Have borrowing costs in the eurozone periphery come down too far, too fast?

Over on his Forbes blog, Open Europe’s Raoul Ruparel asks: is there a bond bubble in peripheral Europe? The thurst of his answer is that, while there are good explanations for why costs have come down so far and so fast, they could certaintly have side effects, not least because people misinterpret the reasons for the move. The full post is here, but below are the key points:

What is driving this and is it a bubble?
There are three key factors at work here:

1. ECB President Mario Draghi’s promise to do “whatever it takes” to protect the euro combined with the unlimited bond buying policy of Outright Monetary Transactions (OMT) has driven borrowing costs down since mid-2012. This effect has been amplified by the expectations of further ECB easing, particularly some form of Quantitative Easing (QE), which would bring yields down even more.
2. There has been some success in terms of eurozone reform, particularly with the successful end to the Irish and Portuguese bailouts as well as these countries’ return to the markets, along with Greece. The eventual agreement on banking union and other aspects of trying to correct the structural flaws in the euro (although I believe it is far short of what is needed) has also contributed to the positive sentiment.
3. Possibly the most important factor though is the very low inflation in the eurozone (and even deflation in some countries). Over the past six months this has pulled the borrowing costs across the eurozone down.

This final point is driven home by looking at the rough and ready version of the ‘real yield’ on ten year debt in Europe (10yr yield minus HICP inflation). As the graph below highlights*, when this is done the UK actually borrows at a real rate which is 2% below Ireland’s.

Could this present a problem? (Hint: Yes)
While the process of collapsing bond yields in peripheral Europe is explainable it does still present some serious causes for concern.

• The huge demand for peripheral bonds does seem to have gone too far with respect to the economic fundamentals of these countries. Debt levels have continued to rise – exacerbated by low inflation – while many countries are barely posting any economic growth.
• More concerning though is that this creates very perverse incentives. Many governments can already be seen professing the success of their policies, citing falling borrowing costs and buoyant financial markets. In reality, these are much more down to the ECB and inflation effects mentioned above.
• The risk is that complacency seeps in (some of which can already be seen) and that the reform process in these countries stalls. Italy and France are prime examples of this. While the European Commission does have additional powers now to encourage further reform, when push comes to shove there is little it can do to force reform on an unwilling political class and population, particularly one with low borrowing costs.
• As detailed here, the banking union looks insufficient to break the sovereign banking loop in the eurozone. The efforts to improve the structure of the eurozone have slowed, the risk is they will grind to a halt until the threat of a crisis returns.
• The performance also looks strange relative to countries such as the US and UK which have always borrowed in their own currency for which they are solely responsible and have clear fiscal and central bank backing. Even with the changes to the euro structure and the ECB promises it’s hard to say that, in another crisis, the same issue wouldn’t arise with regards to a comprehensive lender of last resort (let’s not forget, the OMT comes with plenty of conditions and is limited in scope). Even though accounting for the inflation impact, the difference in risk between peripheral eurozone countries and the likes of the US and UK does seem to be being underestimated.

Ultimately, the crisis highlighted that too much price convergence without economic convergence and reform in the eurozone can actually be a bad thing, with resulting perverse incentives and negative outcomes. While the price action in peripheral bonds might not yet count as a ‘bubble’, investors and politicians would do well to remember these lessons when interpreting the record low borrowing costs.

EU states struggle to find common ground for sanctions on Russia

As we laid out in our Divided We Stand briefing, agreement among the EU 28 on how to respond to Russia's role in the Ukraine crisis is not easy to come by. And if the doorstep remarks of EU Foreign Ministers arriving in Brussels this morning is anything to go by -- that trend won't be changing any time soon.

UK Foreign Secretary William Hague, urged the EU to begin preparation of broader ('Stage Three') economic sanctions saying:

"I hope...we will continue and intensify our preparations for a third tier of sanctions, and other additional sanctions if the circumstances require it."

He was echoed by Lithuania's Foreign Minister, Linas Antanas Linkevičius, who said that Stage Three sanctions were necessary to send a 'clear signal' to Moscow, adding that unrest in Eastern Ukraine was due to "Russian-sponsored insurgency."

Meanwhile, Austrian Foreign Minister, Sebastian Kurz, took completely the opposite line arguing that the red line for Stage Three of sanctions had not been reached.

"We should definitely not, at this point, move to Stage Three [of sanctions]...We are definitely not on Stage Three of economic sanctions, and in my opinion, this is good."

On where the red line would be to step up the EU's response, Kurz argued:

"[The EU agreed that] the third step of sanctions would be unleashed if Russian troops moved into Ukraine...economic sanctions would not just hurt Russia, but they would definitely hurt us too...If we went a stage further on sanctions with every provocation, then we would already be at war."

Luxembourg Foreign Minister Jean Asselborn found himself somewhere between the two, although he remained very cautious on sanctions:

"The referendum has no legal basis so we can’t burn too much energy on this… President Putin clearly spoke out last week that the referenda should be delayed…So we will see. I think Russia is starting to think about what the big problems will be… I think Russia will return from the brink. We will not have the sanctions as the main point today."

Once again then, as Russia essentially endorses the result in the self-rule referendum in Eastern Ukraine, the EU struggles to find a clear line on how, if at all, to respond to recent events.

Timing, not substance, is the biggest obstacle to David Cameron's reform agenda

Our Director Mats Persson writes on his Telegraph blog:

In a recent Sunday Telegraph article that received surprisingly little attention at the time, David Cameron came close to setting out a “shopping list” of what he wants to change in Europe. He outlined seven areas, though they were more principles than policies: powers flowing back, a beefed-up role for national parliaments, less regulation and more free trade, limiting the influence of European judges (possibly opting out of the ECHR, which is not an EU institution), tightening welfare benefits for EU migrants, tougher controls on future EU accession countries and no more “ever closer union”.

Nick Clegg – in a strange kind of way – has almost endorsed the plan, saying that "Now [Cameron] doesn't even talk about repatriation, instead proposing a mild seven-point plan, most of which wouldn't even require treaty change." European Commission President Jose Manuel Barroso has said that the EU wants to "cater" to the UK without "threatening the Union’s coherence" (though he was all over the place on EU treaty change). And in the Financial Times this week, Jean-Claude Piris, former legal guru of the European Council – the key decision forum for EU leaders – concluded that Cameron's changes could pretty much be done without actually changing the EU treaties.

For Cameron, this is a double-edged sword. Sceptics at home already see Cameron’s starting position as a “sell-out” – mere presentational changes that will allow him to recommend a “Yes” vote in the 2017 referendum. This is a premature accusation as there’s a huge range within the Sunday Telegraph piece, from token reform to sweeping changes.

Cameron could cobble together a decent package without changing the EU treaties. First, areas like toughening up rules on access to benefits, removing trade barriers, signing free trade deals or scrapping red tape – key planks in Cameron’s renegotiation agenda – just fall under normal Brussels decision-making (which doesn’t meant it will be easy. Think European Parliament). Secondly, “repatriating” powers wouldn’t necessarily require EU treaty change but could still be meaningful, for example devolving the EU’s irrational regional policy (saving UK taxpayers £4bn over an EU budget period) or exemptions from maddening working time rules for the NHS.

