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Friday, September 28, 2012

Some preliminary thoughts on the stress tests for Spanish banks: lots of optimistic assumptions...

Here is the full report (and the bank-by-bank results) from the latest Spanish bank stress test exercise. Below we provide the key points and our initial thoughts on them.

The tests put the total capital needs of Spanish banks at €59.3bn, but Spanish Deputy Finance Minister Fernando Jiménez Latorre (in the picture) just told journalists during the press conference that, assuming that Spanish banks manage to raise part of the money from other sources, the Spanish government could ask the EFSF for "around €40bn" (as we anticipated here).

Key points: 
  • 14 banks assessed, 7 found to be well capitalised, 7 found to need capital injection. Total needs put at €59.3bn. This falls to €53.75bn when the mergers under way and the tax effects are considered;
  • €24.7bn of the total amount is earmarked for Bankia alone, with a further €10.8bn for CatalunyaCaixa and €7.2bn for NovaGalicia;
  • The adverse economic scenario assessed was: 6.5% cumulative GDP drop, unemployment reaching 27.2% and additional drops in house and land price indices of 25% and 60% respectively, for the three-year period from 2012 to 2014;
  • Cumulative credit losses for the in-scope domestic back book of lending assets are approximately €270bn for the adverse (stress) scenario, of which €265bn correspond to the existing book. This compares with cumulative credit losses amounting to approximately €183bn under the base scenario.
Open Europe take: 
  • The base case scenario seems overly optimistic, the adverse scenario looks more realistic - although we expect a fall in house prices of around 35% rather than the 25% assumed. The prediction that unemployment will peak at 27.2% also seems optimistic given that there is plenty more austerity and internal devaluation to come while the structural labour market reforms are yet to take effect.
  • Oliver Wyman's report strongly assumes that all the previous capital buffers and loan loss provisions have been well implemented with suitable quality of assets. However, this is far from assured;
  • The level of non-performing mortgage loans seems incredibly low at 3.3% currently with losses only predicted to rise to 4.1% under the adverse scenario. This number could well be distorted by forbearance (delaying foreclosing on loans likely to default to avoid taking losses) by struggling banks. It will also massively increase if unemployment and economic growth turn out to be worse than predicted;
  • The levels of recovery on foreclosed assets seem a bit too positive (admittedly a wide range of between 37% - 79% losses depending on type of asset) given the continuing oversupply in the real estate market in Spain. Until the market has fully adjusted, the huge mismatch between supply and demand is likely to keep resale value on foreclosed assets incredibly low;
  • These tests do look to be more intense than the previous ones but ultimately the optimistic assumptions do instantly raise questions over their credibility. The structure of the bailout request is also unlikely to enamour investors, who like to see grand gestures, however, it always positive that taxpayer participation may be limited. 

What keeps the folks in Brussels and Berlin awake at night?

Possibly this graph - from our new report on the internal devaluation needed in the PIIGS for the euro to remain intact.
Source: Eurobarometer

It shows how trust in the EU amongst voters in the PIIGS has on average fallen from 55%  in 2001 to 25% in 2012, in the wake of EU-mandated cuts. On average, 66% of voters in these countries now mistrust the EU (up from 26% in 2001). And Spain still has half of its internal devaluation ahead of it (not to mention Greece). This won't be easy.

Thursday, September 27, 2012

Initial thoughts on Spain's latest austerity budget

We’re still waiting for the full breakdown and figures behind the Spanish budget (which we will analyse and post in due course) but in the meantime here are our initial thoughts:
  • The decision to tap the pension/social security reserve fund for €3bn was surprising. Generally this is a fairly last resort approach, but why Spain felt the need to do this to get its hands on only €3bn isn’t clear, especially with short term borrowing costs still low. Could Spain’s liquidity problems be greater than thought?
  •  The interest Spain will have to pay on its debt will go up by €9.7bn, compared to a total package of cuts of €40bn (undoing almost a quarter of them). For a country the size of Spain even seemingly substantial cuts can easily be offset by the massive debt burden.
  • The majority of the savings (58%) will come from spending cuts rather than tax increases – there is an on-going debate over which is more effective but in the short term spending cuts are likely to harm economic growth (especially given the reliance on the state as an economic driver in Spain).
  • Tax revenue is expected to go up by 3.8% - given that growth is likely to falter this seems incredibly optimistic, even with some tax increases.
  • The basic macroeconomic forecasts for the budget haven’t changed – this suggests that the overly optimistic growth forecasts are likely still in place, despite most investors and international agencies reducing their forecasts.
  • Unemployment is predicted to have topped out this year – again this seems hopelessly optimistic given that structural labour market reforms are yet to take full effect (and there are still more to come) while internal devaluation will need to continue at a rapid pace (see our recent briefing here for more info on this).
So, plenty of issues already, with what seems to be a fairly unconvincing budget given the state of the Spanish economy. 

One final point to note is that Spanish Economy Minister Luis De Guindos kept insisting that the measures were all in line with recommendations from the EU/IMF/ECB troika or in some cases even went further. This looks to be leading into a Spanish reform programme as part of a bailout/bond buying scheme, hinting that Spain may be preparing that request after all.

Not quite a U-turn, but still big news from Monti

Speaking at the Council on Foreign Relations in New York, Italian Prime Minister Mario Monti has made an important announcement regarding his political future after next year's general elections.

He said,
Under special circumstances, which I hope won't occur, I may be asked to come back. I may consider this hypothesis, but I hope not to have to. 
And then went on, 
If requested by [Italian] political forces, I'm available for a second mandate. 
By far the most explicit declaration of intent made by Monti during his time as Italian Prime Minister. But this is not strictly speaking a U-turn. What Monti has said so far (most recently in an interview with the CNN two days ago) is that he will not run in next year's general elections.

However (as we suggested here), he may be willing to stay on, if needed, as the head of a broad coalition of reformist parties.

We're now awaiting the official confirmation of Berlusconi's comeback? 

Germans vs Inflation: the battle continues

In our daily review of UK and continental press, we spotted an interesting consumer analysis survey referenced on the front page of Bild yesterday. The survey - conducted by Axel Springer AG and the Bauer Media Group - found that Germans were conservative and prudent in terms of their finances with 67.9% of respondents possessing a savings book, 57.2% setting aside a specific sum every month, with only 33.8% having a credit card.

In contrast, in 2010, 64% of the UK’s adult population had a credit card – almost double that of Germany’s. This could possibly help to explain how the German and UK debates on the eurozone pass each other by so often, especially when it comes to the role of the ECB. The view from Berlin is that the ECB ought to remain as the guardian of price stability and not engage in activist monetary policies such as bond-buying, while the view from London, Washington and indeed other European capitals is that Draghi’s recent actions mark a decisive turning point in the crisis, and that it is good that he has been able to overcome German resistance – as argued by David Laws at an Open Europe fringe event at the Lib Dem conference.

