Eurozone reform contracts take shape - and they include "fiscal transfers"

As we have predicted numerous times - as recently as in our previous blog post - ‘reform contracts’ in the eurozone could well become the next thing. As a recap, these are agreements where one country commits to a series of structural reforms in exchange for low cost loans, or other form of help, to aid its economy. As we argued back in September - when it was unclear whether the idea would make a comeback - it's one of the  politically more feasible options for Germany as it involves more control and less cash.

@michaelsteen Tricky one. Merkel seems to float reform contracts in this recent interview: http://t.co/rToOm65l9a @SpiegelPeter
— Mats Persson (@matsJpersson) September 16, 2013

@michaelsteen @SpiegelPeter In theory more politically feasible for Berlin than other options, as it involves more control and less cash
— Mats Persson (@matsJpersson) September 16, 2013

Well, Reuters have now got their hands on the latest draft of the plans for these contracts and have published them in full here. The idea now seems to be firmly on the agenda, which is not the same to say it'll actually happen.

Below are the key points of the plans:

• The contracts are seen as a supplementary part of the ‘European Semester’ – the new system of economic governance. They will build on tools such as the macroeconomic surveillance and budgetary oversight, which we have already covered in detail. The contracts are targeted at those countries not making adjustments under the other procedures.

• They are designed to promote “ownership” of reform and “home grown” policies (which lines up with Merkel's comments from yesterday). There is, of course, a tension here, given that by definition they are part of a system of increasing economic oversight and some would say a loss of control of economic policy. As Eurogroup Chief Jeroen Dijsselbloem suggested yesterday, if these countries aren’t pushing these reforms, slightly cheaper loans are unlikely to be the deciding factors in pushing them to do so.

• Further to the above point, the text does stress that the policies will be drawn up by the domestic authorities and will be renegotiable (unlike the bailouts or other parts of the governance system which are more set in stone).That said, they will come with significant “monitoring” – which, to us, evokes the feeling of the EU/IMF/ECB Troika trips to bailout countries.

• The loans will involve “limited fiscal transfers across countries”, the large majority of which would come through the lower interest rate on loans compared to the borrowing countries usual market rate. The open admittance of fiscal transfers has slipped into the draft, this sort of open admission is rare in the eurozone crisis, but given that the contracts are an explicit trade off, it is not entirely surprising (again, as we've argued).

• “The specific amount of financing would not be linked to the direct cost of reforms”. Instead it will be used more generally as an incentive to reform and aid any parts of the economy that need it or to help relieve funding pressure generally. This makes some sense since simply ‘paying’ for reforms seems rather circular and dictatorial. However, making sure the level of reform demanded matches up to the loan size will be very tricky.

So this is something that could fly with the Germans, politically, but how much difference will that make in practice? There are already numerous platforms for reform – bailout programmes, precautionary credit lines, macroeconomic surveillance and budgetary oversight (as well as good old political pressure).

In the end it all comes down to the money. How much will be available and at what price? These questions are yet to be answered, but as with much in the crisis, the likelihood of a muddy compromise looms large.

German business magazine welcomes OE initiative: “Finally - protests from business!”

Leading German journalist and author Bettina Röhl has written a long op-ed for Germany's leading financial magazine Wirtschafts Woche, welcoming the new Open Europe initiative that sees businesspeople across Sweden, Britain and Germany unite for the first time to call for bold EU reform.

In her piece entitled, Finally - protests from business! Röhl commends business leaders for addressing "the blind alley the EU is in.”:

"Now business leaders have spoken up -- some of them for the first time. This is not only good, but it is long overdue. All too often, business leaders find it too difficult to become involved in the political debate....It is not that initiatives were surprising in their substance, and neither are they new. But what is new, is that business itself is speaking. It is formulating its own needs, which are also the needs of the economy of a whole.”

Röhl concludes:

"Anyone who wants to rob Europe of its diversity and drown it in Brussels fatuity, and all of this under the roof of a single currency, has failed splendidly in their rigidity. By throwing their gaze inwards rather than towards to world markets, they either do not care about European competitiveness, or, they have not understood the global economy."

So, we've mostly had positive responses across the board to our joint-initiative - with the odd exception. A leader in the Swedish regional paper Göteborgs-Posten, for example, thinks it has cleverly spotted two “contradictions” in the article signed by some of Sweden's top business people in Dagens Industri.

Firstly, the leader argues that it is inconsistent to call (as we do), for less EU regulation and more services liberalisation – because the latter would require “common rules.” That argument doesn't cut the mustard, we're afraid.

As we’ve pointed out many times before, it's of course fully possible to be in favour of “more Europe” in areas like services liberalisation, and less EU regulation in other fields where it makes less sense for Brussels to be involved. Or is the paper really suggesting that the EU regulatory framework is pareto optimal at the moment and that there's no room for a reform package whose net effect is less but better EU regulation? To bring it closer to home, it's fully consistent to support an ambitious services directive while opposing, say, heavy-handed EU regulation on snus (a variant of dry sniff which is close to religion in Sweden - but a sales ban exists in the rest of the EU).  Also, in theory, under our preferred option – mutual recognition or a “passport” – you wouldn’t actually need more EU harmonisation, but let’s not split hairs. (Suggested reading: Open Europe: Services report, Open Europe blog: Services liberalisation ).

Secondly, the Göteborgs-Posten's leader claims that to in order to "give citizens a stronger say over EU, more EU decisions needs to be made by directly election institutions – like the EU Parliament. Which in turn means more supra-nationalism [or federalism]”.

Yes, that’s the purist, federalist version of how to close the EU's democratic deficit - transfer ultimate democratic accountability to the EP. However, where the leader finds its “contradiction” in the business article is hard to see. This federalist theory is a perfectly respectable one but it reached its prime about a decade ago. To some, the EP might still be part of the answer, but the debate has now self-evidently moved on to other ways in which to strengthen democratic legitimacy, including boosting the roles of national parliaments (where the Dutch – not the British – are leading the way). Göteborgs-Posten is about ten years late to this debate.

Nice try though.

Bottom line: In order for the EU to truly compete in the global economy, it needs to reform. It needs to be more flexible.  It needs fewer rules with a sharper focus. It needs to give  entrepreneurs the space to do what they do best: generate wealth and opportunity. With the right reforms, Europe totally has the potential to rise to the challenges of the 21st century.

 
To find out more about our initiative to ensure that Europe makes the reforms it needs order to be able to compete in the 21st century, click here.

ECB preview – ECB edges towards rate cut as inflation drops

Interest has grown in this month’s ECB meeting, after inflation surprised on the downside last month, falling to 0.7% - far below the ECB’s 2% target.

In all likelihood, the discussion will not be too different from previous monthly meetings, but there are a few points worth flagging up.

A rate cut in November or December?