Finally, the EU specialises in legal acrobatics. When pushed – say when the bloc’s second largest economy risks leaving – it can be amazingly creative. For example, it created a €440bn bailout fund out of thin air and via so-called political agreements, the Danes got four surprisingly effective opt-outs after having rejected the Maastricht Treaty in 1992, which were incorporated when the next EU treaty came around. Something similar can be done for some of the reforms currently being discussed, including giving national parliaments the right to block or revise EU laws.

So it's right that Cameron seeks to maximise the reforms that can happen without EU treaty change. However, not only would a Treaty change be a form of political insurance to the Tory party and public that things have changed but it's also needed since the treaties simply aren’t fit for purpose. With a more integrated eurozone, we need new organisational principles and practical measures to avoid the EU becoming the eurozone, while allowing powers to flow back to countries that wish to be less integrated. A 2017 referendum should be the start of a slimmed down, flexible Europe, not the end destination. A quick and dirty solution will only bring us back to where we are today – and could well generate a referendum result too close to call, solving nothing.

Ironically, the strongest and most plausible contender for a Treaty change is one measure that Cameron – oddly – didn’t mention in his piece: safeguards against the Eurozone writing the rules for the rest of Europe, which will also effectively kill the notion of "ever closer union". Exactly how this principle will be organised needs careful thought (ideas here), but it’s highly desirable that this principle is firmly enshrined in EU law.

Since it’s the eurozone that is now changing the rules via banking union and other measures, not the UK, Cameron would be given a fair hearing in national capitals on this point. It is conducive to a "grand bargain": the Germans and French solve their catch-22, agreeing to beefed up supervision in the Eurozone in return for Berlin underwriting the euro, while the British ask for safeguards against Eurozone stitch-ups in return for nodding through EU treaty change at 28 (which Berlin still prefers). In this scenario, it’s the German-led EU treaty change that may trigger a referendum in France, not the UK’s.

It's whether it can be done before 2017 that remains the biggest question.

Meet the man who wants to blow up the European parliament

In our recent briefing ahead of the European elections, we estimated that anti-EU, protest and anti-establishment parties of various forms are set to increase their share of the vote and their number of seats in the European parliament.

One such party building up some impressive momentum as polling day approaches is the Polish Congress of the New Right, led by the mega-eccentric, bow-tie aficionado 71-year old Janusz Korwin-Mikke. A few weeks ago the party was polling at 2/3% but in recent polls the party has consistently been at or above the 5% minimum threshold, a result which would give it 3 MEPs.

The party is an odd mix of extreme libertarians and nationalists and Korwin-Mikke himself has been around Polish politics since the fall of Communism without much success. Unlike most parties in Poland, the New Right is strongly anti-EU with Korwin-Mikke describing the Commission as "bastards and Communists", and saying that:

"We are going to the European Parliament to show what a nonsensical institution it is. It's not possible to achieve anything sensible there".

In a speech a couple of weeks ago Korwin-Mikke said that the party would go into the parliament in order to detonate a bomb inside it, while one of his MEP candidates claimed that "the European Parliament is a brothel, a role for which it is ideally suited". On the surface, the party bears many similarities to UKIP and the party may want to join UKIP's EFD group in the EP. However, such an alliance is unlikely given that Korwin-Mikke's views make former UKIP MEP Godfrey Bloom appear like Polly Toynbee. For example, his long-standing view is that women should not have the right to vote as they do not "understand politics" and tend to vote for pro-welfare parties.

However, even the party does make it into the European parliament - Polish polls have proved notoriously unreliable in the past - it will not have any wider implications for Poland's membership of the EU where support is among the highest in the whole EU. It could make plenary sessions in Brussels and Strasbourg more interesting though....

European businesses (not so much the City) start feeling the pain of the squeeze on Russia

As we noted in our Battle of Londongrad briefing, while the exposure of the City of London to Russia has been overdone, there are plenty of other sizeable exposures in Europe which could have people worried with regards to the stand off with Russia. Well, in fact they are worrying people and dividing the EU, as we highlighted with our scale showing the divisions on pushing sanctions on Russia.

This week has seen a spate of businesses issuing warnings over potential losses in Russia. The WSJ has a good round up here, but the key ones are:

• Société Générale, one of the largest French banks, announced that it took a €525m write-down on its business in Russia. The loss reduced its first quarter profits by 13% and saw its stock price dip by a couple of percent (since recovered). As we noted, the exposure of French banks to Russia at $51bn is quite sizeable and could certainly cause problems if sanctions were expanded. The FT reports that the bank could face a €5.2bn loss if it was forced to write off its Russian investments.
• Danish brewer Carlsberg has also prepared for the impact as it cut its profit and sales forecast due to uncertainty in Russia, a market which accounts for 40% of its sales and profits. It also posted a 14% decline in first quarter net revenue in Eastern Europe because of the crisis.
• Even though issues for the financial services sector are conspicuously absent (consistent with our findings), other UK businesses were feeling the pinch, with UK based Imperial Tobacco saying that its sales in Russia have declined by 7% in the past six months and that it expects the figure for the entire year to be around 10%.
• More generally plenty of businesses are facing declining sales and preparing for potential losses on investments in Russia, from the world’s largest brewer Anheuser-Busch InBev and Unilever PLC to smaller tech companies hit by the US arms embargo.

Russian President Vladimir Putin’s comments last night, which suggest a quite significant softening in his position, will certainly ease this pain somewhat and provide some light at the end of the tunnel (assuming his position has actually softened, which is another whole discussion for a separate post). That said though, the outlook for the Russian economy whether broader sanctions become reality or not if far from pretty (graph below from IMF forecasts).

One way or another Russia seems unlikely to be the growth market in the next few years that it was before the financial crisis.

So, Nick, how many laws come from Brussels?

In the first IN/OUT Europe debate between Nigel Farage and Nick Clegg on 26 March, the leader of the Liberal Democrats claimed that the percentage of UK laws coming from the EU was 7%, citing research by the House of Commons Library.

This created much debate at the time, particularly as Nigel Farage claimed that figure was actually 75%, quoting the long-standing UKIP supporter Viviane Reding.

We are no stranger to this debate having written a number of times about the futility of estimating the proportion of EU laws implemented in the UK, and the differing claims. However we were surprised to discover that Nick Clegg himself is no stranger to this debate. Here he is writing in 2003:

Probably half of all new legislation now enacted in the UK begins in Brussels. The European parliament has extensive powers to amend or strike down laws in almost every conceivable area of public life.

And in case that was an accidental slip of the keyboard, here he is again speaking in 2004:

Well over 50 per cent of all new laws in the UK now emanate from Brussels and are processed by Parliament and that MEPs are now arguably some of the most powerful legislators in Europe.

That people - usually depending on ideological disposition - give wildly conflicting estimates about the share of EU laws is old news. Radically conflicting estimates from the same person is something new, however.