Incidentally, former ECB chief economist Otmar Issing has an interview in yesterday’s Die Welt in which he warns against the social and economic damage of unchecked inflation:
“Many people come up to me on the street. Savers are deeply insecure and they have every reason to be. [The ECB’s] monetary policy has reached its limits [it] risks losing its credibility.” 
"There is no immediate risk of inflation. However I have my doubts that the ECB will stop its immense liquidity at the correct time. If this fails, prices will rise. I do not anticipate hyperinflation. However, even an inflation rate of 4 to 5% disposes savers and creates social problems… The social partnership between employers and unions, everything depends on a reliable monetary policy. Inflation is the most anti-social policy.” 
“[Pumping more liquidity into the system] is a dangerous argument. In putting out a fire, it is also the case that more water is not always better per se. Ultimately it could turn out that the damage caused by the water exceeds the actual fire damage.” 
Speaking to the German Industry Federation (BDI) yesterday, ECB President Mario Draghi defended the ECB’s new bond-buying programme, and in an apparent swipe at German fears of inflation, that in times of crisis “we cannot always look to the past for answers”. While Bundesbank chief Jens Weidmann may have been isolated in voting against the OMT programme, he retains the backing of a huge swathe of German public opinion which is deeply rooted in the country’s culture of savings and financial prudence.

This battle is not over by any stretch of the imagination.

Wednesday, September 26, 2012

Pressure mounts again for Don Mariano

Spanish Prime Minister Mariano Rajoy's trip to New York for the meeting of the UN General Assembly is coinciding with a particularly eventful week for Spain, on several fronts.

The Rodea el Congreso ('Encircle the Congress') anti-austerity rally outside the Spanish parliament building in Madrid turned violent yesterday, with 35 people arrested and 64 injured. The day before the rally, the Secretary General of Rajoy's party, María Dolores de Cospedal, recalled that the last time the Spanish parliament was 'encircled' was on the occasion of the failed military coup on 23 February 1981. The day after the rally, Spanish Interior Minister Jorge Fernández Díaz congratulated the police for handling the situation "magnificently". We assume these remarks have not done much to placate the protesters.

The demonstrations are clearly not good news for Rajoy and his cabinet. The Spanish government is due to unveil a new reform plan tomorrow, which may constitute the basis of the new Memorandum of Understanding, if (or should we say 'when'?) Spain decides to make its official request for EFSF/ECB bond-buying. As Rajoy himself anticipated in an interview with today's WSJ, the plan will include measures to cut the number of early retirements and the creation of an independent body in charge of monitoring Spain's compliance with EU-mandated deficit targets. Expect further protests fairly soon.

Meanwhile, the deficit of the Spanish central government stood at 4.77% of GDP at the end of August - with the target for the entire 2012 fixed at 4.5% of GDP. The Bank of Spain has this morning warned that, based on data available so far, Spanish GDP is continuing to fall "at a significant pace" during the third quarter of the year.

On the regional front, the rift between the Spanish government and Catalonia seems to be widening by the day. Catalan President Artur Mas announced yesterday that early elections will take place in Catalonia on 25 November. The autumn is going to be very tense, given that the Basque Country and Galicia will also hold early elections on 21 October. Crucially, Mas went one step further this morning, when he made clear that the Catalan people will be consulted on the issue of independence, with or without the authorisation of the Spanish government.

Furthermore, Andalusia's Treasury Minister Carmen Martínez Aguayo said yesterday that the region will “very likely” seek a bailout from the Spanish government. If confirmed, the request would be for a loan of over €4.9 billion. This means that Catalonia, Comunidad Valenciana, Murcia and Andalusia would, in total, need around 80% of the money in the bailout fund set up by the Spanish government to help all the 17 Comunidades Autónomas.

What else? Oh yes, in case you were wondering, Spain's borrowing costs are going up again. The interest rate on ten-year bonds is above 6% today.

In this context, it looks like Rajoy will not be able to hold out for much longer. The time for key decisions looks to be approaching - potentially marking a turning point for the future of Spain and the eurozone crisis. 

Tuesday, September 25, 2012

A German euro exit 'not science fiction' for Il Cavaliere

The Huffington Post has decided to go for a lengthy interview with Italy's former Prime Minister Silvio Berlusconi for the launch of its Italian edition. Il Cavaliere sticks to his form on the euro, firing a salvo at Mario Monti (the Italian elections are drawing closer after all), arguing,
"I would have been less servile than Monti to Germany, a hegemonic state which is imposing the rule of rigour and austerity on other European countries - claiming that one can reduce [public] debt through austerity. But this is an illusion: public debt can be reduced by increasing GDP, which means development and growth."
Despite coming from a different political family, this sounds very similar to what France's Socialist President François Hollande said throughout his electoral campaign.

Berlusconi also seems to have revisited previous claims that leaving the euro "wouldn't be the end of the world" for Italy. He now says "it would be hard to exit the eurozone today", adding:
"There are three possibilities. The first one: convince Germany that we can't go on with austerity only. The second one: Germany leaves the eurozone, which is not science fiction given that German banks themselves have considered the possibility of replacing the euro with the D-mark. And the third one: other countries leave the euro, which would, however, mean the end of the single currency and scrapping Europe."
He says he favours the first option. 'Buona fortuna', Silvio.

Asked about his recent criticism of the fiscal treaty - which his party supported in the Italian parliament - Berlusconi claims,
"As the head of the [Italian] government, I fought a solitary battle over the fiscal treaty in Brussels, because France was perfectly aligned with Germany's pro-rigour stance. I even vetoed the inital draft blocking the discussion...In [the Italian] parliament, we voted in favour of the fiscal treaty for sense of responsibility." 
Interesting claim, as Berlusconi stepped down more than a month before the first draft of the fiscal treaty was tabled..  

In other news, Berlusconi is still refusing to officially confirm his comeback.

Westerwelle's journey into fantasy world

The report presented by the so-called ‘Future of Europe’ reflexion group of eleven European foreign ministers, set up by Germany's Guido Westerwelle, hasn't gone down well in all quarters. The initiative was well-intentioned, for sure, but that's what you get when you suggest that Treaty changes should be decided by super-QMV, we suspect.

Der Spiegel quoted a European diplomat "scoffing" at the initiative:
"It is unimportant for the future of Europe, but very important for the future of Westerwelle."
Ouch. The recipe for this report has been largely concocted within domestic German politics with an added pinch of Polish foreign policy - and it's an odd exercise to spend valuable time on. Swedish Social Democrat MEP Marita Ulvskog - hardly anti-EU - described it best:
"I think it's regrettable that the EU spends so much time on something that by my standards are pure fantasies and so incredibly far from reality...there's no popular support [for this] whatsoever."
EU leaders have enough on their plates trying to match austerity with structural reforms and re-jigging the role of the ECB, without entering the realms of fantasy. Herr. Westerwelle might fancy himself as Narninian character but unfortunately we're living in the real world and not in a wardrobe.

Monday, September 24, 2012

UK Government to announce repatriation of EU crime and policing laws (as recomended by Open Europe)

The Sunday Times yesterday claimed that David Cameron will soon announce that the UK government will repatriate some 100+ EU crime and policing laws. According to the paper, the announcement could come before the Corby by-election, expected to take place on 15th November. The idea is to lure Conservative voters away from UKIP (but that's not the only reason for the timing, we might add).