• The consensus is now moving towards a rate cut this month, or more likely next month. As we pointed out before, this will have little impact given that rates are completely detached from the ECB’s main interest rate and the transmission mechanism remains broken in much of the eurozone. Ultimately, it is a signal that the ECB is keen to keep loose monetary policy. 
• The ECB, though, could well hold back for a few reasons. Firstly, it probably wants to see how the nascent recovery in the eurozone develops. Secondly, it knows this is probably its final rate cut and wants to time it correctly. Thirdly, its medium-term forecast is for inflation to recover (although this is likely to be revised downward in December). 
• FT Alphaville also highlights the interesting point that, given that this will likely signal the end of rate cuts, the response could even be a slight increase in market rates.

A new LTRO in the New Year?

• The shrinking of the ECB balance sheet continues, as eurozone banks are repaying the LTRO loans. Liquidity is dropping rapidly in the eurozone and short-terms rates have edged up somewhat – creating a de facto tightening of ECB policy. This is exacerbated by the continued easing bias by the other global central banks.
• That said, the previous LTROs have served to increase the sovereign-banking loop. They also remain a blunt tool since the amount of liquidity injected relies on demand, while the prospect of this lending being stigmatised under next year’s stress tests could discourage banks from tapping it.

Euro strength weighs on the ECB’s mind

• The strength of the euro in recent weeks, particularly against the dollar, has been covered widely with an increasing number of investors and politicians calling for action on this front. 
• Although the ECB has stressed that it does not target the exchange rate, it has shown before that it certaintly considers it. Draghi has shown a willingness to ‘talk down the euro’ previously, and is likely to try and do so again. However, turning this into lasting success is tricky and clamour for more concrete signs could increase.
• Failure to address the issue also leaves the currency open to volatility, as markets struggle to interpret the ECB’s vague signals and balance them with more defined ones from other central banks.

What to do with the deposit rate?

• This is another aspect weighing on the ECB’s collective mind. As we pointed out before, a cut to negative territory could have many unintended consequences, and is unlikely to be risked in anything but the worst circumstances. Still, the desire to maintain some ‘corridor’ between the regular rate and the deposit rate could make the ECB think twice about cutting rates at all.

As the above suggests though, we stick by our view that the ECB does have limited tools to help promote economic growth. This meeting is also likely to be another test of its new communication policy and whether it can really have lasting market impact. Ultimately, though, pressure for some concrete action from the ECB is likely to increase as long as inflation remains subdued.

European Commission forecasts fragile recovery in the eurozone

The European Commission today released its autumn 2013 economic forecast. The EC broadly sees a

recovery in the eurozone, but does highlight that it remains fragile and that unemployment is expected to increase while further austerity also seems likely. The key figures have been widely covered so we won’t rehash them here. Below we pick out a few key points from some key countries which caught our eye.

CYPRUS
Not much new in what remains a dire forecast for Cyprus. In an otherwise sea of declining figures, net exports remains the one hope as a source of positive growth. Ultimately, any success in this area will be determined by the removal of capital controls. Until this is cleared up, significant uncertainty will remain.

FRANCE
France is facing low growth for this and next year (0.2% and 0.9% respectively). In the meantime, unemployment is going to increase slightly, as “the positive effects of the recent labour market reform are only expected to be visible from 2015.” Unsurprisingly, the Commission notes that most of the adjustment in France has so far come from tax hikes – and warns that “GDP growth significantly below potential and revenue shortfalls, which may be due to unusually low tax elasticity with respect to GDP, are having a negative impact on the nominal deficit.” Actually, the Commission already believes that, absent new measures, France will miss its deficit targets for 2014 and 2015.

GREECE
Despite a positive tone, the figures still make for difficult reading. The forecast recovery is reliant on jumps in exports and in particular tourism, something which is far from guaranteed particularly if the euro remains strong. Also, investment is expected to go from a 5.9% contraction in 2013 to 5.3% growth in 2014. Even from a low base, this looks like a heroic turnaround. Unemployment is also expected to begin dropping next year, over the course of the crisis forecasts on this front have proven misguided. The signs suggest it could still increase slightly or at least remain elevated.

IRELAND
Importantly, the adjustment in Ireland will become increasingly reliant on domestic consumption and investment, the outlook of which remains uncertain. Exports will continue to contribute but significantly less so than recently, while public spending will continue to be a drag on GDP.

ITALY
In line with the IMF, the Commission sees the Italian economy shrinking by a further 1.8% this year and then go back to limited growth next year. The Commission admits that its prediction “does not incorporate the benefits from the full implementation of the adopted structural reforms, as they could take more time to materialise.” Interestingly, the report seems to suggest that the potential benefits of “projected moderate wage growth” in terms of price competitiveness could be offset by the appreciation of the euro vis-à-vis other currencies. As regards Italy’s gigantic public debt, the Commission believes it will begin to fall only in 2015.

PORTUGAL
Again a familiar story, with a tentative turnaround off the back of increasing investment and exports. However, the Commission highlights an important downside risk from the interventions of the Portuguese Constitutional Court, which have already threatened to derail Portugal’s bailout programme. EU Economic and Monetary Affairs Commissioner Olli Rehn reiterated this point in his press conference.

SPAIN
Despite some positive signs, the Commission is quite clear that “still large adjustment needs will constrain the strength of the recovery” in Spain. Furthermore, “financing conditions for households and companies remain relatively tight, in particular for smaller borrowers.” Confirming our previous analysis (see here and here), the Commission notes that the recent decline in Spanish unemployment “was largely driven by a contraction of the labour force and some seasonal factors.” On the deficit side, the Commission has no good news for Spain. Without additional measures, the deficit is expected to increase to 6.6% of GDP in 2015. Remember, Spain has already been given two extra years to cut its deficit and bring it below 3% of GDP by 2016.  

SLOVENIA
Along with Cyprus, the only country forecast to contract next year. Reliant on exports to limit this contract as domestic demand, investment and public spending collapse. The key will be the upcoming bank recapitalisation which the Commission forecasts will cost 1.8% of GDP (as we have noted before, this cost could end up being higher). Whether the government can afford this without external help remains to be seen.

GERMANY
Unsurprisingly, Germany is in a better shape than its eurozone counterparts – with its economy projected to grow by 1.7% and 1.9% in 2014 and 2015 respectively and the unemployment rate expected to keep going down to 5.1% in two years’ time. According to the European Commission, “After a temporary deceleration in 2013, growth in wages and compensation per employee is set to reaccelerate, so Unit Labour Cost growth would remain above the euro area average” – which should help the rebalancing. Interestingly, the Commission’s own figures also show that Germany is breaching the threshold of 6% of GDP for current account surplus. Will Germany get some sort of official warning for this?

A few interesting points then, but as is often the case with these forecasts, they raise as many questions as they answer. Next week’s assessment of the macroeconomic imbalances may provide a bit more meat to the European Commission’s analysis and given the recent political uproar, its view of current accounts could make for interesting reading. In any case, it’s clear that the EC continues to see this as a very fragile recovery.