Bonjour Monsieur Cameron, there are potential allies on EU reform on the other side of the Channel

Henri Guaino, a French MP from the centre-right UMP party and a former special advisor to President Nicolas Sarkozy, has an interesting interview on Europe in today's Le Figaro. Here are some key excerpts:

Q: What is the European Union, according to you?

A: The EU is France, Italy, Germany, Spain, Belgium...The [European] Commission, Parliament, Court of Justice are just institutions at the service of the states and the peoples of Europe. It doesn't make sense to speak of a general interest of the EU that transcends the interests of these peoples and these states. Institutions never transcend anything.

Q: Europe is peace...

A: It's not the EU that created peace, it's peace that created the EU, and the idea that one guarantees peace on the continent by weakening the states is a dangerous one: for years, the weakening of states has been going hand-in-hand with the rise in Europe of populism, extremism and social tensions. Let's be wary that the federalist dream doesn't turn into a nightmare.

Q: Are the European institutions in need of reform?

A: The institutional Meccano has hit its limits: every reform has just given birth to a bit more bureaucratic monster. There are only two democratic institutions: the [European] Council of heads of state and government, and the [European] Parliament. The Council is more democratic than Parliament because heads of state are more accountable to their fellow citizens than MEPs. It is not certain that democracy has gained a lot from shifting from an assembly composed of delegations from national parliaments to a directly elected assembly. But if there were only one decisive reform to be made, it would be to eliminate the prerogatives of the European Commission and turn it into an administration under the authority of the Presidency of the Council.

On subsidiarity, Monsieur Guaino said:

[Subsidiarity] is working the wrong way round. The EU tends to leave to member states what it can't do. On the contrary, it needs to be asserted that the EU is only destined to do what member states can't do. This principle must allow member states to take competences back from the EU, which has too many.

He also suggested that the principle of 'variable geometry' (in plain English, different levels of integration within the EU) should be "applied systematically".       
 
Finally, asked whether the EU "contributes to making politicians look increasingly powerless", Guaino replied:

Yes...The EU has buried the historical, geographical, cultural and demographic realities underneath the rules, the bureaucracies and the procedures. But realities always avenge themselves when they are ignored.

To put this interview into context, Henri Guaino belongs to the same party as pro-integration MEPs such as Alain Lamassoure or Joseph Daul - which illustrates that 'Europe' is an issue that cuts across parties in a number of countries, not just the UK. Secondly, David Cameron may have allies in unlikely places, which if cultivated could prove helpful in a future negotiation.

The anti-EU vote: Spot the difference

Question: What's the difference between these two opinion polls for this month's European elections?

Answer: Ok, the percentages in the bottom graph are slightly higher, but there is a striking similarity.

The top graph plots the front runners in the French European elections: Marine Le Pen's Front National, the centre-right opposition UMP, and Francois Hollande's governing Parti Socialiste.

Meanwhile, the bottom graph plots the latest European election poll results for UKIP, Labour and the Conservatives.

There is always a tendency to see the anti-EU/government/establishment phenomenon as unique to one's own country. These European elections are likely to prove otherwise.

Swedish and Dutch patience running out over proposed FTT?

EU finance ministers met today, with the financial transaction tax (FTT) once again topping the agenda.

They were presented with a new proposal or brief under which the 11 countries pursuing the FTT under enhanced cooperation could move forward. The plan involved significantly amended terms and (again) suffered from a significant lack of detail:

• The scope will be “limited” to “shares and some derivatives”, according to German Finance Minister Wolfgang Schäuble – suggesting bond markets and probably repo markets will be exempt. The level of the tax on shares could be cut from 0.1% to 0.01%.
• This will form part of a “step by step approach”, suggesting the tax will be expanded in the future.
• Non-participating countries will be fully informed on all future FTT discussions.
• The FTT will not be introduced until January 2016.
• It is unclear whether Slovenia will participate in the FTT anymore, given that it did not sign the recent statement on the issue due to domestic problems and uncertainty around its government.
• Reuters reports that the revenue from the adjusted tax is expected to be about a tenth of the original forecasts – putting it at €3.5bn.

Those outside the proposed FTT zone showed quite significant hostility to the process of enhanced cooperation (as it has been conducted in this case) and continued to warn of legal action. UK Chancellor George Osborne said:

“The FTT that people have talked about is not a tax on bankers, it’s a tax on jobs, investment and people’s pensions.”

“Here we have a situation where 11 member states are working up their proposals largely in secret, I do not know how involved the Commission is in this or not. Then as we start our discussions here we get a piece of paper handed to us all by the 11 member states saying this is what we have agreed.”

“We will wait to see the final text of the proposal, but we will not hesitate to [legally] challenge an FTT which has extraterritorial impacts, that damages other member states, including the UK, or that damages the single market.”

Osborne was notably annoyed by the fact that the one page sheet on the new proposal was presented to the other EU ministers only five minutes before the meeting. His position was strongly backed by Swedish Finance Minister Anders Borg, who said:

“Even if this is a rather narrow proposal, there is a clear risk of a slippery slope toward a broader proposal with much more harmful effects on growth, and particularly on the capital markets.”

“The burden of proof is on the countries that want to enter the enhanced cooperation to prove, beyond a reasonable doubt, that those not participating are not harmed by this measure.”

“We did not support the U.K. when they started this legal case; we are much closer to doing that, because the process has not been satisfactory during these last few months…I’m very disappointed in the process.”

While even Eurogroup Chief and Dutch Finance Minister Jeroen Dijsselbloem warned:

“The impression I get is that, you [meaning the 11 FTT countries] have found a very, very small common ground, which is still very vague on the basis for the tax, when it will actually take place, on what products etc. but you have decided we must come out with something before the elections. That’s fine, but please also respect that we’d like to know a little more.”

“I don’t think that there is any basis at the moment for the Dutch government to consider joining, certainly not on what we have here… I’m a little disappointed in the way the process is going at the moment.”

All in all then, while there is talk of progress on the FTT, its scope has been slashed as expected, while the time line has been pushed into the long(er) grass. The process under enhanced cooperation has taken a public hammering, while it remains clear that those involved are struggling to find any clear agreement.

However, the fact that the Swedes and Dutch have expressed their anger so openly highlights that this will continue to be politically fraught. In addition, that the 11 countries seemingly want to reserve the right to expand the FTT in future, means this still has a way to run and future legal challenges are a genuine possibility.

ECJ throws out UK's FTT challenge, raising questions about whether it can be trusted to police the EU treaties

This morning’s ECJ judgement that the UK’s legal challenge against a proposed Financial Transaction Tax (FTT) is premature was what many had expected. The UK had challenged the decision to authorise the use of so-called ‘enhanced cooperation’ (where a smaller group of EU members can move ahead with legislation even if it does not have broader EU support) for the FTT. For the UK Government, today’s result is not what it had hoped for (an annulment of the decision to authorise enhanced cooperation), but neither is it the worst outcome.

Today’s ruling effectively said that the court could not rule on the UK’s substantive objections to the FTT since the final shape of the tax is unknown and subject to further negotiation between those taking part. This does not prejudice the UK’s ability to mount a second challenge once the final FTT has been agreed and its implications are clearer.