To recap: Under the Lisbon Treaty, the UK has the right to use a ‘block opt-out’ from around 130 EU crime and policing laws, including the European Arrest Warrant, Eurojust and rules on data sharing, or see ultimate jurisdiction over these laws transferred to the ECJ. An unavoidable choice, in other words, between more or less Europe. After using the block opt-out, the UK can then choose to opt back into individual laws on a case-by-case basis.

In a report published in February, we argued in favour of the UK taking the opt-out and then having an honest and open debate about the most crucial laws that it wanted to keep, possibly seeking to renegotiate these so that the ECJ - whose rulings are almost always in favour of 'more Europe' - is left out of the mix. Our recommendation was subsequently backed by over 100 MPs, in a letter to the Telegraph. We have since argued in favour of taking the block opt-out on numerous occasions, calling on the government to announce it this year (giving them enough time to negotiate opt-ins). Absent a major U-turn, the UK government will now follow our recommendation. In truth, it was always going to be difficult for it to avoid taking the opt-out, given the political climate.

The debate has now shifted to what, exactly, the UK government should seek to opt back into, with the Lib Dems and Tories currently in talks, with the former naturally wanting to sign up to more laws than the latter. According to the Sunday Times, "dozens" of measures are on the table - we'll return to what we think the UK should remain part of, in the very near future.

In the meantime, in an exceptionally well-timed debate, Open Europe, alongside Centre Forum, organised a fringe event on Saturday, at the Lib Dem conference in Brighton, looking at this very issue. The debate featured our very own Stephen Booth, Lib Dem MP Tom Brake, Tory MP Nick de Bois and Lib Dem MEP Sarah Ludford. A write-up of the event can be found here.

Meanwhile, in the Far North

One of the consequences of the eurozone crisis is that media, pundits and market analysts have been forced to become experts of what previously would have been seen as the most obscure political events. Thus, the Finnish local elections now have international significance (although they are still not making any headlines) as they serve as a barometer for the extent to which "Europe" as an election issue can trickle through to the local level. The theory being that the closer the issue gets to citizens, the harder for EU leaders to sell more integration.

An opinion poll for Finnish public broadcaster Yle puts the anti-bailout (True) Finns party at 17.2% - three times higher than in local election in 2008. Compared to 2008, all parties except for the Green party and the (True) Finns party would lose voters.

With a majority of voters from all Finnish parties - apart from the small Swedish People's Party - seemingly opposing more eurozone bailouts, expect Finland to remain assertive. Starting with the rumoured leveraging of the ESM.

Friday, September 21, 2012

The view from Sweden: Barroso is making it more difficult to be pro-EU

This is spot-on.

Sara Skyttedal, vice-president of the Youth wing of the European People’s Party – the pan-EU party Commission President Jose Manuel Barroso belongs to – has a blistering piece  in today's Svenska Dagbladet. She takes Barroso to town over his 'State of the Union' address, in which he called for Europe to become a "federation":
"As Vice-Chairman of [the EPP's] youth wing, YEPP, I can only say that representatives such as Barroso make it more difficult to be pro-EU [EU-vän] “
She continues:
"At a time when crises are raging across Europe and when countries need a helping hand, the eurocrats see an opportunity to demand extensive transfers of power and centralisation in return. Barroso suggests the creation of a banking union and argues that the EU in the end must become a federation. This is a frightening development, since even though Barroso himself says that a superstate isn’t the end goal, it is it hard to interpret his vision in any other way.”
She argues that politicians have ”time and again” ignored the subsidiarity principle. Taking aim at the Swedish political class, Skyttedal says:

“Just as there are many signs that the EU makes it harder for member states to fight the centralisation of powers, Sweden has reinforced this tendency on its own”, arguing that the requirement for EU-membership should be deleted from the Swedish Constitution.
“Those of us who are active in the EPP…must take a bigger responsibility for the liberal-conservative family in Europe. In these circles we must dare to bring up the problems that exist. Large parts of our respective parties were once active in the Yes-campaigns, both for EU and euro membership, but it’s time to swallow our pride and take up the fight against supranationalism and to show it’s possible to have a realistic attitude to the EU, which doesn't automatically mean arguing in favour of leaving the project altogether."
“The EPP-family is the biggest one in Europe, but includes members that unfortunately work in the opposite direction to the EU that we rather want to see. What we think the EU needs is less supranationalism, less political interference and definitely not a federation.”
Hear hear.

Sweden isn't exactly a European hegemon (those ambitions pretty much died in 1709) but it's an interesting country for the UK and Europe in at least two respects: first, it's actually doing well, both on the fiscal and banking front. Secondly, how the country responds to the drive for further euro integration will be an interesting proxy for how easy it'll be to reconcile a more tightly knit eurozone block with the EU-27. Most importantly, the banking union with the single market.

70-80% of Swedes oppose joining the euro, and that debate is dead (baring random calls from the occasional politician and opinion former who still cling on to that particular dream - it's almost cute), but the country has fundamental choices ahead of it - such as whether or not it joins the the ECB's banking supervision structure - so Europe needs to be discussed. 

Though a majority of Swedes would echo the sentiment contained in Skyttedal's article, there is still a contingent in Sweden, particularly on the centre-right (associated with Carl Bildt, the Swedish Foreign Minister) that clings on to a vision of an ever-closer integrated EU as a liberal inroads into its dominant domestic social democratic model, and also as a catalyst for Swedish internationalist idealism, i.e. a 'peace project'.

Historically, both of these assumptions contained some truth but firstly, Sweden's social democratic domination has already been broken and secondly, the single currency - clearly - has proven less of a liberal trade project and more an ideological over-reach (think Greece). The eurozone crisis is now causing friction in Europe, rather than the opposite, and it most certainly isn't aiding either Europe in the world or facilitating enlargement (which is a legitimate EU foreign policy tool).

In other words, this traditional Swedish centre-right vision is dated and needs upgrading - which is true for other contingents in the EPP. Skyttedal's article is an important reminder that if we want to save what's good in Europe, Barroso's "federation" vision - which risks a massive popular backlash - is the opposite of what's needed.

The path for true pro-Europeans must lay elsewhere.

Thursday, September 20, 2012

ECB's own budgetary discipline not inspiring confidence

With budgetary discipline the only game in town in the eurozone, it must have been a bit of an awkward moment at the ECB when they realised that the bank's new Frankfurt headquarters (pictured), currently under construction and due to be completed in 2014, will come in significantly over budget.

