating takes away pressure for the vital reforms that many of these countries need.

After having spent a decade in opposition calling for a more dynamic European economy and a slimmed-down, more democratic EU, the Conservative leadership’s cocktail of Eurosceptic fiscal federalism is not only intellectually inconsistent but, in the key debate about the future of the EU, needlessly aligns the UK with European federalists and socialists such as François Hollande.

At the same time, it locks Britain into a weak negotiation position over future EU treaty changes – which will be needed if the eurozone is going to move to fiscal union – as Britain can hardly block the same treaty change that it has effectively argued for.

Instead of prejudging the eurozone’s future, Britain should spend all its political capital on convincing Merkel that Europe as a whole needs to move in the direction of free trade and structural reform. This means that, instead of talking about “digital government” as Cameron and Merkel did yesterday, Cameron should have said the following: “I will support the Chancellor’s vision for a Europe based on responsible spending, sound money, liberal cross-border trade and respect for the rule of law. Like the Chancellor, I believe that Europe must learn how to live within its means and reform itself if it is going to remain a vibrant economic actor on the world stage. But just as Germany will need to seek the right conditions to be comfortable with its new position in Europe, so must Britain. Since we cannot join the euro, Britain will need a different – and more flexible – set of arrangements under EU law than euro members. This is the only way to reconcile continued EU membership with UK public opinion.”

In the end, this would benefit Germany, Britain and Europe as a whole.

Euro opinion polls point to more fudge

Some interesting opinion polls from the heart of the eurozone from the last couple of days:

In Greece, a series of polls shows momentum ahead of the country’s re-run election next month shifting slightly from the radical left anti-bailout and austerity SYRIZA party to the pro-bailout and austerity centre-right New Democracy party, though SYRIZA is still set for gains compared with its election result earlier this month. New Democracy, which won the elections with 18.9%, now leads with between 25.6% and 27.7%, a lead of between 0.5% and 5.7% over SYRIZA. That means that together with the establishment socialist PASOK party, which won 13.2% at the elections, a pro-bailout coalition could be formed with a majority of seats in the Greek parliament, something that evaded the parties last time.

The polls also showed support for staying the euro at 65% versus 25% against. While staying in has enjoyed a consistent majority, voters are potentially starting to re-align their party choice accordingly - realizing perhaps that ripping out the bailout package comes with massive risks - albeit this could change again before the elections and remember, SYRIZA remains the joker in the pack.

Meanwhile in Germany, public opinion seems to be shifting in the anti-euro direction, with an opinion poll published on Friday by German state TV ZDF finding that 79% of respondents rejected eurobonds as a solution to the crisis, which is a stark reminder for the rest of Europe how far away we actually are from eurobonds. Interestingly, though, support for euro membership itself was also waning, with 50% (up from 43% in February) saying they believed it carried more disadvantages than advantages for Germany, with 45% taking the opposite view (down from 51% in February).

These opinion polls - together with events of recent weeks - point towards one conclusion: we're looking at yet more fudge. As we've pointed out before, as sceptical as one might be about the future of the euro, there's still considerable scope for negotiations on all sides of the Greek crisis, and therefore, chances that the country can find a settlement and agreement with its creditors after the elections that allows it to stay in the euro remain strong. It would be different if the public were to turn against the euro itself, which it isn't at this time.

The stakes are simply far too high for another round of Russian roulette.

Does the SPD really support eurobonds?

Update 1.45: It looks like Trittin has performed one of the fastest and sharpest u-turns of recent times, as he is quoted by Reuters earlier today as saying: "Merkel should stop blocking eurobonds" and suggested it could be a condition for his party's support for the fiscal treaty. This is also a matter of semantics though, as the Greens remain in favour of a limited form of fiscal burden sharing or debt mutualisation. It still illustrates the wider point however: eurobonds are in for a rough ride in Germany.

Update 1.15pm: Die Welt has published a more detailed follow-up on the issue and the Green party has followed the stance of its oft senior coalition partner and also rejected eurobonds at the present time. Green parliamentary co-chairman Jürgen Trittin said that while he agreed with the economic principles behind them, they were the wrong solution at this time, not least because it would require changing the EU Treaties. The paper states that both parties prefer an alternative, only partial, pooling of eurzone debt, possibly via a debt redemption fund.