The ECJ judgement (in full here) said:

“It is clear that the objective of the contested decision is to authorise 11 Member States to establish enhanced cooperation between themselves in the area of the establishment of a common system of FTT with due regard to the relevant provisions of the Treaties. The principles of taxation challenged by the United Kingdom are, however, not in any way constituent elements of that decision.”

“The two pleas in law relied on by the United Kingdom in support of its action must be rejected and, accordingly, that the action must be dismissed.”

“Those effects are dependent on the adoption of ‘the counterparty principle’ and the ‘issuance principle’, which are however not constituent elements of the contested decision, as stated in paragraph 36 of this judgement.”

“That review should not be confused with the review which may be undertaken, in the context of a subsequent action for annulment, of a measure adopted for the purposes of the implementation of the authorised enhanced cooperation.”

However, while the UK will get a second stab at challenging the FTT, today’s ruling poses major questions about how ‘enhanced cooperation’ works and how it is used in the future. The EU Treaties stipulate that authorisation of enhanced cooperation (which is given by a qualified majority vote of all EU member states) is conditional on the proposed legislation respecting the integrity of the single market and not impacting on those not taking part – this is meant to be a legally enforceable safeguard for those countries not participating.

Enhanced cooperation is a relatively new phenomenon that has only been used twice before (for a European Patent Office and divorce law), but it could have huge implications for the future of the EU and Britain’s place within it. In an increasingly multi-tier EU, enhanced cooperation may be used more often by countries that want to integrate further. For those that don’t wish to follow suit, it is vital that their rights in the single market are respected.

Let us start with an analogy. Imagine you had agreed to let your neighbour build a new house based on a certain agreement and set of plans. Halfway through building it becomes clear that he has adopted a new plan which will hamper your view or infringe on your land. You appeal to the council but they rule that it is too soon to tell where the house will end up and that they can only rule when the house is built. Tearing down a house is much messier and more costly than stopping one being built in the first place. Hardly seems efficient or fair, does it?

Yet, in this case, this seems to be what the ECJ has done. It has effectively decided that it could not decide whether the decision to authorise the FTT proposal does respect the rights of those not taking part because the final outcome of the FTT negotiations cannot be known now. This is strange because this is by definition true in pretty much all cases of enhanced cooperation, since the countries involved negotiate the finer points of the legislation amongst themselves after getting approval to go ahead.

While this may seem legalistic and technical it raises a fundamental question: are the authorisation criteria for enhanced cooperation worth anything? Surely, any decision on the use of enhanced cooperation should be made on the basis of the proposal that is on the table, irrespective of whether it might change (for the better or worse) by the time it is finally agreed as a legal act, which could still be challenged in any case. The potential spill-overs should be examined before those member states not involved give those involved the go ahead. Otherwise they are ultimately authorising an unknown piece of legislation, which once it has built up a political head of steam could be much harder to challenge later on.

By its very nature, enhanced cooperation will be used for controversial proposals but today’s ECJ judgement has increased uncertainty surrounding this procedure (it was already uncertain) and undermines the logic of the process for authorising its use. We cannot know what the long term implications of this will be for the EU and the UK but they could be important.

As for the FTT, the UK will have another chance to challenge the final legislation (which may end up being watered down anyway due to concerns from those taking part) but by the time it gets to that point, there will be so much political capital invested in it, it may make it harder for the court to strike it down, even if the UK has good legal grounds.

Would it not be easier if 'Brussels' simply dissolved the people and elected another?

In less than a month's time voters across the EU (that is those who decide to vote) will head to the polls to elect the new European Parliament. Ahead of the elections there has been a lot of speculation about the surge in support for a range of populist anti-EU, anti-austerity, anti-immigrant and anti-establishment parties and what this will mean.

Breaking the parties down into these sub-groups illustrates that the potential 'anti-EU vote' is a complicated phenomenon. In a new briefing published today, we estimate these parties could win as much as 30.9% of the vote in May, up from 24.9% in 2009. This will give them 218 out of 751 seats (29%), up from 164 out of 766 (21.4%) in the current parliament. (You can see our criteria for categorising the parties in the briefing).

These parties, loosely termed by Open Europe as the ‘Malcontents Block’, span the political spectrum and differ substantially from each other, ranging from mainstream governing parties to outright neo-fascists, and will not therefore form a coherent block. The largest increases are among the anti-establishment parties typified by Beppe Grillo's Five Star Movement in Italy and the anti-EU vote is largely driven by the rise of the Front National in France and UKIP in the UK. Having said this, we acknowledge that the European elections are in part used by anti-establishment parties to drive a domestic agenda, sometimes with limited links to "Europe". Still from free movement to the bailouts, European issues are now trickling through to voters' decisions.

Sources: Vote Watch Europe and Open Europe calculations

However, despite the strong performance of these anti-EU parties, the EP will continue to be dominated by parties which favour the status quo or further integration. The vote share of parties identified by Open Europe as being ‘critical reformers’ – parties which believe the EU needs fundamental reform if it is to survive – is set to go from 53 to 39 seats.

The net effect of the anti-EU vote could therefore ironically be to make the EP more integrationist: by crowding out critical reformers, by reinforcing the corporatist tendency of the two main groups who will want to freeze out the anti-EU MEPs, and by binding the EP and Commission closer together.

Source: Vote Watch Europe and Open Europe calculations

Another one to watch out for is voter turnout. If turnout is roughly the same this time around (43%), we estimate that 74.4% of all voters will have voted against the EU, for radical change, or not bothered to vote at all, with only 25.6% of all eligible voters actively turning out to vote in favour of status quo/more integration parties.

This is not to say that all 'non-voters' are anti-EU or anti-status quo - some have tried to put words in our mouth to that effect (somewhat predictably). However, it clearly reinforces the European Parliament's remoteness from voters and the thin democratic mandate that MEPs can rely on to push their agenda in the Parliament. Some may be tempted to see voter apathy as a 'net neutral' - we don't know how these voters would vote after all and they're voting for other things apart from Europe anyway. This is a familiar argument that has been used many times in the past as a pretext for pressing ahead with more integration. However, to conclude that voter apathy in fact means 'endorsement' is naive, intellectually dishonest - and outright dangerous as it'll only create even more fertile ground for an even more hostile response in future.

Source: Vote Watch Europe and Open Europe calculations

Worryingly for the UK and other liberal minded EU governments, the share of MEPs explicitly dedicated to free market policies is also expected to fall from 242 (31.6%) to 206 (27.4%).

Source: Vote Watch Europe and Open Europe calculations

All this means that the EP elections may be bad news for David Cameron. The EP has an effective veto over some of Cameron’s potential flagship reforms (outlined in his recent Sunday Telegraph article), including EU-US free trade talks, services liberalisation and rules on migrants’ access to welfare.

The consequence of giving the European Parliament more and more power under successive EU treaties is that these elections matter. MEPs now have equal status with national governments in the vast majority of EU policy areas from regulating working time to bankers' bonuses. Despite this, turnout has fallen in every European election so far and this time around we could see more anti-EU MEPs elected than ever before.