Otmar Issing: EU will only live up to expectations when tendency toward centralisation and bureaucratisation resisted

This post is part of a series of interviews carried out by our sister organization, Open Europe Berlin. To read the original interview between Otmar Issing, the former Chief Economist of the European Central Bank, and Open Europe Berlin in German click here.

Otmar Issing addresses the audience at the Open Europe Berlin launch, Oct.2012

OEB: What does Europe mean to you?

Issing: Following the terrible wars and dictatorships of the past, for me, Europe means a continent of peace and freedom.  The freedom to travel, and particularly for young people -- to learn, study, and to make friends beyond national borders. The single market, a barrier-free market serving over 500 million people, is the economic dimension, and the prerequisite for prosperity and employment in Europe. 

OEB: What does the European Union mean to you?

Issing: The European Union embodies the institutional structures, which preserve the aforementioned achievements.  The European Union will live up to expectations only when the tendency towards centralisation and bureaucratisation are resisted. 

What does the euro, the shared currency, mean to you?

Issing:The euro represents a promise of a stable currency to the citizens of the euro area.  During the first 14 years of the euro, the central bank fulfilled this promise by way of its obligatory price stability policy.  However, the existing economic policies of many countries continue to be contradictory to [the ECB's] policy, which is absolutely necessary to the guarantee of long-term stability for the euro and the eurozone. 

"If the euro fails, then Europe fails!" To what extent do you agree or disagree with this statement?  

Issing: Europe is far more than the euro. It is more than currency and economy. But a collapse of the euro, which I consider rather unlikely, would indeed cause considerable economic and political turbulence and it would set European integration back. 

'More Europe' in which form of the EU? In which policy areas should the European Union (a) do more; (b) change its practice; or (c) do less? 

Issing: ‘More Europe’ is a mantra, which in my opinion, lacks concrete content and easily leads to the misguided adoption of ever further centralization.  Should the EU wish to realize its aspiration of becoming the leading voice for Europe on the global stage then it must:

• Create the preconditions for growth and employment;
• Encourage the individual member states to take responsibility for the implementation of necessary reforms;
• Accommodate the principle of subsidiarity, rather than continuing to shift competencies to the European level. 

Spanish unemployment: A temporary turnaround?

New data on Spanish unemployment are out today. The headline figures look, once again, rather encouraging. The overall unemployment rate has fallen below 26% in the third quarter of the year, and there are 39,500 employed people more than in the previous quarter.

The number of unemployed people has gone down by 72,800 - which is the largest decrease in a third quarter since 2005.

However, a few points are worth making:

• The rise in the number of employed people is due to an increase in self-employed and temporary workers. The number of employees on permanent contracts has actually fallen by 146,300. One can see the glass half-full or half-empty here. This finding can mean that the Spanish labour market is becoming more flexible, or just that the increase in the number of employed people is driven by seasonal workers - especially in the tourism sector.

• Employment is growing in the services sector, but is decreasing in agriculture, industry and construction. Another sign that the improvement in Q3 figures could be tourism-driven. This is not, in itself, a bad thing - given tourism is definitely one of Spain's key resources and it is obvious that the Spanish economy needs to rebalance (away from construction). But it can't quite be seen as a permanent source of growth, since the flow of tourists is per definition dependent on which season of the year you're in.

• As we noted on this blog when the figures for Q2 came out, the number of active Spaniards (those working or actively searching for work) continues to go down - marking a further 33,300 decrease.

• Seasonally adjusted data show that the unemployment rate has actually increased by 0.21% from the previous quarter, and that the level of employment has not stopped going down since Q2 2008. 

European Council draft conclusions: have Merkel's 'reform contracts' made a comeback?

As we noted in our previous blog post - and as we predicted in our briefing trailing the German elections - Angela Merkel could now well be pushing for so-called 'reform contracts' or 'competitiveness pacts' (which is what they're called in the CDU/CSU manifesto). The idea involves trading exceptionally strong reform commitments in the eurozone periphery in return for German cash.

We've managed to get our hands on an updated version of the draft European Council conclusions (which is doing the rounds in Brussels) ahead of the meeting of EU leaders later this week.

And what do you know, the following paragraphs have made it in (our emphasis):

"The Commission will provide a first overview of the implementation of country-specific recommendations that will be a basis for the monitoring of their implementation. This will also assess growth and jobs enhancing policies and measures, including the performance of labour and product markets, the efficiency of public service, as well as education and innovation in the Euro area.

On this basis, work will be carried forward to strengthen economic policy coordination, including on the main features of contractual arrangements and of associated solidarity mechanisms."

It's a vague formulation - and hard to know exactly what it means - but we think it's at least fair to assume that the idea is back on the agenda (our view is it never quite went away). As we've argued repeatedly, the kind of beefed-up supervision and enforcement that the Germans have in mind would most likely require EU treaty change. The nature, scope and timing of such a Treaty change is anyone's guess at the moment, however.

Dutch contortions on budget highlight potential limits of eurozone rules

Jeroen Dijsselbloem (L) and Olli Rehn (R)

The Netherlands, Germany's most prominent triple A ally, has been through a bout of political upheaval in recent weeks, which could have brought down the government. The troubled coalition of the centre-right VVD and centre-left PvdA was struggling to find a majority in the Dutch Senate for its 2014 budget, which aims to comply with the EU's deficit rules.

After several months of discussions with opposition parties the government narrowly managed to convince three opposition parties last Friday to support measures for the 2014 budget: the left-liberal D66 and two small Christian parties: the Christian Union and the SGP.

European Commissioner Olli Rehn's conflicting statements on the issue illustrate how the Commission now must attempt to cajole the member states into line. He suggested in June that the Netherlands should ideally aim for a 2.8% deficit, with Finance Minister (and Eurogroup Chairman) Jeroen Dijsselbloem responding that the 3% EU deficit target was already difficult enough. This week Rehn praised the Netherlands for reaching a deal on a 3.3% deficit in 2014, even saying that the US should follow the example and "go Dutch". By the way, the government's own economic advisory agency, the CPB, thinks the real deficit will be 3.5%.

Martin Visser, the finance editor of the Netherlands' most-read daily De Telegraaf commented that:

"Even before all the calculations are made, Rehn provides a political judgment instead of a purely economic one."

When push comes to shove, the European Commission is always liable to grant a bit more wiggle room to national governments - illustrating the difficult in enforcing the EU's souped-up budget rules. This week German Finance Minister Wolfgang Schäuble criticised Rehn’s decision to exempt large scale public investments from calculations of member states’ structural deficits, describing it as a “re-interpretation of criteria”. What constitutes a 'structural deficit' is, of course, always open to debate and therefore finessing.

On a side note, Dijsselbloem's role as Eurogruop chair is undoubtedly getting tougher. Telling other eurozone member states to get their house in order when your own country has been in the EU's "excessive deficit procedure" since 2009 must be increasingly difficult.

