Showdown between France and Commission set to test EU’s budget rules

It has been widely reported over the weekend that the European Commission (EC) is seriously considering rejecting France’s new budget proposal which will see it run a deficit of 4.3% next year rather than the EC target of 3%.

As the graph above shows, France has strayed significantly from the path originally agreed with the EC, even after it requested and was granted additional time to meet its deficit targets just last year.

Importantly, this is the first time a country has flagrantly flouted the budget rules. Other countries have missed their targets or asked for extensions, but with the presumption of good faith and serious efforts being made to meet said targets. However, with its latest budget France has rejected the previously agreed cuts (worth 0.8% of GDP) and offered just 0.2% of GDP in savings. In other words it has flat out chosen to ignore the rules.

This may seem like semantics but it puts the EC and the EU more broadly in a tough position. With much of peripheral Europe failing to meet the fiscal rules agreed under the Stability and Growth Pact (SGP), the Fiscal compact and the European Semester, many have already been questioning the effectiveness of these tools. Ultimately, the EC risks replaying one of the key features of the previous crisis – letting a big country break the SGP and then being unable to effectively enforce it for other countries, helping to facilitate the large build-up of sovereign debt.

This is therefore a key test of the viability of the new rules and whether this time will really be any different. Combined with the renewed bank stress tests and bail-in rules, the coming months are an important testing ground for the new financial architecture which the Eurozone has put in place.

Sadly, as Reuters highlights, another fudge looks to be on the cards. While the EC will probably reprimand France to the fullest extent before getting to outright fines, it will also work up a new looser programme which gives it more time. This helps all sides save face and avoids the risk of further weakening French President Francois Hollande to the benefit of the Front Nationale (something which the EU wants to avoid).

As for what happens now, the EC will provide a verdict on the budget by the end of the month in what will be one of the last acts of the Barroso Commission. This is of course all complicated by the hand-over of the EC and the wrangling over who will actually be in charge of enforcing the budget agreements. When all is said and done another muddle through is likely, but with the Eurozone facing economic stagnation investors may be less than convinced by such moves.

Handelsblatt: France is the new sick man of Europe

The front page of Germany financial daily Handelsblatt today depicts France as the sick man of Europe, warning that "a once proud nation faces economic decline." Of course warnings of French decline have been made before - notably the famous ticking baguette bomb on the front page of the Economist a couple of years ago - but it is striking that the German press is increasingly reflecting these concerns.

The front page trails a detailed eight page feature which the paper introduces by arguing that:

"Our most important neighbour is mired in crisis. France risks falling behind when it comes to its budget, its labour market and its industry. However, the country could be successful if only it stops making itself smaller."

The timing might be slightly ironic given that the French economy 'outperformed' the German economy in the last quarter - albeit by staying flat as Germany contracted by 0.2%. Handelsblatt has itself warned that Germany was "no longer a champion" but the German economy is still pretty robust, and should bounce back quickly, while France's problems are much more deeply entrenched.

A new eurozone economic policy "made in France"?

The appointment of Arnaud Montebourg - an outspoken critic of German and EU-mandated austerity and pro-competitivenesses policies - as the new French Economy Minister has not gone down well in Germany.

In a feature piece headlined, "He insults Germany and is promoted", Die Welt claims that "his appointment is controversial – he is known for his failures". The paper goes on to argue:

"He sees himself as the legitimate successor of Jean-Baptiste Colbert, the finance minister of the legendary French Sun King Louis XIV... In his previous post of Minister for Re-industrialisation, he above all others terrified foreign investors with class warfare slogans, and now has acquired even more powers in the government of President Francois Hollande".

The paper also claims that Montebourg secured his new position by threatening Hollande that, unless given the Economic Ministry, he would resign from the government - a move which would have been hugely destabilising given his position as a figurehead on the left of the Socialist Party. The paper has a round-up of some of Montebourg's more memorable quotes:

On globalisation, free trade and protectionism:

“The EU is the only one that does not protect itself against unfair competition. We have become the idiots of the global village...For 30 years, consumers have made the law in Europe and the result has been a disaster. Me, I defend the producers."

On the European Commission's application of competition and state aid laws:

"[These people] exercise law in the manner of the taliban, [they are] fundamentalists who apply the [legislative] texts blindly to the detriment of European interests".

On Angela Merkel and Germany's actions during the eurozone crisis (back when the French Socialist Party was still in opposition):

"The issue of German nationalism is resurfacing through the policy à la Bismarck [of Angela Merkel]."

And:

"Mrs Merkel is killing the euro, and it would be time to show the failure of the German model, rather than singing its praises."

Even allowing for the fact that Montebourg is playing to the gallery a fair bit, and that the new government's economic policy will remain more pragmatic overall, it is clear why his appointment will raise concerns in Berlin and beyond about France's already fragile economic situation. In the meantime, we're looking forward to new additions to his already impressive repertoire of memorable quotes.

Eurozone private sector growth beats expectations, but hides divergence

This morning saw the release of the latest set of Markit Purchasing Managers’ Index (PMI) - a set of indicators used to measure the economic health of the manufacturing and service sectors. The figures for the eurozone as a whole once again beat expectations.