Executive board member Jörg Asmussen let the cat out of the bag in his welcome address at today's 'topping-out' ceremony, revealing in his welcome address that:
We are monitoring the construction progress, costs and price developments very closely, adjusting and adapting where necessary. As a public institution, we are committed to using our resources responsibly. This is essential. So far the ECB has spent approximately €530 million in construction and other costs, including the purchase of the site. In 2005 the overall investment cost was estimated at €850 million at 2005 constant prices. It is anticipated that increases in the price of construction materials and construction activities from 2005 until the completion of the project in 2014 will lead to a €200 million increase in the overall investment cost. 
In addition, there have been a number of unforeseen challenges that needed to be dealt with. The two major challenges unforeseen in 2005 were, first, that the original tender for a general contractor did not yield a satisfactory result and the ECB had to change to a different contractor model, and second, that the Grossmarkthalle – a large industrial heritage building from 1928 – presented a number of challenges that were not detected in the initial examination conducted prior to the acquisition:
  • the foundations turned out to be insufficient and required additional support; 
  • the roof coverage was found to be contaminated and therefore could not be disposed of as envisaged; 
  • and parts of the concrete construction had insufficient steel support.
These factors are likely to account for additional costs of about €100-150 million, or a 10-14% increase in the overall investment cost. The resulting delay in the construction works on the Grossmarkthalle, as well as the entrance building, has been incorporated into the existing time schedule.
So overall the total cost is likely to come in at around €1.2bn, a tidy sum of money, even at a time of multi-billion euro bailout funds. We estimate that the cost of the new building amounts to around half of the outstanding cuts the Greek coalition still has to make in its latest austerity package.

DPA notes that the new building will hold 2,300 personnel, seemingly large enough for a central bank. Although when you consider that the ECB is currently looking to take over the supervision of 6000 financial institutions - a job which national supervisors currently employ tens of thousands of people to do - one does wonder whether another new building could be needed in the near future. 

We can't say the ECB is setting a great example for austerity, especially given that is now a precondition for accessing its new bond-buying programme.

Creative Bailout Thinking, Spanish Style

One should give some credit to the Spanish government for its determination in trying to make bailouts look like something else. Today's El País reports that Spain is planning to request that the unused money from the €100 billion bank bailout package agreed with the Eurogroup a couple of months ago be used to buy Spanish bonds on the primary market.

This, in turn, should be enough - or at least this is what people in Madrid hope - to convince the ECB to start buying Spanish debt on the secondary market. According to the paper, the results of the independent audit of Spain's banking sector - whose publication has been postponed to 28 September - are expected to confirm that Spanish banks need a total capital injection of no more than €60 billion.

Therefore, the Spanish government is confident that, assuming that banks will be able to raise at least part of the money from alternative sources, it will only have to use less than half of the rescue package for bank recapitalisation - which would leave some €55-60 billion available. In other words, Spain sees the possibility of obtaining ECB support without having to apply for a separate EFSF bond-buying programme - i.e. without having to ask for more money.

Good effort, but too many 'ifs' remain. First of all, the results of the audit should not be taken for granted. As we recently argued, the real capital needs of Spanish banks may turn out to be higher than the €60 billion Mariano Rajoy and his cabinet are currently betting on. Furthermore, even if the €60 billion figure were confirmed, it is fair to assume that Spanish banks may face unreasonable borrowing costs on the markets - compared to what is on offer through the bailout funds. Therefore, they may find it much easier to just ask the government for cash.

Secondly, according to the draft agreement that we published on our blog (see here), Spain does indeed have the right to request that part of the €100 billion be used for purposes other than bank recapitalisation. However, in order for this to happen, the Memorandum of Understanding will have to at least be substantially revised and a whole new one may need to be created. Now, Rajoy is assuming that no new conditions would be imposed if Spain were to apply for a bond-buying programme - and the European Commission appears to share his view. However, it is far from clear whether this will actually be the case (see the recent comments from Eurogroup chairman Jean-Claude Juncker and Dutch Finance Minister Jan Kees de Jager).      

Finally, it remains to be seen whether the ECB or Germany will agree to such a plan, especially since it further muddies the water between bailouts and conditionality - not exactly clear cut as it is under the ECB's bond-buying programme.

Rajoy may have to make a decision fairly soon. The markets do not like prolonged uncertainty, and the first signs of impatience are already visible. Whatever the solution, it will need political approval from all the parties involved, as much as creatively adjusting current plans may seem, there is no circumventing this fact. 

Wednesday, September 19, 2012

Westerwelle's Future of Europe report - worth getting excited over?

The so-called ‘Future of Europe’ reflexion group of eleven European foreign ministers, set up by Germany's Guido Westerwelle, to discuss and propose ideas on organisational and structural change in the EU held its closing meeting on Monday. Yesterday it released its final report and conclusions, the broad thrust of which is that, to emerge from the crisis, Europe needs more economic and political integration.

In terms of the economic and fiscal side, the majority of the proposals in the document have already been agreed or proposed, such as the “reinforced economic governance framework” – i.e. the fiscal treaty and a single supervisory mechanism for eurozone banks. Even the possibility of making the ESM into a fully-fledged European Monetary Fund has already been voiced. Furthermore, these proposals will only apply to eurozone members and any non-euro members who participate voluntarily.

It is therefore the political/institutional side that is the most interesting and here are the key points that we’ve picked out:
  • More powers for Baroness Ashton and the EU’s External Action Service;
  • More majority decisions in the Common Security and Defence Policy sphere including joint representation in international organizations where possible, and in the longer-term a European defence policy which for some members could eventually involve a European army;
  • Strengthening the Commission should be strengthened so it can fully and effectively fulfil its role as the engine of the Community method;
  • Moving to a super-qualified majority for future EU Treaty revisions (with the exception of enlargement) which would be binding for those Member States that have ratified them;
  • A more “streamlined and efficient system” of EU governance which could include a directly elected Commission President, a European Parliament with the powers to initiate legislation and a second chamber for the member states.
Most of these proposals have been around the block once before but some journalists have gotten very excited about this, with the Guardian splashing the story on its front page. Running with a "Britain is isolated" theme it also noted that:
"The likelihood is that the 11-country consensus will swell into a majority among the EU's 27. Britain also stands apart from this. The 11 include Germany and France, the big ones, plus Italy, Spain and Poland – after Britain the biggest EU countries.”
Well, not quite.

Sure, some of these proposals are conspicuous, and certainly they pose a challenge for Britain. However, many of them have almost no chance of going ahead, certainly not in the immediate future. Firstly, the report represents less of a consensus amongst the relevent states and more of a brainstorming session with lots of dissenting views. As the note itself states:
“The report reflects our personal thoughts. We wish to underline that not all participating Ministers agree with all proposals that have been put forward in the course of our discussions, and that the Member States’ individual treaty obligations and rights within the various policy areas have to be taken into account.”
As stated above, there is significant momentum for more integration in economic, fiscal and banking affairs, but its hugely unlikely to spill over into foreign policy which exists in a parallel political sphere. This is simply a way to re-state the long-standing German desire for a Europeanised foreign policy (the practical difficulties of which have been made clear many times, most recently over Libya).

Super-QMV for treaty change won't happen either - not least since Berlin itself would block it if push comes to shove, as would Paris - unless they would be willing to risk - for example - QMV on the European Parliament's second seat in Strasbourg. 