So, after a whole range of eurozone reforms (think Fiscal Pact, six-pack, two-pack etc) the lesson seems to be that legal rules just won't trump politics.

Plus ça change...

Eurozone inflation hits its lowest levels for three years

Eurostat yesterday released its latest inflation statistics and the data for the eurozone provides some food for thought.

Inflation reached its lowest levels (1.1% on an annual basis) since February 2010. This might seem surprising on the surface given all the talk of a eurozone recovery and a turn around. Why hasn’t inflation followed? Well, generally inflation is a lagging indicator and therefore any recovery will take some time to feed through to prices and wages. However, as the graph below suggests, there is more at work here.

There has been significant disinflation (falling inflation but not negative inflation, which is deflation) in the eurozone and more importantly in the PIIGS. For all the talk of internal devaluation in the eurozone it has taken some time to feed through to the Consumer Price Index (CPI). Due to factors such as indirect tax increases and sticky prices and wages, it has taken some time for the impact to be fully felt – now that this is beginning to happen it is unlikely to stop immediately and could carry on for some time.

The data also shows that because of the effect described above, inflation in the PIIGS is diverging from the rest of the eurozone somewhat and particularly from the stronger countries in the north.

What does this mean for the ECB?

The FT has a couple of pieces today discussing this, calling on the ECB to do more to tackle the disinflation in the eurozone. While inflation is clearly well below the ECB’s target, the current nature of the inflation does present some issues for ECB policy.

• Firstly, there is the standard one size fits all conundrum – as inflation plummets in the PIIGS it remains stable in the north and threatens to increase as these countries post higher levels of growth. Adjusting the policies to suit these countries more could prompt unwanted outcomes in the stronger countries. Politically, it’s also worth remembers just how wary Germans are of inflation, as we highlighted recently. Finding the correct line between these two camps is incredibly tricky for the ECB.

• Secondly, while the struggling eurozone countries could use a boost in demand, the ECB may struggle to find the necessary targeted approach to do this. One measure which has been widely mooted is another long term refinancing operation (LTRO) to help boost liquidity in the market. However, as the graph above shows, there was no boost in inflation from the previous rounds, despite it totalling around €1 trillion. This is largely because the money did not filter through to the real economy and therefore did not impact consumer price inflation. Although things are improving there is still plenty of fragmentation in the market and loans to the real economy continue to fall in the PIIGS.

• This point also applies more generally in our view in terms of the tools at the ECB’s disposal. As we discussed at length here, although the ECB can do much to stop the break-up of the euro, it has fewer tools to help promote economic growth in the current circumstances, particularly in specific economies.

• In our view disinflation is not such a risk for many of these countries, in fact many need to see reductions in prices and wages to help boost their competitiveness, although it does of course have knock on impacts for their already flagging GDP growth. That said, deflation is a bigger risk because these countries have such large debt to GDP levels, which would only be exacerbated by deflation – although for countries such as Greece the need for further debt relief is already very apparent so the marginal impact of deflation is smaller.

All in all then, low inflation in the eurozone seems here to stay for some time due to the periphery pulling the average down, even if a fuller recovery eventually materialises. This will create some new issues for the ECB to deal with, however, given the divergence between countries it may well struggle to find the tools to have a big impact on this.

'Budget Deadline Day' in Europe

As you may have noticed, yesterday saw numerous governments across Europe unveiling their latest budgets for the coming year. Rather than just being a coincidence, this is down to the fact that yesterday was the deadline for eurozone governments to submit their budget plans to the European Commission – 'Budget Deadline Day', if you will.

As part of the ‘Six-pack’ set of rules, eurozone governments must have their budgets endorsed by the Commission, although the ability to actually force changes to the budget plans is limited for those countries which are not missing their targets already (except for significant peer pressure).

As with football’s transfer deadline day, there were some frantic negotiations, albeit without the minute to minute media coverage. Below, we take a look at the budgets of the Italian, Irish and Portuguese governments.

Italy
Italy yesterday unveiled its new ‘Stability Law’ – the budget guidelines for 2014-16. There’s some encouraging stuff in there, notably a package of tax cuts for businesses and workers worth €10.6bn over three years (of which €2.5bn to be cut in 2014). Nothing massive, but it's a start. The money to cover for these cuts is due to come from a number of public spending cuts. However, the draft budget will now have to be adopted by the Italian parliament, and some of the measures may change.

Prime Minister Enrico Letta has confirmed Italy aims to bring its deficit down to 2.5% of GDP by the end of next year. That said, the problem for Italy remains its weak growth – which in turn threatens its fiscal targets. Last week, for instance, the Italian government had to adopt a set of urgent measures to find a further €1.6bn and make sure the deficit stays below 3% of GDP this year. Unlike other countries, the budget may hold less importance for Italy’s economic future with the focus now on much needed political reform and improvement in the business environment.

Ireland
Debate over the Irish budget has been going on for some time, and the government managed to secure a lower level of headline cuts than expected ahead of time - €2.5bn compared to €3.1bn. However, the budget remains controversial with the Irish Independent running the front page headline, "Unkindest cuts", because they fall on pensions, healthcare and unemployment benefits for young people.

For the most part, although this budget was about tinkering around the edges rather than making the huge cuts we have seen before, the government focused on adjusting lesser known taxes to reap numerous small savings. Interestingly, the government also committed to reducing tax evasion and tackling the view of the country as a ‘corporate tax haven’. It will be key to see if this impacts the number of multinationals locating in Ireland and if it has any knock-on impact on economic growth.

Portugal
Of the three, this is probably the most concerning budget. Following a difficult summer for Portugal, politically at least, the government has once again been forced to find a further €3.2bn in cuts. However, the government has once again taken the same approach by heaping the cuts of public sector workers pay (up to 12% in parts) and on pensions. Action on these areas is needed. However, it has also been repeatedly struck down by the Constitutional Court. This might be setting the scene for another showdown.

This has evoked concerns from within the Commission, and it will be interesting to see whether a full endorsement is forthcoming. Portugal also confirmed it will miss this year’s deficit target and the continuing push to ease next year’s target suggests little confidence that it will meet that one either. The good news is that Portugal’s borrowing costs remain well below their peak, and some market access once it exits its bailout next year seems likely. That said, unless it can get a hold of the public sector reform needed, some additional aid still looks likely.

Overall then, a bit of a mixed bag. Few marquee measures, but some positive moves in terms of focusing cuts on spending rather than tax hikes.

Berlusconi virtually out of Italian parliament, but clearly not yet out of Italian politics

The Italian Senate's Immunities Committee has recommended that Silvio Berlusconi be ousted from parliament as a result of his recent tax fraud conviction. The Committee will now submit a motion to the full Senate for approval within the next 20 days. The final plenary vote is supposed to be a mere rubber-stamping exercise, so we wouldn't expect any surprise. 