Original post:

There's a school of thought out there - usually fairly uninformed - which has it that a German government that features the SPD (social democrats), could fairly effortlessly strike a deal with Francois Hollande over further fiscal integration, which would include, for example, eurobonds and greater ECB intervention. People arguing this point notes that SPD supports eurobonds, while doing fairly well in opinion polls. That should cut it right?

Well, this view tends to underestimate the German cross-border consensus on sound money and budget discipline. And from today's Die Welt we learn that the SPD has retreated from its previous support for Eurobonds, thereby distancing themselves from their French counterparts. Thomas Oppermann, the party’s speaker in the Bundestag said:

"We oppose the uncontrolled pooling of debt… There is absolutely no need for general eurobonds". 

Oppermann added that:

“I speak for [Germany] and not for France”.

And there you have it from the horse's mouth...this will be a long, unpredictable debate in Germany.

The EU's Big Five (& Austria): where are they at ahead of tonight's summit?

The 'growth dinner' of EU leaders is about to start. No big decisions are expected (this is a meeting of EU leaders after all) but here's an overview of where the different big countries are at:

Germany

Berlin  remains fiercely opposed to Eurobonds, but interestingly, EU Energy Commissioner Günther Oettinger - a fellow member of German Chancellor Angela Merkel's CDU party - argues in an interview in today's Handelsblatt:

"Eurobonds are a matter of timing. I advice all participants not to position themselves inherently against them."

Similarly, Rainer Brüderle, the parliamentary leader of the FDP (Merkel's junior coalition partner) told German radio Deutschlandfunk that if structural reforms and budgetary discipline were implemented, Germany should not rule out the introduction of Eurobonds “at a later stage".

It won't touch Merkel for now, but an indication that Germany is set for a long, grinding and existential (in the euro sense of the word at least) debate on this issue.

Austria

It looks like Austrian Chancellor Werner Faymann is on a different wavelength to his Finance Minister Maria Fekter. The latter is opposed to the idea of debt-financed growth à la Hollande, while Faymann told Kleine Zeitung in an interview that he "fully supports" Hollande in wanting to discuss Eurobonds at tonight's meeting. However, the Austrian Chancellor made clear that Eurobonds are "a long-term project that cannot be realised in the next two or three years" while stressing the need to also have strong mechanisms to ensure that budget discipline is "an absolute prerequisite" for the proposal to be implemented.

France

French President François Hollande held a joint press conference with Spanish Prime Minister Mariano Rajoy earlier today. Nothing new came out of it and France's focus at the tonight's summit remains:

• Fiscal stimulus is necessary to achieve deficit and debt reduction; 

• Greece must remain in the eurozone, and its partners need to do more to help the country return to growth. However, previous commitments must be respected;

• No taboos on Eurobonds - they must be discussed. Their main purpose is to cut the financing costs of struggling eurozone countries.

We can't help noting how Hollande of late stropped referring to the fiscal treaty as frequently, instead stressing the 'growth pact' for the eurozone.

Spain

In his joint press conference with Hollande, Rajoy simply reaffirmed Spain's priorities for tonight's meeting (and the near future), saying that "financing" of states and banks was "the most urgent" of all the issues:

• Immediate action is needed to keep borrowing costs at sustainable levels for Spain and other peripheral eurozone countries. Rajoy stopped short of mentioning the ECB during the press conference, but a new round of ECB bond purchases is clearly on his wish list

• Eurobonds are not a priority, but could be discussed as part of a broader, long-term debate on  deepening European integration;

• He also said that the EU need "certainties" including that "the euro will exist for ever and no country will default [on its debt]." The EU institutions should start sending clear messages on these points. Okay, Rajoy...

Italy

Staying true to his style, Italian Prime Minister Mario Monti has kept awfully quiet, although he has warned that trying to isolate Merkel tonight would be "impractical and counterproductive" (no kidding). Monti and his cabinet are presumably doing a lot of work behind the scenes, based on a couple of specific proposals (which we mentioned here and here).