Banking union, and calls for EU treaty negotiations to be opened by 2014 - as called for by Barroso in his 'state of the union' speech last week - is where the story is at.

The context for this whole initiative is effectively German domestic politics. While no one can question Guido Westerwelle’s European credentials, he is arguably one of the most side-lined Foreign Ministers in the whole EU, and the Future of Europe group is a way for him to show he's still a player.  For Merkel this serves as a useful exercise at a time when the German government is über-sensitive to accusations that it is not sufficiently ‘pro-European’ - but without actually having to do anything. 

Finally, it is worth contrasting the lofty idealism of such - and similar - proposals with the cold, harsh realities of public opinion. As we reported on Monday, support for the EU and the euro has hit an all-time low in Germany, in France a majority of those surveyed said that given the opportunity now, they would vote against ratifying the Maastricht treaty, while the EU debate in the Netherlands is also become more complex.

Germany and banking union: building the chinese wall

Update 14.15: Reuters has seen an internal document drafted by German MPs from Angela Merkel's ruling coalition - setting out their views on plans for a eurozone banking union. The MPs focus on three main aspects:
  • ECB oversight should be limited to systemically important and cross-border banks;
  • Monetary policy and banking supervision tasks should be clearly separated within the ECB;
  • The document also makes clear that deposit guarantees "will not be unified across Europe". They "may be harmonised, but the responsibility must remain national."  
And here is our original post from this morning: 

Yesterday's Die Welt claimed that Germany is pushing a proposal which would see less powers for the ECB's Governing Council under the Eurozone's banking union. Under the Commission's proposal, the ECB's Governing Council would have the final say over both monetary policy and matters of supervision. This could trigger a series of conflicts of interests as the Governing Council would in effect become the judge, jury and executioner - i.e. it would simultaneously make decisions on bond-buying, bank liquidity provisions and whether banks should be recapitalised or closed down (the latter could trigger losses due to the first two). That incentive structure does not feel right, and the 2009 de Laroisière report for the Commission explicitly warned against it.

The Commission's proposal sees supervision responsibilities being outsourced by the ECB Governing Council to a new  Supervisory Board - consisting of representatives from national authorities - but with the Governing Council still having the final say. In addition, the Chairperson and the Vice-Chairperson of the Supervisory Board would be elected from the members of the Governing Council.

According to Die Welt, during last week's meeting of EU finance ministers in Cyprus, Germany put forward a counter-proposal designed to address these concerns. It involves the creation of a completely independent committee within the ECB consisting of national authorities, where voting weights would mirror the size of each member country's financial markets (and therefore their share of the cost). All of this is unconfirmed, but such an arrangement would take care of two issues:

Firstly, a Chinese Wall would be erected between supervision and monetary policy (at least in theory). 

Secondly, unlike the Commission's proposal which fails to spell out whether non-euro countries joining the single supervisory mechanism (SSM) would get voting rights on the new Supervisory Board (an ambiguity which attracted the wrath of Swedish Finance Minister Anders Borg), this arrangement would make joining far more attractive for the likes of Sweden and Poland.

According to Die Welt, the German proposal would give non-euro members a vote on the supervisory board in return for subjecting their banks to the SSM.  There are a huge number of other issues that non-euro countries will still have to consider, such as the constant risk of being outvoted by a eurozone caucus and no discretion on tailored national regulation, i.e. capital requirements (hello Sweden). It is also unclear how this proposal reads legally (the ECB's statute will have to change anyway, but still).

What's clear is that the Commission's proposal still needs a lot of brushing up.

Monday, September 17, 2012

Merkel caught in the middle between the Bundesbank and the ECB

In her traditional news conference following the summer recess, German Chancellor Angela Merkel walked a fine line in questions about the eurozone crisis, having to maintain a delicate balancing act with regards to different elements within her governing coalition.

For starters, she has to contend with the increasingly fractious rhetoric from the CSU – the Bavarian sister party of her own CDU – on the eurozone (see here and here for examples). The latest example being Bavarian Prime Minister Horst Seehofer’s argument that the €190bn cap on German liability imposed by the German Constitutional Court in its ruling on the ESM and fiscal treaty last week should apply to the euro-rescue effort as whole, including the ECB’s new OMT bond purchasing programme. However Merkel has rejected this interpretation on the basis the two are not linked. Speaking earlier today, she told reporters that:
“If the ECB determines that monetary transmission has become difficult, then it must take measures to ensure price stability - it is not up to us to set it limits.” 
Seehofer later confirmed that “this is the only issue which we interpret somewhat differently than in Berlin”, adding that it was nonsensical for the Court to cap Germany’s liability at €190bn only for “it to be suddenly increased by many multiples through other means”.

On the other hand however, Merkel did not issue a statement of blanket support for the ECB’s actions, adding that Bundesbank President Jens Weidmann’s recent interventions – in which he has been fiercely critical of renewed ECB bond-buying were “understandable and always welcome”, a statement widely interpreted in Germany as a subtle rebuke of Finance Minister Wolfgang Schäuble’s comments in an interview with Frankfurter Allgemeinen Sonntagszeitung yesterday in which he criticised Weidmann for his public dissent, arguing that “I'm not sure that making this debate semi-public helps to build confidence in the [European] central bank.”

Merkel is in a tough position because, having invested so much in the euro-rescue, she cannot afford to oppose the ECB’s ‘big-bazooka’ strategy. At the same time however she cannot allow Weidmann – whose views are widely respected and shared by the German public – to become completely isolated for fear this would provoke a substantial domestic backlash.

How long Merkel will be able to keep her fractious coalition together on one hand while also keeping the German public – whose support for the EU and euro has hit an all-time low – onside remains to be seen, especially in the event of unforeseen developments such as Germany actually suffering direct losses on its loans to Greece and/or losses on ECB holdings of Greek debt.

Do the Germans and French still believe in Europe?

The front page of today's Die Welt reads "Germans no longer believe in Europe". According to a TNS Emnid poll carried out in July in Germany, France and Poland on behalf of the Bertelsmann Foundation, support for the EU and the euro has hit an all-time low with 49% of Germans saying they believe they would personally be "better off" without the EU, with only 32% saying that they would be "worse off". By contrast only 34% of French and 28% of Poles said they would be better off without the EU.

The poll also found that 65% of Germans (and 36% of French) believed they would be better off had the euro not been introduced.  

While the gap between French and German public opinion reflected in the above poll is striking, it is not all good news from France as far as the European Commission is concerned. The front page of today's Le Figaro runs with the headline, "The French and Europe: The disenchantment" (although the French word désamour can also be used to describe someone 'falling out of love'). The paper reports on a "shocking" IFOP survey conducted twenty years after the Maastricht Treaty was signed - and the euro was officially created.

According to the poll, if a referendum on the Maastricht Treaty were held today, 64% of French would vote against it. Indeed, one could argue that the French were never hugely enthusiastic about the Maastricht Treaty - only 51% voted 'Yes' in the original referendum. But the finding remains very significant.