A couple of quick thoughts:

• The expulsion from parliament would certainly be a hard blow for Berlusconi, but wouldn't mean the end of his political career. With all due differences, comedian Beppe Grillo has shown that it's fully possible to lead a party from outside parliament. 

• Most importantly, Berlusconi's large public support is unlikely to evaporate overnight. In the eyes of many Italians, Il Cavaliere remains the example of a successful self-made entrepreneur - and the victim of a conspiracy of left-leaning judges.

• Indeed, once the process to expel him from parliament is completed, Berlusconi will find himself with a couple more trials under way - and no more parliamentary immunity. However, he remains unlikely to spend any time behind bars because of his age.

• That said, the key aspect at this stage is perhaps what will happen to Berlusconi's party in the near future. As we noted in our previous blog posts, the confidence vote in the Italian Senate earlier this week triggered a mutiny that ultimately forced Berlusconi to an unexpected U-turn. Things seem to have cooled down a bit, but the risk of a party split off the back of Wednesday's rebellion remains. This would be a bigger setback than the loss of a seat in parliament.

• On a more general note, one of the reasons why Berlusconi still looks likely to remain a rather influential figure in Italian politics is the lack of an obvious substitute to take the lead of Italy's centre-right forces. So far, Berlusconi has to a large extent, either by hook or by crook, been able to keep his side of the political divide together. The day he leaves the stage, we may well witness the fragmentation of that side of the Italian political spectrum. The impact of such a split on the country's political stability is difficult to predict at this stage.

Things looking rosier for Italian PM Letta, as Berlusconi faces potential mutiny

As we argued in our post yesterday, it was "not unrealistic" for Italian Prime Minister Enrico Letta to win tomorrow's vote of confidence in the Italian Senate, even if, on paper, he didn't have the numbers to do so.

A potentially key development now seems to confirm our first impression. Carlo Giovanardi, a centre-right Senator and a senior member of Silvio Berlusconi's party (see picture), has just confirmed earlier rumours that a new pro-Letta group of 'rebel' centre-right senators is to be formed, and will support the government tomorrow.

Giovanardi said,

"We do have the numbers [to form a new group], we are even more than 40, and we firmly want to maintain the balance of the government. This is why we will give [Letta] our vote of confidence." 

Clearly a game-changer. If this new group comes through with the votes, then Letta will have a much bigger chance of winning the vote of confidence and staying in power.

Equally significantly, if Berlusconi keeps pushing for a showdown but Letta ends up winning the confidence vote thanks to defectors from Il Cavaliere's party, this will almost inevitably have consequences for the future of the centre-right in Italy.  

Keep following us on Twitter @OpenEurope and @LondonerVince for real-time updates.

German Elections: The European Reaction

Mixed Reaction in the Med

Spanish daily El Mundo runs with the headline “Merkel, Merkel über alles”, while an article in the paper argues that a Grand Coalition (composed of Merkel's CDU/CSU and the centre-left SPD) “would lead, to a certain extent, to a relaxation of the austerity Merkel imposes on Europe.”

Meanwhile, Spanish Foreign Minister José-Manuel García Margallo went even further with his hopes that new German government would relax the pace of austerity in the eurozone's Southern periphery, telling Cinco Dias that “Eurobonds will come.”  (We disagree with this assessment, read our German election briefing to find out why.)

An editorial in El Pais suggests that the result “validates [Merkel’s] European theses”. Les Echos agrees, arguing that it is “illusory” to expect a Grand Coalition to “fundamentally” shift Berlin’s approach to the eurozone.

In France Les Dernieres Nouvelles D'Alsace argues that the election outcome is "unlucky for France, whose voice does not count anymore, and will only be heard again when the French economy improves". Meanwhile, Le Figaro splashes a beaming Merkel on its front page with the headline, "The Triumph of Merkel," pointing out that a victory like this has not been seen in over half a century.

From Greece - less congratulatory tones. An article in Greek daily Ta Nea carries the headline, “Europe becomes Merkeland after the triumph of the Queen of austerity.”

 Northern Europe congratulates victorious Merkel - but warns of the challenges ahead

A leader in Dutch daily Trouw argues that Merkel was re-elected because of the German public's "reluctance to engage in big adventures." However, it adds that "for Europe, Merkel's victory is good news...Merkel believes in political and monetary entrenchment of her country in Europe - and without Germany the euro is a lost project."

Meanwhile, De Volkskrant quotes an unnamed EU ambassador of a eurozone country saying that the member states are "27 poodles on the leash of Angela Merkel". The newspaper adds: "the Empress herself stresses that she is in favour of a European Germany, and that is undoubtedly true". The paper goes on to criticise Dutch PM Mark Rutte, saying, "Mark wants what empress Angela wants. The German voter has on Sunday decided the European agenda of Mark Rutte".

Belgian centre-left daily Le Soir  takes a consiliatory tone, arguing: "Certainly the Greeks don't like [Merkel]. But what would Greece and the euro today be if she hadn't insisted that the Greeks must tighten the belt before receiving European funds? Who else in the European Council would have managed to keep heads cool when having to listen to the cries on the streets of "Merkel, Hitler"?"

Meanwhile, Politiken from Copenhagen congratulates Merkel, while urging her to take action, saying,“The key is that the German government creates stability and firmly stands behind its support of EU and the euro... It is necessary that the new German government puts itself at the forefront of a European recovery"

Austria's Der Standard reports on Merkel's "middle-direction, mediocrity, " which "gives the Germans soundness and stability." Separately, a piece in the Telegraph argues Merkel's re-election should not lull the Germans into complacency, which could prevent it from making the necessary reforms to fix the underlying structural weaknesses in its economy.

Central Europe: Move forward the debate

Lidové Noviny from Prague takes a more critical view of Merkel's re-election, saying that she has "brought no solutions, and the eurozone remains a risk for the lasting prosperity of Europe." The paper writes that, "It is indeed sad that the euro-sceptic party Alternative für Deutschland has narrowly failed to reach the Bundestag. This would have opened the political debate in Germany. But next year will see elections for the European Parliament and then the AfD could get a breakthrough."

Polish daily Rzeczpospolita says that "a miracle is expected from Merkel: reform the EU to make it attractive for future generations. The new government has to show that it is possible in crisis-torn Europe to combine sound economic policies with growth incentives. The young generation needs a signal that it is not eternally damned to live worse than their fathers and grandfathers."

Varied reactions then as expected. However, there does seem to be a consensus that, for better or worse, Merkel will continue to set the tone and agenda for Europe for some time to come.

Why Germany's 'boring' elections should still concern David Cameron

Our Nina Schick wrote this op-ed for today's City AM:

For a vote touted as decisive to the future of the Eurozone, the German election campaign – which reaches its climax on Sunday – has been lacklustre. With barely any talk of Europe, it’s been defined by domestic issues – from data protection, to rent control and taxation.