The usual response from the Brussels bubble to voter apathy is that people don't 'understand' the EU. Perhaps, this time politicians might spend more time trying to understand why the electorate is looking for alternatives to the likes of Schulz, Juncker and Verhofstadt or not bothering to vote at all.

Judgement day for the EU FTT: Will the ECJ rule in favour of taxation without representation?

There has been an important development brewing in the UK’s flagship case against the EU's proposed Financial Transaction Tax (FTT). We've known for some time that the European Court of Justice (ECJ) will take a shortened proceeding and rule on the case on the 30 April – this has now become public, as European Voice reported this morning. A ruling hadn't originally been expected until 2015. We expect the ECJ to either throw out the case or rule against the UK - which is problematic for numerous reasons.

We have covered the FTT extensively and the court case is an important marker for the UK’s place in the EU.

The UK claims that the use of enhanced cooperation here is fundamentally against the EU treaties as it imposes costs on those outside the FTT-zone. If the ECJ rules against the UK, it could become a wide-ranging precedent with three key effects:

• Allowing for the broader use of enhanced cooperation (even with extraterritorial impacts) including for eurozone integration
• Making it more difficult for the UK to employ a veto over further EU integration it's not part of 
• Undermining trust in the ECJ as a fair, impartial arbiter and guardian of the single market

However, it's important not to be too alarmist about this. While the ruling looks unlikely to go in the UK's favour (but it still could) it seems more likely to be dismissed on grounds of the UK's challenge being premature (given that the proposal is yet to be finalised) rather than being outright wrong. So the UK will have another shot at challenging the final decision.

Also, the FTT is likely to be substantially watered down so the actual effect might be far less damaging than the Commission proposal pursued under enhanced cooperation. As a key proponent of a watered down FTT, the UK is already to a large extent a winner. Finally, this is a different sub-set to the eurozone (with Ireland and the Netherlands outside).

Below is a Q&A on the issue - pardon the length of it.

What are the UK’s objections?
As a recap, the UK has called for the decision authorising the use of ‘enhanced cooperation’ for the FTT to be annulled. As such it is not directly challenging the measure itself. The key reasons for the UK’s challenge are (as published by the ECJ):

1. The FTT is not compatible with Article 327 of EU Treaties which states that any member states not participating under enhanced cooperation must not feel any impact. The FTT will hit UK firms if there are any transactions with those inside the FTT zone.
2. There is no basis in international tax law which justifies imposing taxes on a sovereign state which does not wish to be part of said tax regime. Adopting a law with extraterritorial effects does not fit with the code of international tax law.
3. The tax will be distortionary and impact competition across the EU. Rather than improving the single market it could fragment it.
4. The FTT is not compatible with Article 332 of the EU treaties which states that any expenditure from enhanced cooperation will come from those directly involved. Given that taxes will be raised from UK and other countries not involved, this has been breached. The UK would also likely be directly responsible for collecting and enforcing this tax due to rules on mutual assistance, producing a further burden.

What are the potential outcomes from the ruling?

1. The ECJ rules in favour of the UK – seems very unlikely, but not impossible. In this case the Council would be forced to reconsider the FTT. It would need to adjust the details of the FTT to fit with the ECJ’s ruling and then get renewed support for enhanced cooperation.
2. The ECJ rules against the UK and dismisses some or all of its claims – possible. This could amount to the ECJ ruling that the FTT does not have any extraterritorial effects nor that it cuts across the single market. This would not only set a worrying precedent for any future challenge against the specific nature of the FTT itself but also for the UK’s position in the EU more generally, weakening its ability to bloc future eurozone integration with a direct or indirect impact on the UK. Combine this with the growing use of intergovernmental agreements and using the single market legal base for eurozone integration and it's clear the net effect is reduced UK leverage in Europe. 
3. The ECJ deems the challenge premature or unwarranted – likely. Given that the FTT is still a work in progress and the final proposal remains uncertain, the ECJ could throw the complaint out on technical grounds. This would not be too detrimental to the UK, although it would still be a blow as the UK was hoping to stop the FTT as soon as possible. It would also mean that, out of four key legal challenges on financial services at the ECJ (short selling, FTT, bankers bonus cap and ECB location policy) the UK is now at 0/2 - not exactly an encouraging score.

Usually, ECJ cases take a minimum of 16 months to work their way through the process of deciding a case. This has taken around 12 months.Written proceedings and arguments were concluded in January this year, normally the case would then move onto a hearing and an Advocate General would present an opinion before the final ruling. The fact that the ECJ has effectively skipped two steps and moved straight to the ruling. This could suggest that the ECJ considers it a straightforward case, which is unlikely to have been the case if the ECJ ruled against the European Commission (always very controversial).

Does this mean the UK was wrong to launch its challenge?

• In the end, we still think it was the right thing for the UK to do. It seems clear to most that there are numerous negative side-effects from the FTT, many of which seem to break rules enshrined in the EU treaties. The broader point is that the UK is right to establish the boundaries of what the EU can do and what enhanced cooperation can be used for. 
• The one caveat in this instance is that, given the large and growing concerns about the FTT, it has floundered and stalled on its own to a large extent, suggesting the legal challenge may not have been necessary. This would especially be true if it ends up going against the UK and setting the precedent described above.

Is this the end of the story?

If the ECJ rules in favour of the UK, the European Commission will need to table a new proposal. If the challenge is either thrown out or goes against the UK, the Government can still challenge the final legislation (as opposed to the decision to authorise enhanced cooperation). 

If the ECJ does end up throwing out the challenge for being premature, then the process has taught us little and the final result remains to be seen. It does raise the question though: why was authorisation given for enhanced cooperation before the final make-up of the proposal was known?

The ECB gives Portugal a helping hand with its return to the markets

Portugal this morning followed the lead set by Ireland and Greece and issued new debt for the first time since its bailout in 2011.

Portugal managed to sell €750m of 10 year bonds at an average borrowing cost of 3.58% and with demand totalling €2.6bn (3.47 times the desired amount). This is a successful return, albeit not quite as large as Greece’s or Ireland’s issuance.

Again, many people will be asking why a country with uncertain funding conditions over the coming years saw such solid demand for its debt, even before it exited its bailout. As with Greece, we would say many of the factors are more to do with the state of the broader market than specific to Portugal:

• The issue remains small with a decent yield – there will always be demand for this kind of risk and return.
• This is particularly true in the current market where interest rates are at record lows and there is a dearth of safe assets which still yield a decent profit.
• The ECB and the eurozone have shown their commitment to keeping the eurozone together and have shown a renewed aversion to private sector write downs on sovereign debt. This combination provides insurance to investors that, even if the Portuguese economy struggles, the rest of the eurozone will ensure that it continues to pay its debts.
• Of course, all that said, the reforms which Portugal have instituted and which have helped boost exports will play some role in encouraging investors.

One specific point to note though is that, on top of the general support given by the ECB mentioned above, it also gave Portugal a more direct helping hand.