Furthermore, a large majority of French also think that the adoption of the euro has had a negative impact on the competitiveness of the French economy (61%), unemployment (63%) and price levels (89%). Interestingly, though, 65% of respondents are opposed to returning to the franc.

Furthermore, the survey also found that 60% of respondents are in favour of "less European integration" of budgetary and economic policies, while 56% consider it "unlikely" that, in the long term, EU member states will give up their sovereignty to establish a "single European state".

Another tough reality check for European Commission President José Manuel Barroso's recent calls for a "federation of nation states" in Europe. As we already noted last week (see here), public opinion across Europe does not really seem to be on the same wavelength...

Friday, September 14, 2012

Is the crisis starting to get to Juncker?

Asked by a journalist earlier this afternoon what the significance the upcoming Troika report would have for the further Greek rescue effort, eurogroup head and Luxembourg Prime Minister Jean-Claude Junker replied that:
"If the donkey were a cat it could climb trees and spend the whole day in the treetops"
Answers on a postcard.

¡Cuidado, Señor Rajoy! The Catalans mean business (and the lesson is for the eurozone)

As we have noted before, whether you sit in Brussels, Berlin or Madrid - and like the idea of more central control - beware regionalism.

The relations between the Spanish central government and Catalonia seem to have reached a new level of tension in the past few days. Somewhat paradoxically, fresh from asking Madrid for a €5 billion bailout, Catalan leaders are starting to talk tough. There have been plenty of hints at independence - although the actual I-word has not been used in public speeches so far.
A pro-independence rally also brought Barcelona to a standstill on Tuesday, 11 September - when Catalans celebrate their national day, La Diada. In a perfect illustration of the forces of regionalism, local police said up to 1.5 million attended the rally, while the Guardia Civil (Spain's national police), cited 600,000 as a more realistic number. In any case, there were a lot of Catalans out on the streets.

Fueling the reinvigorated independence mood is Catalan Governor Artur Mas. The "success" of the pro-independence rally, he argued, shows that Catalonia can become "a normal nation in Europe" (during his speech he had only the Catalan and the EU flag behind him, see picture).

Yesterday, the Catalan Governor drew an interesting parallel with the eurozone crisis. He said,
"I think the same is happening between Catalonia and Spain as between northern and southern Europe. Northern Europe has grown tired of southern Europe. And southern Europe has grown tired of northern Europe because of its way of acting. I think that there is mutual fatigue between Catalonia and Spain, too. Catalonia has grown tired of not making progress and Spain [has grown tired] of Catalonia’s way of acting. Catalonia thinks it contributes a lot and is not respected. And Spain thinks Catalonia is always asking and complaining."
He said the time had come for a referendum on Catalonian independence, threatening early elections if Catalonia does not get greater tax collection powers. However, taking his eurozone parallell to its logical end point, he did not say whether the north and south in the eurozone should also opt for a divorce.

Because, as we have argued before (see here and here) and just as the Governor suggests (though, just to be clear, we're not taking any positions in the debate on Catalan independence!), Spain is a microcosm of what may be to come in the eurozone:
  • Catalonia wants greater taxation powers since it feels that is losing out under the current system. Only two out of 17 Comunidades Autónomas (the Basque Country and Navarra) are allowed to collect all taxes by themselves, and then send part of the money (the so-called cupo) to the central government. If Catalonia gets the same deal, it says it will save cash. So Catalonia wants to opt out of most of Spain's transfer union. If Spain finds it difficult to hold its together, how much more complicated will it be for the euro to move to a transfer union - and then hold it together?
  • And in a perfect illustration of what individual responsibility does: Basque Country and Navarra, the two regions that raise and spend most of their own taxes, are amongst the Spanish regions with the strongest finances (and likely to meet their deficit target at the end of the year). Catalonia is the has the highest debt/GDP ratio of all Spanish regions (see here).
Catalonia is not about to go independent. But this debate is a huge flashing warning sign for the eurozone.         

Thursday, September 13, 2012

Too soon to jump to conclusions: the Dutch debate on Europe has only started

As we said in our pre-election briefing, the Dutch elections saw a shift back to the centre, compared to the early signs of the campaign. Granted, a stronger combined majority for the two main parties - centre-right VVD and centre-left PvdA - than many had expected. The Socialist Party stayed on the same number of seats as last time around, while the populist Party for Freedom suffered a pretty heavy defeat (losing nine seats).

Senior Brussels figures were quick to hail the result as a victory for the pragmatic, pro-European centre over the crazy fringe. A victory for further European integration, euroscepticism can't win votes, sort of thing. Some media outlets drew similar conclusions - with some exceptions - claiming the anti-bailout mood in Europe is much over-stated. But is this interpretation right?

There's no doubt that the centre parties mounted a strong comeback, in the face of an increasingly sceptical public on Europe. But to see this election as a victory for the very specific vision of Europe that involves "ever closer union" is spurious. A few points:

First, Geert Wilders is no proxy for unease about where Europe is heading. In almost all aspects of policy Wilders is extreme, and his decision to bring down the last government has undoubtedly worked against his party. The Dutch may not like bailing out other countries, but they do not like reckless politicians either, and some voters considered a vote for him wasted.

As we noted in our pre-election briefing, the centre parties too - particularly VVD - have struck a more euro critical tone of late, perhaps in response to the strong rhetoric coming from Wilders and the Socialist Party. On Europe, the VVD may have crowded out Wilders, particularly by talking tough on bailouts. Regarding Greece, almost exactly repeating Wilders's words, Prime Minister Mark Rutte said, for example, that:

“Enough is enough…An exit may be inevitable, but it will be up to Greece to make that decision…An orderly exit is possible, but not desirable.”

In a comment piece in the FT last year, Rutte was one of the first to call for a clear mechanism to push countries, which do not meet the austerity targets, out of the eurozone – at the time widely acknowledged to be a shot across Greece’s bow. On the EU budget, he has sided with the UK in trying to achieve a real terms payments freeze in the EU's 2014-2020 budget, saying, "If we countries need to cut our budgets, also the European institutions need to do with less."

The Social Democrats, led by Diederik Samsom, played a role in triggering the elections by refusing to support the previous government’s budget dictated by EU deficit rules. It is true, this was their prerogative as the opposition. Nonetheless, they did their fair share of anti-Commission posturing such as:
"[It's about] how the Treaty is being applied…The economy is suffering damage in an unnecessary way because of the demands of the Commission".
And during the election campaign, the party had some other interesting things to say about European integration, such as:
“I’d reserve [Eurobonds] for the moment Europe is away from the abyss. Eurobonds are no rope to drag you out of the abyss. Economies need to converge and public debt needs to stabilise first.”

“I don’t support the blueprint of [EU-federalist D66 leader Alexander] Pechtold with his European government, Finance Minister and Parliament.” 
In the party manifesto, it called for a reduction to both the EU budget and the Dutch contribution to it - not even the UK Tories did that.  