We Germans love a good debate on taxation. But while Germany’s main parties can differentiate on domestic policies, there is no substantial difference on the Eurozone. Long after the vote, and regardless of which coalition takes the helm in Berlin, Germany will remain a slow and deliberating player. No surprise, then, that commentators have dismissed the campaign as the “most boring” in recent memory.

Coalition dynamics may make the vote more interesting, however – and the UK, especially, should take heed. While most initially thought the likely outcome would be a continuation of the current centre-right coalition between Angela Merkel’s CDU/CSU and the liberal free market FDP, this may be changing. With as many as 30 per cent of voters undecided, this election will go down to the wire.

Recent polls show support for Merkel’s CDU/CSU dropping, while support for the centre-left Social Democrats (SPD) has risen. The latest figures predict that Merkel would not be able to form a parliamentary majority with the FDP. There is even a chance the FDP won’t make it past the 5 per cent threshold needed to win seats in the Bundestag. Last weekend, the party crashed out the Bavarian parliament after state elections.

We may see a backflip to the grand coalition of 2005: Merkel’s CDU/CSU and the SPD. While these dynamics won’t change much in the Eurozone, they are important to the UK.

It would be in Britain’s best interest to see a continuation of Merkel’s current coalition. She is a key ally for David Cameron, and will have a decisive influence in determining the success of his EU renegotiation strategy. Both Merkel and Cameron have a similar vision of the EU: based on free trade, reduced regulation, and improved competitiveness. It’s unlikely that anyone other than Merkel will become Chancellor. But if she enters a grand coalition with the SPD, things might not look so rosy for London.

First, in German politics, the foreign ministry usually goes to the junior coalition partner. While relations between Paris and Berlin have been strained since Francois Hollande took office (his spending rhetoric rubs Germans up the wrong way), a SPD foreign minister would be more likely to turn to Paris than London. Under the last grand coalition, the SPD’s foreign minister Frank Walter Steinmeier (also a contender for the post this time around) notably undermined some of Merkel’s foreign policy plans.

Second, the SPD is keen on further financial regulation. Only a few days ago, its parliamentary spokesman vowed that pushing forward delayed plans for a financial transactions tax would be a “high priority” for the SPD if they enter into a grand coalition. Not great news for the City of London.

In short, German coalition semantics may not mean much to the Eurozone – but they certainly will to the UK.

No quantum leap on eurozone integration after the German elections

Our Director Mats Persson has an op-ed in today's Wall Street Journal, where he argues,

A satirical cartoon in the Italian magazine L'Espresso, depicting a father and son, illustrated it best: "Papa," says the son, "I have to go to the toilet."

"Hush," answers the father. "Hold it until after the German elections."

By now most commentators have realized that there won't be a quantum leap toward more eurozone integration following the German elections. However, while most have focused on coalition dynamics, there are in fact three far more profound limitations that will continue to restrict Germany's ability to act in Europe long after the Sept. 22 elections, and will prevent any swift move toward a euro-zone banking union or fiscal union: One of these limitations is political, one is constitutional and one is economic.

First, German public support for the euro remains highly conditional. According to a recent Open Europe/Open Europe Berlin poll, a majority of Germans support more euro-zone integration if it means more central controls over other countries' taxation and spending. However, a clear majority remain opposed to any policy that involves putting German cash on the line, such as further loans to struggling euro-zone countries, write-downs of existing loans, a joint banking backstop or fiscal transfers.

This is neither surprising nor new. In the 1990s when the euro was forged, the gulf between public and elite opinion was already conspicuous. But despite mounting scepticism, the cost of saving the euro hasn't actually trickled through to people's wallets. If that ever changes, via a slow-down in the German economy, or if savers start to really feel the pinch from the European Central Bank's low interest rates or future possible money printing, we may quickly hit the limit of what the public is willing to endure.

Let's not forget that, given Germany's regional structure, there's almost always another election on the horizon. Between now and when Greece is supposed to exit its bailout program in June 2015, for example, there will be at least five state elections in Germany, as well as the European elections in 2014. German politicians cannot escape public opinion.

Second, the German republic was set up after World War II specifically to prevent hasty centralizations of power. Ironically, this was done at the behest of the Americans and the British—though both Washington and London have been vocal critics of Berlin's cautious approach in the euro-zone crisis. Systemic circuit-breakers such as Germany's Constitutional Court were put in place to counter rash decision-making, while the modern German constitution in 1949 got rid of the federal government's Weimar-era emergency powers.

Today, slowness and consensus are encoded in the very fabric of the German constitutional DNA. This will not change after the elections, nor should we wish it to. While it is unlikely to rule against the ECB's bond-buying program, the Constitutional Court will continue to lay down new red lines for what Germany can and cannot do. The Court has already said that before the euro zone moves to a transfer union, a change to the German constitution will be needed, which will first require a referendum.

It's constitutionally complicated, for example, to write down Greek debt, given that 75% of it is now owned by taxpayer-backed institutions in Germany and the rest of the euro zone. If those institutions take losses on what until now have been loan guarantees, that will in effect turn the euro zone into a transfer union for the first time, which the Constitutional Court has said is illegal. German politicians will continue to have one hand tied by the court in Karlsruhe for years to come.

Then there is the third and most fundamental limitation: Germany can't afford to underwrite the euro forever. If implicit debt, such as the liabilities of Germany's social-security system, are taken into account, the real level of German public debt would be 192% of GDP—much higher than Italy's 146%. Germany has also racked up an exposure to the struggling peripheral countries of around €1 trillion—equivalent to some 40% of its GDP. If Berlin were to begin accepting losses on this, the cost could snowball quickly, as all its sovereign debtors would look for equal treatment. Furthermore, Germany faces a demographic time bomb.

By 2050, the country's current population of 82 million is projected to have declined to around 70 million—less than in 1963. Far fewer workers will be around to finance the country's pay-as-you-go social-security system. This is worse than it looks. Germany, of course, already has its own deeply unpopular transfer union. In this system, out of 16 federal states, only three—Bavaria, Hesse and Baden-Wurttemburgh—are permanent net contributors, with Hamburg moving in and out of that status. Under a hypothetical euro-zone transfer union, these four German regions would proportionally carry a huge burden.

All of this means that there's a relatively stable trajectory to German's EU politics, which defies electoral cycles. So can we expect any movement after Sept. 22? Maybe a little. Particularly in a coalition government that included the center-left Social Democratic Party, we may see some easing of austerity in favor of structural reforms in countries such as Greece or Portugal. But Germans won't give up their deep-held belief in frugality overnight.

Almost any German government is also likely to continue to insist on strong controls over other countries' taxation and spending, most likely via the EU institutions, as quid pro quo for more cash. So the complicated sequencing that's pitting the Germans against the French will continue to dog the euro zone. Make no mistake, Germany will remain a slow, deliberating and frustrating actor for years to come.

Third EU legal opinion of the week, this time on banking union: bad news for Germany?