Die Welt reported on this issue today, terming it a “trick”. In reality, the ECB has altered its collateral rules so that, when Portugal exits its bailout, its government bonds will still be eligible as collateral for its lending operations. The change was snuck through as part of a package of changes in ECB/2014/10 ‘amending guidelines for ECB/2011/10’ last month.

The ECB’s line seems to be that this was simply a move to bring all the ratings from different agencies into line for collateral, so they correspond to the correct level in the other agencies. This is a fair point, but the timing seems more than coincidental, especially since these rules have been in place since 2011.

The thinking is that, without this change, demand for Portuguese debt would have been limited since it couldn’t be used to gain liquidity from the ECB (we explained here why ratings are still important for just this reason). As such, the ECB looks to have given Portugal a helping hand.

We have written before about concerns over the ECB’s independence during the crisis, particularly in relation to adjusting its technical rules to aid struggling countries. This seems pretty close to falling into that category and highlights that, even though the crisis has eased somewhat, the ECB still finds itself treading some difficult boundaries with regards to its independence.

All that said, this remains a positive, if small, first step for Portugal. Questions remain about whether it will be able to fully fund itself without a credit line from the EU/IMF and whether export growth will be enough to offset the collapse in domestic demand and investment.

Is the eurozone crisis over? The Germans think not…

There was an interesting poll in today’s FAZ conducted by INSA for Bild on whether Germans believe that eurozone crisis is over or not.

The results were pretty comprehensive with 81% saying that they do not believe the crisis is over compared to 7% who do.

Furthermore, 34% of Germans believe that Greece is on the road to recovery compared with 39% who believe the country has not done enough to reform its economy. Clearly they remain very unconvinced by the efforts of the Greeks.

In the same vein, Eurostat this morning put out its first estimate of the debt and deficit figures for the end of 2013. As might be expected they don’t make particularly pretty reading. As the graph below highlights, the debt levels in many EU countries have continued to increase and by substantial amounts in Cyprus, Greece and Slovenia – all due to bank bailouts/recapitalisations.

With debt levels continuing to rise and the long term structure of the eurozone still developing it remains premature to cast the crisis as over - at least the Germans seem to think so.

How in the world did central banks miss this?

An interesting story has been developing over the past couple of weeks and has been flying under the radar somewhat, though Alex Barker over at the FT has covered this story very well, here, here and here.

The issue is that the Bank of England has found wording in the details of the EU’s Bank Recovery and Resolution Directive (the bank bail-in plans) which could prohibit governments from protecting central banks against losses when they  provide emergency lending to banks in a crisis. Quite a surprising find given that the final text has just been passed (the error was found with only weeks to spare).

This is the Emergency Liquidity Assistance (ELA), which we have covered here and here. As a recap, this is the lending which a central bank takes on in a crisis and offers to banks at less favourable rates if they have no other choice to avoid a liquidity crisis. As might be expected it was used heavily by the UK and many eurozone countries during the crisis.

Essentially, the concern is that it could expose the BoE to greater risk since it will not have the backing of the UK treasury when extending liquidity assistance, which is risky and can be very large when a financial sector the size of the UK’s is in crisis.

In fact the story now seems to have run through its full lifecycle:

• The BoE located the problem and alerted the European Parliament (EP) and other member states, while requesting to reopen the text of the legislation to amend the wording.
• The EP accepted and even published a revised text to take account of the concerns - see article 27 (2).
• In the end, however, the move was formally vetoed by the Netherlands, Finland and the Czech Republic due to concerns that reopening the text would lead to a raft of other demands, notably by France, Italy, Sweden and Portugal who were seeking further assurances that they could issue guarantees for bank bonds without requiring bank bail-ins first.

This may potentially be a very big deal - but there could also be ways around it. Ultimately, ELA can still be extended it just cannot have a blanket guarantee from the government. The central bank balance sheet should be strong enough to deal with this, although if losses were taken it could become an issue – would bail-ins be required, say, before the central bank was recapitalised? Furthermore, this doesn't just impact the UK, ELA was heavily used in the eurozone and is arguably more important for the eurozone than the UK since the ECB still struggles to act as a real lender of last resort.

However, this episode also speaks volumes about how EU rules are decided and assessed - and, in this instances, doesn't necessarily reflect well on the Treasury and the BoE:

• That the deal isn't now re-opened despite an obvious flaw in the legislation is symptomatic of EU law - the constant fear of  reopening deals or reassessing them due to uncertainty over what countries might begin to demand. This too often used as an argument against reform, when in fact it should be one in favour of reform. It highlights the need for a broader overhaul of the legislative approach and the need for a clearer structure and mechanism to reassess legislation. All too often this fear paralyses the process of improving or changing the EU.

• That said, looking at the revised EP text, there do seem to be a huge amount of changes (the text in bold and italics). This seems to highlight some severe concerns with the original agreement and again brings home concerns over the level of uncertainty - what is a precautionary recapitalisation? - that continues to dog the agreement.

• The alliances that built up on this issue are also interesting and somewhat unusual. The UK had the support of the European Parliament and even France and Italy, although they seemingly wanted to reopen the text for other reasons. However, Netherlands and the Czech Republic were firmly against, while Germany was very hesitant. The UK should take comfort in this. On this particular issue, the divide wasn't eurozone versus non-eurozone - that potential divide remains one of the biggest liabilities in the UK-EU relations, particularly in financial services. 

Most importantly though, how in the world did finance ministries and central banks - including the Treasury and BoE effectively - miss a provision which governs fundamental central bank actions? Admittedly, we didn't spot it either and it is a very technical clause but these are exactly the types of things that central banks should be on the look out for. It certainly raises some serious questions about the level of oversight and analysis of EU legislation both at the EU and national level. How did everyone miss this the first time around? If the central banks weren’t involved earlier, should they be on important financial legislation such as this?

Credit to the Bank of England for at least detecting it. Better late than never (well, sort of, in this case). 

Divided we stand - EU struggles to find common position for sanctions on Russia

In a new flash analysis out today, we look at where each EU member state stands on expanding sanctions against Russia.

The summary notes:

There is a huge diversity of views within the EU on what to do next with regards to Ukraine and Russia. This is mostly down to divergent interests (economic, political and cultural) for different member states, as well as varying views on the effectiveness and implications of further sanctions. Countries range from Poland and the Baltics, which have very strong economic links with Russia but remain very hawkish, likely due to historical experience, to countries such as Bulgaria and some Mediterranean countries which remain quite dovish. Open Europe has attempted to quantify this on a Dove/Hawk scale from -5 to +5. The average ranking for EU members is 0.4 suggesting that the bloc as a whole remains someway off from finding the unanimity needed to push further sanctions.

In terms of trade links to Russia, Lithuania has the largest trade turnover at almost 32% of its GDP, while the Netherlands, Slovakia and Estonia also have high levels at 11%, 11% and 14% of GDP respectively. There is however, no strong link between deeper trading links and a more dovish approach to sanctions on Russia, suggesting the discussions are informed by a number of complex factors.  