The Italian government yesterday adopted plans to unblock between €20bn and €30bn by the end of the year to make overdue payments to private firms that have supplied goods or services to the public administrations. Could this be a sign that Monti's proposal to temporarily exempt overdue payments to businesses from the EU's deficit and debt rules is gaining ground in Berlin? Possibly...

UK

The UK will continue to voice its opposition to a financial transactions tax (the Commission STILL has not given up on this proposal and will apparently present a massaged impact assessment tonight showing that the negative effect on EU GDP is not bad at all, never mind what it said initially). Cameron will also, rightly, push for various pro single market measures. It will be interesting to see how the UK responds to ideas for 'project bonds' and topping up the European Investment Bank. Cameron will also urge "decisive action" over Greece/the euro and may also provide some (largely irrelevant) advice on how the Greeks should vote in the forthcoming elections and the Germans should respond to proposals for Eurobonds.

In any case, as always, EU leaders will have a lot to talk about.

Euro-bonding

After the G8 summit, French President François Hollande claimed that he would "not be alone" in proposing Eurobonds at tomorrow's informal dinner of EU leaders in Brussels. But, who, exactly, are his bed fellows?

Italian Prime Minister Mario Monti is undoubtedly a supporter of Eurobonds, along with former Economy Minister Giulio Tremonti. However, Monti has also repeatedly stressed that Eurobonds should not be "an excuse to relax budget discipline". From the US, Monti said that, for the moment, he would seek a mere agreement on the "evolution towards Eurobonds." (whatever that means).

Monti is also likely to prioritise his own proposal: exempting public spending on certain "strategic" sectors from the EU's deficit and debt rules - a proposal which no doubt will rub Angela Merkel completely the wrong way. Monti is unlikely add fuel to the fire by also insisting on Eurobonds.

What about Spain, a perceived beneficiary of debt pooling? Well, Prime Minister Mariano Rajoy yesterday told reporters that, at this stage, the priorities for his government are "fiscal discipline, structural reforms and financial stability" - not Eurobonds. He added,

The most important thing is to take decisions that can be enacted in 24 hours. We can't enter debates [about the creation of Eurobonds] that can last for years. 

Quite right Rajoy. The Spanish PM will not want to take on Merkel over the proposal either - his main concern is the future of Spain's banking sector. As speculation mounts that Spain may be forced to tap the eurozone's bailout funds to deal with its banks, Don Mariano wants Germany on side.

Even the European Commission itself is saying that the time is not yet ripe for Eurobonds, instead pushing for the less controversial 'project bonds'. In an interview with the Wall Street Journal over the weekend, Commission President José Manuel Barroso said,

We think that it's only when there is an increased level of convergence and discipline that Eurobonds can appear as something credible. [Eurobonds should not be seen as] an invitation for irresponsible fiscal behavior or having some kind of moral hazard.

So who else? The Austrians, whose Finance Minister Maria Fekter said in an interview,

Growth financed by debt? Those are the recipes from the day before yesterday. The arguments that are put forward by France's new president François Hollande are nonsense and got us into this whole mess in the first place.

Or the prudent Finns? Hardly.

Well, there's one: David Cameron.

At least this time around, Cameron will not have a French President calling him an "obstinate kid" and asking him to stop interfering in eurozone politics.   

Eurobonds are an economic risk and a political dream

In today's City AM we argue,

THE idea of Eurozone countries pooling their sovereign debt in the form of Eurobonds re-emerges every time the euro crisis suffers another turn for the worse. Curiously, the idea’s chief proponent seems to be the UK government, which has made several interventions, stressing the need for the Eurozone to move to “fiscal burden-sharing”. This puts it in the company of European federalists such as Romano Prodi and Jean-Claude Juncker, and socialists such as François Hollande.

However, the UK government, like most other advocates of Eurobonds, tends to gloss over the details. There are at least three economic reasons, and a huge political reason, as to why Eurobonds are no easy fix. 

Firstly, the moral hazard entailed in Eurobonds is huge. Remember, for large parts of the past decade, Greece was treated by markets the same way as Germany, and was able to borrow money at almost the same interest rates. Everyone can see the results.