It seems to be a week for big legal opinions in the EU. We've had opinions on the FTT, the EU’s short selling regulation and now on the European Commission’s plan for a Single Bank Resolution Mechanism (SRM) – a key component of the banking union.

We have noted the importance and implications of the others, but this might turn out to be the most significant - although it is far less categorical in terms of ending the debate.

As we noted when the SRM proposal was published, the plan is based on a significant legal stretch where the 'single market article' (Article 114 of the Treaty on the Functioning of the European Union, TFEU) is used to justify transferring bank resolution powers to the Commission. In particular, Germany raised concerns regarding this legal base, suggesting treaty change may well be needed.

In the meantime, the EU Council of Ministers' Legal Service had been tasked (by the relevant working group for the proposal) with answering two key questions:

i) Whether Article 114 TFEU is the suitable legal basis for adopting the proposed Regulation;
ii) Whether the delegation of powers to the Board envisaged in the proposal is compatible with the EU Treaties and the general principles of EU law, as interpreted by the so-called 'Meroni' case law of the ECJ (see here for some background on the case).

Those who have followed our coverage of the other decisions will notice significant similarities with the short-selling case for example, given that the questions focus around the use of Article 114 and the 'Meroni case'.

However, in this instance the legal opinion seems to mostly side with the European Commission:

"The Council Legal Service has reached the conclusion that the centralised decision procedure described in the proposal cannot be regarded as an isolated regulatory measure with autonomous purposes, but is conceived as an element contributing to an on-going harmonisation process in the field of financial services, without which its establishment would have no sense."

Essentially, the Legal Service shares the Commission's view that the SRM proposal is needed to prevent fragmentation of the single market and that it will be applied uniformly. It also notes that the SRM is vital to the implementation of the Bank Recovery and Resolution Directive and the Capital Requirements Directive (the bank bail-in plans and the EU’s transposition  of the Basel III rules, essentially), while also arguing that, given the move to a single supervisor, a single resolution mechanism makes sense. Later on in the opinion, it is noted that the judgement on whether the necessity of an SRM set up in such a manner is ultimately a political decision – leaving it open to interpretation.

Furthermore, the opinion does contain an interesting caveat:

"The proposal does not contain a robust system to guarantee the budgetary sovereignty of Member States, notably throughout the transitional period during which the target funding level has to be achieved. Purportedly, during this period, the Fund will not have the necessary means to face conveniently resolution decisions and recourse to extraordinary means of funding might be needed…the Council Legal Service is of the view that the use of Article 114 TFEU as legal basis of the proposal would be contingent upon the introduction of an adequate system to safeguard the budgetary sovereignty of Member States."

This highlights that the creation of the single resolution fund could have financial implications for the budgets of member states (an issue which usually requires unanimous approval). This is especially true given that the funds built up from industry levies will not be ready for some time (up to ten years).

The FT notes that the German government has focused on this point and stressed the need to protect budgetary sovereignty. It has also suggested that the recent ruling on the UK short selling case actually backs up their position, given that it shows the limits of article 114 and highlights the limits to transferring new powers to EU institutions (we’re inclined to agree with them on this one). Today's legal opinion reinforces the German government "in its central legal concerns", says the German Finance Ministry.

It seems clear that this opinion is unlikely to settle the debate. Even if it is judged legally sound, the proposal remains hugely controversial from the political point of view. That said, with Germany still weighing up whether to try to renegotiate the proposal or push ahead with its own intergovernmental plan, this opinion could shift the balance.

State of the (same old) European Union

It’s that time of year again, when European Commission President José Manuel Barroso delivers his ‘State of the European Union’ speech, laying out all his hopes and dreams for the coming year – few of which make it through the decision making gauntlet.

This year’s speech seems little different and, frankly, was a bit all over the place.

Barroso talked up the prospect of greater national flexibility, but, as always, within the end-goal of ever closer "political union". He said:

"The EU needs to be big on big things and smaller on smaller things - something we may occasionally have neglected in the past. The EU needs to show it has the capacity to set both positive and negative priorities."

"I value subsidiarity highly. For me, subsidiarity is not a technical concept. It is a fundamental democratic principle. An ever closer union among the citizens of Europe demands that decisions are taken as openly as possible and as closely to the people as possible.

"The European Union must remain a project for all members, a community of equals."

"I believe a political union needs to be our political horizon, as I stressed in last year's State of the Union. This is not just the demand of a passionate European. This is the indispensable way forward to consolidate our progress and ensure the future."

Therefore, despite mentioning subsidiarity, Barroso's end goal remains clear – full political union. A feature of the eurozone crisis has been that Barroso and the Commission have been increasingly sidelined when setting the agenda (which member states now dominate). This is also due to the fact that there will be a new Commission in place soon.

The Q&A session revealed that, despite Barroso's professed desire to "find ways" to "make Europe stronger", he is rather less open in practice.

In response to Conservative MEP Martin Callanan (who had said he had no interest in being European Commission President) he said:

"Let me tell you very frankly, I think that even if you were interested you would not have a chance to be elected as President of the Commission. And do you know why? I’m not saying that happily. Because I think your party, and your group, is increasingly looking like UKIP and the eurosceptic, anti-European group. And I start to have some doubts that you’re going to be elected in Britain yourself, and if it’s not UKIP that is going to be the first force in the British [European] elections. Because when it comes to being against Europe, between the original and the copy, people prefer the original. That’s probably why they’re going to vote more for Mr Farage than for Mr Callanan. And I don’t say this with any kind of satisfaction, because even if we have some differences, we have worked very constructively with the Conservatives – the British Conservatives and the Conservative group – in many areas."

Once again, it seems the Commission would rather help UKIP rather than work for reformers who don't share a belief in 'ever closer union'.

Barroso's analysis of the crisis hinted at his on-going denial of the role of the euro in causing the crisis:

"We can remind people that Europe was not at the origin of this crisis. It resulted from mismanagement of public finances by national governments and irresponsible behaviour in financial markets."

"What I tell people is: when you are in the same boat, one cannot say: 'your end of the boat is sinking.' We were in the same boat when things went well, and we are in it together when things are difficult."

There is still a sign that Barroso believes that all eurozone woes were caused by the financial crisis – though it may have been a trigger and there is no doubt that national finances were mismanaged, there can (or should) also be no denying that the structural flaws of the euro are what have caused the crisis to be as long and deep as it has been.

The Commission's hope that banking union is the eurozone cure has already come up against resistance from Germany, which is deeply sceptical of the Commission's desire to increase its own power. Barroso's insistence that the proposal be implemented in full before next year's elections will not have helped much on this front and simply highlighted how out of touch he remains with the concerns of even core eurozone countries.

So, despite some lip-service to greater flexibility, reform and acceptance of the shortcomings in the EU and the eurozone, the solutions presented by Barroso remain the same – greater political integration. Fortunately, this is very likely to be Barroso's last 'State of the Union' speech, while member states such as Germany and the Netherlands have shown themselves more open to reform.