The key graph is below (click to enlarge).  Clearly there is a huge level of divergence, based off a number of factors (not just total trade turnover, which is shown on the vertical axis).

Despite all this, further sanctions remain on the table. In the analysis we examine what form further sanctions could take. It would likely be sanctions on: specific firms, sectors or broader financial sanctions. The fallout of all of these has the potential to be serious, possibly explaining some of the divergence across the EU.

Attention now turns to tomorrow’s meeting between the West and Russia. The focus remains on a ‘diplomatic solution’ but with Russia warning of civil war (not least because it fits its narrative of instability), and calling for the UN to condemn Ukraine’s actions to remove pro-Russian forces in Eastern Ukraine, this remains very uncertain.

The Farage allowances episode is primarily a sign of a fundamentally broken allowances system

The Times today uses the news that Nigel Farage is to be investigated by the EU’s anti-fraud office OLAF, following a complaint from an ex-Ukip official that £60,000 of EU allowances paid into his personal bank account have gone “missing”, to attack the “fraudulent prospectus” that he is “the politician who is not a politician”.

The chief allegation is that:

"The Ukip leader has received £15,500 a year from the EU since at least 2009 to pay for the upkeep of his constituency office, a small converted grain store near Bognor Regis, according to transparency reports filed on the party’s website.  

However, the grain store was given rent-free to Mr Farage by Ukip supporters 15 years ago. Utilities and other non-rental costs amount to no more than £3,000 a year, according to the former office manager, leaving about £12,000 a year unexplained."

The paper also notes that Mr Farage “also revealed that he used a proportion of his [General Expenditure Allowance] to pay more than £1,000 a month towards a controversial second EU pension scheme of which he was a member between 1999 and 2009.”

We looked at this additional pension scheme back in 2009, when it closed to new members, and it was controversial for two reasons. Firstly, it was two-thirds funded by taxpayers and, second, the system relied on MEPs being honest enough to fund the shortfall in their allowances out of their own salary. Credit to Farage for leaving the scheme - but being part of it in the first place doesn't reflect well on him (though he's one of many, many MEPs from all parties who were or still are).

Whatever the rights or wrongs of Farage's actions, this illustrates that the EP's allowances and expenses system is still miles away from what taxpayers should accept. The General Expenditure Allowance is notoriously vulnerable to abuse because it is generous, has a wide list of potential uses and does not require MEPs to produce receipts. The Times' leader itself admits that "It is probable, even if these allegations prove to be true, that Mr Farage has done nothing illegal".

Predictably Farage's response casts him as the victim of a "politically motivated attack from what is the establishment newspaper." The general expenditure allowance, he said, "is given to every MEP and we can spend it how we want to," adding:

"We have used the money to promote the cause of Britain leaving the European Union and we have done that unashamedly"

It is right that Nigel Farage is subject to proper scrutiny and that investigations are carried out if he has a case to answer, but there's still no proof he has done anything illegal. And whether singling out Farage will actually help or hurt his cause remains to be seen. However, what's clear is that the EP's allowance system must urgently be reformed.

The EP allowances system is something that we'll most definitely return to.

Can the real Super Mario please stand up?

Former Italian Prime Minister Mario Monti may be out of Italian politics, but it's fair to say he still likes to talk - especially when travelling abroad.

In an interview with Belgian daily De Morgen and Dutch daily De Volkskrant, Monti seems to hint at what many Bundesbank-fearing Germans already suspected: that the ECB's pledge to do "whatever it takes" (i.e. the OMT, the new bond-buying scheme) was de facto grounded in a political decision - contrary to what the ECB's mandate dictates.

Here is what Monti said in the interview:

[At the June 2012 European Council], I have used my full negotiating position in order to get a line approved that looks boring at first glance. At 4 am, the signatures of all leaders had been provided, including the ones of [German Chancellor Angela] Merkel, of my good friend the Dutch Prime Minister Mark Rutte, and of Finnish Prime Minister Jyrki Katainen, you can say the monetary firepower from the North [...] The line established, in short, that eurozone countries who did their homework, like Italy, were guaranteed ECB support. That statement – at the highest political level – didn’t impress the markets, because the leaders did have the authority, but no money. One month later, ECB President Mario Draghi came out with his famous statement: the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough. That did calm the markets, because Draghi did have the money. 

Monti is clearly trying to claim some credit - and the headline of the interview in De Volkskrant is actually "Mario Monti: the man who saved Europe". However, if Monti is right, it clearly means that the ECB's political independence was seriously compromised, since, strictly speaking, there should be no link whatsoever between a political agreement and ECB action..

Draghi's statement is one of the main reasons behind the fall in borrowing costs for countries in the eurozone periphery - some of which have yet to deliver on real economic reform. Monti may have given Draghi some of the credit - but he has also given fuel to those Germans who fear the ECB's independence is a thing of the past.

The EU stands united in the face of Russia - or does it?

So, about Ukraine...

Arriving in Luxembourg this morning to discuss events in Ukraine with his European counterparts, British Foreign Secretary William Hague called for a "clear and united" EU response to Russia's 'escalation' of the crisis.

Hague added:

There is very little doubt -- there can't really be any real doubt -- that this [the unrest in Eastern Ukraine] is something that has been planned and brought about by Russia. The forces involved are well armed; well trained; well equipped; well coordinated and behaving in exactly the same way as what turned out to be Rusian forces behaved in Crimea, before the full Russian military takeover of Crimea.

He added:

I don't think denials of Russian involvement have a shred of credibility.

Meanwhile, Jean Asselborn, the Foreign Minister of Luxembourg, arriving at the same meeting did not seem to get the memo. He said the following:

I cannot actually imagine -- just how the EU could not identify with the men dressed in black in the Maidan -- I cannot imagine that the Russian side identifies with the men in black, with guns and weapons, that are occupying administrative buildings and government buildings in Eastern Ukraine.

He added:

I am still convinced after I heard President Putin, and the Russian Foreign Minister, that the Russians do not want to destabilise East Ukraine and do not want to occupy Eastern Ukraine.

Meanwhile Frans Timmermans, the Dutch Foreign Minister, opted for a more cryptic message, mixing his ducks with horses. Asked if he thought forces in Eastern Ukraine were acting under Russian directions, he replied:

If it looks like a horse, and it acts like a horse, then it is probably a horse -- not a zebra.

As clear as mud.

Why is the UK so bad at counting people who come and go?

The ONS has now admitted that its figures for net migration into the UK were underestimated for the best part of a decade. For the period 2001-2012 it has said that 346,000 more people came to the UK than under its previous count. That the migration figures are liable to revision should be no surprise as the underlying original data - the International Passenger Survey (IPS) - is (as the name suggests) only a survey. The UK Government doesn't properly count who comes and leaves. However, the underestimation is still startling. 

Of the newly found 346,000 (the green line charted below) it is assumed that most of it can be accounted for by EU migration.

Source ONS

As we can see from the purple line net EU migration picked up after 2003 peaking in 2007 at over 100,000 per year. This coincides with the period of the majority of the ONS under-counting. The ONS believes its under-counting was due to a failure to recognise the large numbers of EU migrants coming through regional airports. Under the original IPS figures for the 1996-2011 period, a net figure of 3.9 million came into the UK of which 800,000 were from the EU. So who are the newly discovered 346,000 and how many EU migrants did actually come to the UK?