Equally, Europe Minister Ben Knapen, a CDA member - whose party may be needed to achieve a government with majority in both houses of the Dutch parliament - said that "there should be a legal possibility for countries to voluntary or forcefully leave the eurozone. Only then the moral hazard - which is like a hostage - can be dealt with". He also urged to "correct the power the European Commission, which has been enormously growing in recent years."
On the wider point about the Netherlands in Europe - and whether this election will make it more or less assertive - the centre parties may be far more supportive of the status quo in Europe, but they are different on economic and social policy, completely different sides of the political spectrum in fact. Making the coalition work at all will be a huge challenge. Throwing the difficulties of the eurozone crisis into the mix makes the task even harder, while any pressure for greater integration may force the governing parties to be seen as acting tough, under the pressure from opposition parties.

No, the Dutch haven't turned into head-banging eurosceptics. But all of this is to say that the debate about the Netherlands' role in Europe, in the face of further euro integration, may just be kicking off.

Yesterday's Karlsruhe ruling: Good news for Germany and Europe?

Following yesterday’s ruling by the German Constitutional Court in which it gave the go-ahead to both the ESM and fiscal treaty, German politicians from all the main parties were tripping over-themselves to praise the Court and its ruling. Speaking in the Bundestag, Chancellor Merkel declared it “a good day for Germany and a good day for Europe” while Foreign Minister Guido Westerwelle praised “the [Court’s] wise decision in the pro-European spirit of our Constitution.” The SPD’s parliamentary leader Frank-Walter Steinmeier also welcomed ruling, in particular the additional participation rights for the Bundestag.

While some politicians - including those who had themselves lodged legal challenges - said they were disappointed, even politicians who have been among the fiercest critics of the euro-zone bailouts declared their satisfaction, with, for example, the FDP’s Frank Schäffler describing the verdict as a “victory for democracy”, claiming that with the imposition of the cap on German liability, “The ESM has lost its sharpest tooth”.

However, interestingly the German media has adopted a more sceptical tone altogether. For example, today’s Süddeutsche comments that:
“In their ruling, the judges clearly called out the risks of the euro-rescue but drew few consequences. Their reservations do not change the fact that Europe is moving together under great financial and political risks.” 
In a front page op-ed, Die Welt editor Thomas Schmidt draws in the ECB OMT bond-buying angle – something that we also cover in our analysis of the ruling - arguing that:
“The Court watches over German money and the issue of democratic legitimacy. It is clear that the ECB decision has opened the way into the bottomless transfer union in principle. It is equally clear that the legitimacy of the path towards the further deepening of European integration is poorly grounded. This must and will result in yet more legal challenges. 
FAZ's economics editor Joachim Jahn describes the verdict as “a slap in the face of financial policymakers”, but warns that:
"With the requirement to secure a liability cap binding under international law, the judges have at least curbed the potential harm to the taxpayer… It is however questionable how much exactly the Karlsruhe order would be worth in an emergency. A protocol to the effect that Germany does not feel itself bound by alternative interpretations of the agreement is would be easy to obtain. Whether this would be considered material by the ECJ in the event Italy and Germany were to argue over reserve liabilities is by no means certain."
Last but not least to Bild Zeitung, whose chief editor Nikolas Blome argues that:
“The ECB’s [OMT] programme is perhaps well intended but not well executed. It is highly dangerous – and here the Court’s ruling changes nothing. The double whammy of the ESM and ECB is essentially so strong so as to be able to save every eurozone member. However, exactly this will lead all eurozone states into temptation: why enact painful reforms and brutal savings when it could be supposedly easier at the expense of the others, and Germany in particular?” 
The relief of Germany’s politicians is palpable, but the battle for the future of the euro – and the role of the ECB in particular – is still far from over.

Public opinion and Europe: back in the real world

Brussels is on manoeuvres. European Commission President Barroso yesterday called for a quantum leap towards a "federation of states" (see here) and today his counterpart in the European Council, Herman van Rompuy, put forth a wishlist covering a range of items that will trigger more eurozone integration (a eurozone budget, debt-pooling, etc). With yesterday's Dutch elections being interpreted as a victory for the centre over the eurosceptic fringe, and the Karlsruhe guys in red robes out of the way, the European project is breathing some fresh air again, right?

Well, as ever, it's more complicated than that. We will return to the Dutch elections in a sec, but for now, US-based German Marshall Fund published the 2012 edition of its Transatlantic Trends survey which is quite interesting.

The chart below caught our attention:

With the exception of Germany - which is not surprising given its desire to export German budget dsipcline in return for lending its credit rating - a majority of respondents in all the other eleven EU countries included in the survey is opposed to "more EU economic oversight of national finances."

Even more interestingly, the share of respondents opposed to greater EU control over national finances has increased since last year's survey in France (58% from 55%), Spain (56% from 53%), Italy (49% from 47%), Portugal (59% from 56%) and the Netherlands (58% from 55%).

As consolation, 'only' 79% of the British now think that the UK should retain control over its finances (down from 84% in 2011). A vaguely asked question about helping "countries with budgetary difficulties" - which is too imprecise to have a real meaning - also saw a declining share of the population supporting it.

A federation of states remains a tough electoral sell everywhere...

Wednesday, September 12, 2012

EU treaty change: Nowhere to run, nowhere to hide…

 It’s not the focus of the SW1 bubble today, but David Cameron will be taking a deep breath after Jose Manuel Barroso used his ‘state of the Union’ address (we know…) to call for a debate on rewriting the EU Treaties in 2014. It seems there is now no avoiding the major strategic decisions on Europe that both the Conservatives and the Lib Dems have been desperate to avoid lest they tear apart their increasingly fraught marriage.

In one of his most overtly political speeches to date, Barroso was explicit: this crisis is the perfect time to take the next great leap towards a federal Europe. “Where we cannot move forward under the existing treaties, we will present explicit proposals for the necessary Treaty changes ahead of the next European Parliamentary election in 2014, including elements for reinforced democracy and accountability,” he said. “No one will be forced to come along. And no one will be forced to stay out. The speed will not be dictated by the slowest or the most reluctant.”

He hinted that the new treaty discussions would be a wide-ranging affair rather than the more limited crisis-response changes made so far. “This is not just a debate for the Euro area in its present membership. While deeper integration is indispensable for the Euro area and its members, this project should remain open to all Member States.”

The details of the proposals were left open but Barroso did offer his broad vision for the future:
“A deep and genuine economic and monetary union, a political union, with a coherent foreign and defence policy, means ultimately that the present European Union must evolve.”
“Let’s not be afraid of the words: we will need to move towards a federation of nation states. This is what we need. This is our political horizon. This is what must guide our work in the years to come.”
“I call for a federation of nation states. Not a superstate. A democratic federation of nation states that can tackle our common problems, through the sharing of sovereignty in a way that each country and each citizen are better equipped to control their own destiny.”
There was much talk of making the EU “more democratic” and he hinted that his preferred vehicle for doing so is the European Parliament, whose role he described as “essential.” He called for the development of pan-European political parties and for the parties to announce their candidates for Commission President as part of the election campaign.