Berlusconi's swan song may not be easy listening for Letta

September has come, and summer is (almost) over - but the heat won't leave Italy for a bit. The Italian Senate's Immunities Committee has begun debating whether to strip Silvio Berlusconi of his seat as a result of his recent tax fraud conviction. As we wrote on this blog several times (see here, here and here), the outcome of the vote that will follow this debate could be decisive for the future of Prime Minister Enrico Letta's shaky coalition government.

A quick recap:

• Under Italy's new anti-corruption law, Berlusconi won't be able to stand for election for the next six years due to his tax fraud conviction. As we said, he also risks losing his seat in the Italian Senate.

• Berlusconi's PdL party wants to delay the vote in the Senate's Immunities Committee, arguing that the opinion of the Italian Constitutional Court and the ECJ should be sought first. The legal reasoning behind the request is that, according to Berlusconi's party, the anti-corruption law can't be applied retroactively - that is, it doesn't cover crimes committed before its entry into force in December 2012. The problem is the other parties (including Mr Letta's Democratic Party, currently in government with Berlusconi's PdL) are not on the same wavelength and want to wrap everything up as quickly as possible.

• A preliminary vote on the request to refer the matter to the Constitutional Court and the ECJ could take place tonight or tomorrow. It remains unclear when the final vote will happen. However, several key members of Berlusconi's party have made clear that, if the Committee refuses to delay the final vote, it will be the end of the coalition with Mr Letta's Democratic Party.

In other words, Italy seems to be heading towards fresh political instability. If the existing coalition collapsed, snap elections would become a concrete possibility - but not the only one. The ball would once again be in the court of Italian President Giorgio Napolitano, who would presumably try and put together an alternative majority (with the help of 'rebel' Senators from Beppe Grillo's Five-Star Movement and Berlusconi's party) before throwing the towel in and dissolving parliament. 

The Dutch coalition is facing stormy waters

According to prominent pollster Dutch Maurice de Hond, just one year on from last year's elections, the Dutch government coalition of the centre-right VVD and centre-left PvdA would lose more than half of its parliamentary seats if elections were held now. They would only retain 30 of their 79 seats, representing 12% (in the case of the VVD) and 7% (in the case of the PvdA) of Dutch voters.

Geert Wilders’ right-wing populist PVV remains the most popular party, which it has been since late last year, and would double its number of seats from 15 to 32, representing one in five Dutch voters. We commented after the elections last year that the relatively bad results for Wilders and the eurosceptic Socialist Party - which would also see an increase in its seats from 15 to 24 according to the latest poll - was hardly the victory for the centre that some had suggested.

The opinion poll also reveals that 48% of respondents do not believe that the coalition will still be in power in 6 months time, while 37% believe it will.

While there is a majority in the Lower House, the coalition doesn't have one in the Dutch Senate. The Dutch government has already announced that there is an agreement within the coalition on €6 billion in extra austerity measures and that the details will be unveiled by Finance Minister Jeroen Dijsselbloem on "Prince's Day" on 17 September. The plans would see the Netherlands closer towards the EU budget deficit target.

Although the Senate does not traditionally reject the government budget - the last time this happened was in 1907 - the VVD-PvdA coalition has reportedly approached two opposition parties, the D66 and CDA, to see whether they'd like to join the coalition in order to obtain a majority in the Senate. The D66 have refused.

The Dutch economy faces huge challenges, with a housing bust which saw house prices falling 20% below their 2008 peak, while no less than one million Dutch households find themselves in negative equity. That's one in four households with a mortgage. The ECB has expressed concern that mortgages are putting enormous pressure on the financial positions of Dutch banks, while the world's largest bond investor, PIMCO, has noted the Dutch economic crisis may spill over to government bonds, suggesting it will no longer buy Dutch government paper and that the triple A country may face French borrowing levels in future.

The Dutch economic advisory council of the Dutch government has a stark warning:

"Dutch households now have the highest level of long-term debt in the euro zone. In 1995, the debt ratio in Germany was at the same level as in the Netherlands (about 56%); for Dutch households, it is now twice as high as in Germany"

At the same time, the newspapers continue to run stories about the ongoing eurocrisis, with extra assistance to Greece on the horizon. This is something Prime Minister Mark Rutte said would not happen. In addition, as we report in today's press summary, immigration has become a heated topic; according to a recent poll, 81% of the Dutch population are opposed to the lifting of labour market restrictions for Bulgarians and Romanians in January 2014.

In an attempt to address the public's sense that things are out of control, the Dutch government has published its EU “subsidiarity review”, an assessment of what the EU should and shouldn't be doing, which it will present to other EU governments in the coming months.

However, the above would suggest that the Dutch electorate will need a lot of convincing if it is to put its faith in the mainstream parties again at the next election.

Some ratings still matter in the eurozone

A general view seems to have come to pass (and not without good reason), that ratings actions in the eurozone have much less significance these days. This is mostly because the ratings agencies tend to 'lag' the market – meaning that a downgrade only comes once everyone already knows a specific country is struggling. The main outcome is usually a bad-tempered back-and-forth between governments and the agency in question, and then another call for EU regulation of rating agencies.

However, sometimes a rating change comes along that could have some material impact. In this case, it comes from a lesser known agency – Dominion Bond Rating Service (DBRS). In an interview with Spanish daily Expansión this morning, their Head of Sovereign ratings Fergus McCormick warned that Spain’s rating remains under pressure and that it is too early to tell if the crisis has bottomed out (as many in the Spanish government have suggested might be the case). DBRS' latest report on Spain, from March this year, also struck a more cautious tone.

This is interesting because, as Reuters pointed out in July, DBRS is the last rating agency to give Spain (and Italy for that matter) an A rating.

As the article also explained, this could cause problems for Spanish banks for the following reasons:

• They hold a large amount of Spanish government bonds as collateral for their borrowing from the ECB;
• Under ECB rules, the ECB judges collateral based on the highest single rating from four eligible agencies (S&P, Moody’s, Fitch and DBRS);
• The value of these bonds is subject to a haircut – for example a highly rated 10yr+ government bond would be subject to a 5% haircut, meaning a bank could borrow up to 95% of the bond's value under the ECB’s liquidity operations (see here for the full ECB collateral haircuts);
• However, once the rating falls, the haircut to such a bond jumps to 13%. This means banks using such bonds as collateral would have to reduce the amount they borrow from the ECB or produce more collateral to cover their current level of lending.

As of July 2013, Spanish banks were borrowing a combined total of €252 billion from the ECB, although this is well down from a peak of €411 billion in August 2012. This suggests that Spanish banks should have plenty of surplus collateral to fill any hole that opens - the muted market reaction so far also suggests as much. That said, the banks are currently de-leveraging significantly (selling off assets to reduce their balance sheets) and running a tight line in terms of balancing the books and trying to keep costs as low as possible. A hit such as the one described above is likely to be far from welcome.