Secondly, Eurobonds would inevitably take away pressure for radical reform. As painful as it is, at least the Eurozone crisis is forcing Club Med countries to pursue long-overdue reforms of their pension and tax systems, labour markets, and so forth. Piggy-backing on Germany’s credit rating could take away this pressure. And linking back to moral hazard, the focus could again be on growth via debt, rather than through structural reforms.

Thirdly, most of the proposals for Eurobonds would see only part of the Eurozone governments’ debt underwritten jointly, with the rest remaining national. This option would be a major economic gamble. Not only would it be extremely difficult to implement on existing debt stocks, it could also send borrowing costs on the nationally-denominated debt skyrocketing – which would ultimately outweigh the benefits of having Eurobonds in the first place. In addition, a half-way house would mean that a substantial euro rescue fund would still be required, since the Eurozone continues to lack a lender of last resort – putting extra pressure on the credit ratings of Germany and other “core” euro countries.

The first and second problems could be dealt with, in theory, by imposing strong EU budget rules. But the record of Eurozone countries of abiding by such rules – and the lack of credible enforcement mechanisms – does not inspire confidence. The third problem can only be solved by going for “full” Eurobonds, meaning no national debt at all.

However, this is where politics – and a bit of constitutional law – kicks in. German taxpayers are not ready to accept higher national borrowing costs to underwrite Greece, Portugal and Spain. Nor are they willing to accept a euro based on watered-down budget discipline. Going down that road risks a major backlash – which could lead to the Germans pulling the plug. In addition, the German Constitutional Court in Karlsruhe has already expressly forbidden Eurobonds without a change to the German “basic law”.

In any case, Eurobonds would take years to implement. The answer to the current crisis must lie elsewhere.

How to upset three EU leaders in one day - by Francois Hollande

French President François Hollande made his debut on the international stage at the G8 and NATO summits in the US over the weekend. Perhaps a sign of the rocky ride ahead of him, he managed to upset at least three of his fellow leaders.

Germany: Hollande decided to officially add Eurobonds to his wishlist - turning him into the best friend of the British government. Speaking after the G8 summit, he said he will present a package of proposals at the informal meeting of EU leaders tomorrow, adding,

Within this package of proposals there will be Eurobonds, and I will not be alone in proposing them. I had confirmation on this at the G8.

The Germans immediately hit back. German Deputy Finance Minister Steffen Kampeter told German radio Deutschlandfunk,

I believe that prescription [i.e. Eurobonds] comes at the wrong time and carries the wrong side-effects.

Hollande has also expressed strong reservations about German Finance Minister Wolfgang Schaeuble taking over the chairmanship of the Eurogroup. Hollande is reportedly insisting that Schaeuble should resign from his post before taking on the new role (which doesn't make much sense, as the Eurogroup is supposed to be a forum for the finance ministers of eurozone countries).

Spain: Speaking to the press in Washington, Hollande said of Spanish banks,

It would most probably be desirable to have a recapitalisation, and it would most probably be necessary that this recapitalisation takes place through mechanisms of European solidarity.

This is the eurozone's worst-kept secret (as we argued here), but perhaps not the most prudent thing to say. Spanish Prime Minister Mariano Rajoy, who was not at the G8 but joined the NATO summit, swiftly fired back,

If he said that, it must be because Mr Hollande has information that we don't have. Therefore, I don’t think Mr Hollande said that because, logically, he doesn’t know how the Spanish banks are.

The two will have time to settle the issue when they meet in Paris tomorrow.

UK: As we've noted, David Cameron and Hollande have more in common than what one might think, but on some issues the two are still poles apart, for example an EU financial transaction tax which Hollande continues to push for. Before the bilateral meeting at the UK Ambassador's residence in Washington, Cameron told reporters,

On the financial transactions tax, I'm very clear, we are not going to get growth in Europe or Britain by introducing a new tax that would actually hit people as well as financial institutions. I don't think it is a sensible measure. I will not support it. 

Do these rows come down to lack of experience for the new Président or are they simply examples of classic French negotiation tactics? We're still not sure...