He also called for a “better developed set of instruments” to bring wayward member states into line with the values of the EU, “not just the alternative between the ‘soft power’ of political persuasion and the ‘nuclear option’ of article 7 of the Treaty,” which currently allows the EU to suspend the voting rights of countries deemed to be in “serious and persistent breach” of the values set out in the Treaties.

In short, it looks like the European Commission is shaping up for a full scale constitutional shake up of the EU a year before the General Election in the UK, a year that is already packed full of EU agenda items: the block opt-out of crime and policing law, the Government’s audit on EU powers is due to be published, there are also European elections, where UKIP could do very well, the aftermath of the long-term EU budget talks and the appointment of a new UK EU Commissioner. There are a huge number of strategic decisions for the UK involved in this discussion (which we have looked at, and will continue to look at).

But one thing is clear, if Barroso gets his way, there will be nowhere for Cameron to hide from an EU renegotiation before 2015.

Tuesday, September 11, 2012

The 'forgotten man' of the euro crisis catches a break...

While everyone is gearing up for the EU's 'Super Wednesday', Portuguese Finance Minister Vítor Gaspar has made a quite important announcement. As we anticipated in our daily press summary more than two weeks ago, following its fifth monitoring mission to Lisbon, the EU-IMF-ECB Troika has decided to give Portugal one extra year to make the budget cuts agreed under its bailout programme.

The 'forgotten man' of the euro crisis will therefore be allowed to close the year with a deficit of 5% of GDP (instead of the previously agreed 4.5%). Portugal will then have to cut its deficit down to 4.5% of GDP (instead of 3%) next year and to 2.5% of GDP in 2014. No doubt the one off transfers from pension funds to push the deficit below previous targets finally caught up with them. 

The news is particularly interesting - and not only because Portugal seems to have fairly easily achieved what Greece has failed to obtain so far, despite Greek Prime Minister Antonis Samaras's recent 'diplomatic offensive'. In fact, Portugal is still expected to return to the markets in September 2013 (exactly one year from now). Given that the country has been allowed to run a larger deficit for this and next year, this suggests that it will have to borrow more money to cover for it.

For the moment, Gaspar has made clear that nothing has changed on that front, and Portugal will try to raise the money from private lenders (i.e. will not ask the EU and the IMF for more cash).

However, this brings us on to another interesting fallout from the ECB's new Outright Monetary Transactions (OMTs). Since currently bailed out countries, such as Portugal, can access support from the ECB when they are due to return to the markets, there is a good chance that the ECB could buy up some existing Portuguese debt from the secondary markets in September 2013, allowing banks to reinvest this money in the  new debt Portugal will issue. This also allows Portugal (and the eurozone) to sidestep the IMF's demand that countries be able to show clear funding streams for 12 months (which led to the second Greek bailout request).

So, despite delaying its deficit target and not being guaranteed market access within twelve months, Portugal looks able to avoid a second bailout with the help of the ECB (at least for the moment). One should now only ask whether the conditions attached to the Portuguese bailout programme will satisfy the ECB, especially after they have been eased...

New figures show that 51.4% of UK goods exports are sent outside the EU and we run an EU trade deficit – does that tell us anything?

New trade figures out today show the UK exports more goods to countries outside the EU than to countries inside EU. But what is the relevance of this or the fact that the UK continues to run a trade deficit with the EU?

Key facts:

UK goods exports to EU in July 2012 £12.5 bn (48.6%)
UK goods exports to non EU in July 2012 £13.2 bn (51.4%)

As the graph below shows, the UK has for most of recent history sent far more than 50% of its total goods exports to the EU. The UK's services trade is more diversified but it is a traditional argument that the EU's customs union is vital to the UK's goods exports. The recent figures for July 2012 seem to buck the trend due to weak EU export and better non-EU export figures. As an aside, the proportion of UK goods exports going to eurozone countries fell to 43.6%, the lowest share since records began in 1988.

So is 50% significant?

The simple answer is no. 50% is a rather arbitrary figure;** it would make little difference if the UK only exported 40% to the EU - it would still be vital to ensure it continued, although it could be argued that the less the UK relies on the EU for its exports the stronger its hand politcally.

But the more important question for now is whether the UK’s membership of the EU is the best way to promote trade and if so whether this benefit is offset by the other costs of membership (budget, regulation, CAP, etc).
Is the UK’s trade deficit with the EU a strong card to play if we left the EU?

The second potentially significant trade figure out today shows a UK trade deficit with the EU in goods of £4.3bn - bigger than that for non-EU goods.

However, the UK's record in goods also needs to be considered along with its more healthy balance in services trade, but even when services are included the UK still posts a total trade deficit with the EU.
So is it a strong card?

If the UK left the EU would it be able to strike a deal that preserves the UK’s trading relations with the rump EU without the costs? One argument goes that its deficit is a ‘trump card’ that will force the remaining EU to conclude a favourable Free Trade Agreement (FTA).

Yes the UK has a deficit but what is more important is total volume of trade. For the UK total EU trade is now less than 50% of its exports. Less than it was, but for the EU (ex UK) the UK would amount to only 22% of its total exports (E306bn out of E1,348bn) – who has the upper hand? Clearly for the EU 22% of its total exports is a lesser consideration than the UK's 50%. Striking a trade deal should be mutually beneficial, but things are seldom that clear and, given recent hostility to UK financial services exports, the comparitively weaker UK position could be significant.

Does the UK’s membership of the EU discourage its trade outside the EU?


Mostly no, although the future is less certain. The UK’s non EU trade is governed by the EU’s Common Commercial policy which includes the EU's network of free trade agreements and its seat at the WTO. In outsourcing its foreign trade policy to the EU, the UK is trading off its specific negotiating requirements against the weight of a common negotiating position, backed by the incentive of the Single Market. The EU has a reasonably good record in pursuing liberal trade deals, where its combined weight helps, however sometimes UK priorities (services) get subsumed to others' priorities. One area where being in the EU does not help UK trade is the protectionism surrounding agriculture, where the UK on its own would probably chose to import cheaper products from outside the EU than currently allowed.

What is the best way to increase UK trade?

In our recent paper “Trading Places” we looked at the operation of the EU from the perspective of UK trade and concluded that it was currently working. Not at as well as one might like, but still working. However the outlook may change; the benefits of the Single Market may not be increased due to problems implementing further liberalisation in services and the EU may lapse into protectionism in its external policy leading to less favourable trade deals for the UK that stop it benefiting from growth markets for its services.

But, of course, UK membership of the EU includes other membership costs (EU Budget, CAP, regulation etc.) so in order to ensure that EU membership remains beneficial for the UK, the Government needs to reduce these costs as well as increasing the benefits where possible.

Given that the UK, with mixed success and too different degrees, has been pursuing a liberal trade agenda in the EU for some time and the caveats noted above, this is no longer enough to ensure the benefits will continue to outwiegh the costs over the long term. The Government therefore needs to do far more to reduce the cost side of the equation, which requires the renegotiation of the UK's terms of membership.

** We accept that the UK’s trade to the EU is inflated by both the ‘Rotterdam Effect’ and import displacement particularly as a result of the CAP.