The answer is that we do not know. The 2011 census, which is a more accurate dataset, suggested that there were 2.7 million EU migrants in the UK of which 1.1 million had come from the 'new' post 2004 accession states. But this may itself be an underestimate and will include a large number of longer term migrants. It is likely that the ONS is right to suspect that their figures for EU migrants were underestimated but unless the UK starts counting people in and out we will never accurately know.

This is one of the biggest problems with the EU migration debate: the absence of reliable data and information erodes public trust in free movement. Yes, EU membership involves some loss of control over the border. But the UK is still out of the Schengen 'passport free' zone and other countries - via more effective identification (a complicated discussion in itself), taxation and border systems - are far better than the UK at counting.

What’s wrong with Finland? Part 2

Since our last post on this issue things seem to have only got worse for Finland.

The European Commission’s latest economic forecast (see table below, click to enlarge) made pretty dire reading with Finland expected to be one of the worst performers in terms of economic growth over the next two years.

Furthermore, it seems that the credit rating agency S&P has finally caught up with our analysis of Finland, putting its AAA rating on negative outlook, suggesting that it may lose it in the next couple of years. Similar to our concerns about the rebalancing of the Finnish economy, the demographic problems and a stubborn lack of competitiveness, S&P noted:

“Finland’s persistent subpar growth rate reflects deep structural demographic and economic imbalances that hamper the government’s efforts to achieve fiscal consolidation. We consider that there are downside risks to growth and policy implementation.”

“We believe that the economy remains vulnerable to any slowdown of economic activity in the euro area or among other major trading partners, such as Russia.”

As the second part of the quote suggests, the situation in Ukraine and the potential sanctions on Russia are also likely to worsen the outlook for Finland.

The graphs above (data from Bank of Finland) highlight that Russia accounts for a decent chunk of Finnish trade and given the dwindling sources of growth any hit to this could certainly hamper the rebalancing of the economy and the reform/recovery process.

Furthermore, as we have flagged up before, Finland is one of the many countries heavily reliant on Russia for gas and energy more generally. With Putin’s threat to cut off gas to Ukraine the situation has potentially escalated another step, at least in economic terms, Finland is one (of the many countries, including Russia) which is on the front line.

Once again, all this is not to say that Finland is an economic basket case, far from it, but that even the healthy economies in Europe are undergoing some serious overhauls and reforms, further complicating the crisis response and, now, dealing with issues such as the Ukraine-Russia crisis.

Greece exits the wilderness and returns to the markets

It has been labelled by some as the “amazing comeback”. Greece has this morning sold €3 billion of five-year bonds at an interest rate of 4.95% - and the demand exceeded €20 billion.

To be fair, the turnaround in investor sentiment with regards to Greek debt is pretty astonishing and the demand for the first Greek bond issue has outstripped even the most optimistic forecasts. As the newswires pointed out this morning, it increased quite significantly overnight:

But this outcome has left a few people scratching their heads and wondering what this means for Greece and the eurozone – both of which continue to struggle when judged on a broader set of data indicators. Below, we try to address some of these questions in a reader-friendly Q&A.

Why has demand been so strong?

There are a couple of reasons for this, and they have little to do with Greece.

• The bond auction remains small, and the yield fairly decent relative to other peripheral economies and 'junk' or high yield bonds of similar length. And there will always be investors looking for a better return. After all, even in the immediate aftermath of the Greek debt restructuring there were plenty of investors willing to take a punt on the newly formed bonds in the secondary market – and many of them ended up with good returns.
• This links to a broader problem in Europe, and even in developed economies – the shortage of safe assets and the lack of yield. Given the rock-bottom interest rates and dwindling inflation, the level of return available on many financial instruments is not what it used to be, and investors are keen to find new avenues to boost their gains.

But isn’t there a huge amount of risk involved?

Actually, given the structure of the deal and the environment involved, maybe not as much as one would expect (click on the graph to enlarge).

• Firstly, the bonds will be issued under English law. This will stop them being restructured in a similar fashion to the previous Greek bonds, meaning that the investors have significantly stronger legal protection.
• Secondly, the maturity of the debt is quite short, especially relative to the very long term (20+ years) maturity on the loans from the eurozone. This ensures that payment of these bonds falls well before Greece needs to start paying off its official loans – as the graph above highlights.
• Thirdly, the ECB’s promise to purchase government bonds if the crisis escalates again still stands. Furthermore, this has been combined with greater support from the eurozone for Greece and a new aversion to write downs of sovereign debt. 
• All of this means the likelihood of losses on Greek private sector debt has been significantly reduced. It has not been eliminated, but if any write-down were to be forthcoming it would most likely be losses on official sector loans, not least because they now make up 66% of Greek debt.

This has almost come out of nowhere in the past week or two: why such a rush?

• The first, obvious reason is Greece’s need for further funding. The issue of a funding gap this year and over the coming years (estimated to be around €20bn up to 2016) has been well covered. This bond issue, combined with some new fiscal measures and probably the leftover capital in the Greek bank bailout fund, will help fill most of that fiscal gap over the next couple of years. It also potentially paves the way for further debt issues.
• However, there are deeper political reasons. As shown by yesterday’s anti-austerity strikes, this morning's bombing outside the Bank of Greece and the dwindling majority of the government in parliament (which now stands at only two seats), there still is a significant amount of political uncertainty around. The government seems to harbour hopes that this return to the markets will galvanise its support, and act as a symbol of the turnaround it has helped to create.
• Furthermore, with the European elections around the corner and the opposition SYRIZA party looking set to do well, the government seems to believe that this issue could somewhat also boost their support at the polls.

But how much of a turnaround does this really signify for Greece?

While it’s certainly a positive, the macro level data for Greece remains worrying. As the charts below show (courtesy of Natixis), unemployment remains very high. In particular, youth and long-term unemployment are both stubbornly high, and threaten to become a drag on the economy in the longer term. While business activity has stopped its decline, the hope of a swift recovery is yet to be based on clear evidence. There is a long way to go in the structural reform programme, as highlighted by the 329 reforms recommended by the OECD.

More broadly, Greece’s long term strategy for competing and growing in the eurozone remains unclear, and it has zero room to absorb further economic shocks. Citi - forever bearish on Greece - took it upon themselves to be the buzzkill amongst all this optimisim with the chart below (via FT Alphaville). Ultimately, it remains a small symbolic step, especially given the size of the bond issue.

 Will Greece get to spend this money as it wishes?

That seems hopeful at best. While Greece may have a little more flexibility compared to when the funding comes from official loans, of which almost every penny is clearly assigned, there will be little wiggle room. As even those countries outside bailout programmes have found, the oversight at the eurozone level is now quite significant. Greece’s budget still has to be agreed in tandem with the EU/IMF/ECB Troika, and little flexibility is likely to be allowed, especially since there is already an outstanding funding gap which needs to be filled.