Eurozone Composite PMI (Aug A) M/M 51.7 vs. Exp. 50.9 (Prev. 50.5)
Eurozone Services PMI (Aug A) M/M 51.0 vs. Exp. 50.2 (Prev. 49.8)
Eurozone Manufacturing PMI (Aug A) M/M 51.3 vs. Exp. 50.8 (Prev. 50.3)

German Flash Composite PMI (Aug A) M/M 53.4 (Prev. 52.8)
German Services PMI (Aug) M/M 52.4 vs. Exp. 51.8 (Prev. 51.3)
German Flash Manufacturing PMI (Aug A) M/M 52.0 vs. Exp. 51.2 (Prev. 50.7)

French Composite PMI (Aug) M/M 47.9 (Prev. 49.1)
French Services PMI (Aug) M/M 47.7 vs. Exp. 49.2 (Prev. 48.6)
French Manufacturing PMI (Aug P) M/M 49.7 vs. Exp. 50.2 (Prev. 49.7)

We covered this issue in detail last month and, needless to say, our thoughts haven’t changed much in such a short space of time, but there are a couple of points to note.

• Again, this is another small positive piece of data for the eurozone, in particular the eurozone services PMI is at its highest point for 2 years while the manufacturing at its highest since June 2011.

• That said, the on-going problem of divergence (which we have discussed before) continues to loom large. As Germany continues to post strong economic data, France looks to be showing signs of struggling, despite its unexpectedly positive GDP growth in the second quarter of this year. This divergence has the potential to become a serious problem for both the ECB (in terms of trying to balance its monetary policy) but also for the Franco-German axis which has long been at the core of the eurozone and vital to its stability.
• This turnaround in economic data for the eurozone has unfortunately coincided with problems/issues elsewhere in the global economy. The Chinese economy (a big source of trade for the eurozone) has shown signs of stumbling, while the US Fed is toying with the prospect of tightening its monetary policy - this could impact global liquidity and sentiment with suitably negative knock-on effects for the eurozone. With Germany leading the way as an export orientated country and many in the periphery  looking to copy this (through choice or Troika programme), the eurozone continues to be reliant on external demand.
• The combination of positive economic data and long term forecasts of loose ECB policy are helping boost sentiment in the eurozone more broadly. However, some significant questions are looming, notably how to fund the likes of Greece, Portugal and Ireland as their bailout funding winds down over the next year. These issues have so far been pushed into the long grass but the time is quickly approaching where answers are needed, unfortunately indicators here are much less positive than the PMIs. More ad-hoc structures seem to be the likely outcome.

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

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

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

CDU/CSU support:

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

CDU/CSU oppose:

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

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

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

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

Steinbrück envisages a Europe led by Franco-German-Polish axis (Hello Cameron!)

Peer Steinbruck laid out his foreign policy in a talk at Berlin's Free University

Peer Steinbrück , leader of Germany’s centre-left SPD Party, and Merkel’s main opposition in September’s elections, laid out his foreign policy in a speech yesterday. It could have been a bit of ‘a non-event’. Germany’s Europe policy can hardly be expected to change in terms of substance, regardless of whether or not Steinbrück seizes the chancellery from Merkel come September. 

Although Steinbrück is critical of elements of Merkel’s vision for Europe, when it comes to the nitty-gritty of substance he mostly agrees. This can be put down to the fact that the traditional conservatism of the German public is more deeply rooted than its occasional impetus for grand reforms.

Against this background, we were expecting a lot of rhetoric, but no grand revelations. But then Steinbrück said something interesting.

Discussing Europe’s role in the world, he called for a Franco-German-Polish axis to shape its future. “This triad of Germany, France and Poland must take the initiative for a new beginning of European foreign and security policy,” said Steinbrück.

The first point to make here is that while the Franco-German alliance in European affairs is nothing new (strained though that partnership may be at the moment) the allusion to Poland as European leader on the world stage is. (And is one that will please a certain Polish Foreign Minister.)

However, the most interesting part of Steinbrück’s speech was the country he did not mention when discussing Europe’s role in the world: the UK.

Whilst Angela Merkel has gone out of her way to point out the importance of the UK playing a leading role in Europe, Steinbrück said the future lies in a Berlin-Paris-Warsaw axis. A signal to London and David Cameron as the Conservative seek new EU membership terms? Possibly.

As we’ve argued before, if Steinbrück became Germany’s next chancellor, the general thrust of Germany’s eurozone politics will likely remain. That’s not big news. The real significance of a centre-left German coalition after the September election for the future of Europe may instead be Berlin being far less interested in striking a new Anglo-German bargain.

We dare to guess that Number 10 wasn’t entirely happy about Steinbrück’s remarks.

Sorry - who are you again? The rather indifferent German response to French socialists' attack on Merkel

Who wears the trousers?

On Friday Le Monde got a big scoop with the news that French President Hollande’s Socialist party had drafted a strongly worded paper criticising Angela Merkel and her focus on austerity, accusing her amongst other things of “selfish intransigence”. It’s not exactly news that all was not well with the ‘Franco-German motor’ but still pretty explosive stuff and we were keenly anticipating what the German response would be. 

However, even taking into account the number of caveats (not an official policy document etc.) this reaction was pretty muted, both in terms of the media and politicians (in contrast the story was still on the front page of Le Figaro today). Most of the main German papers ran the story online, only setting out the basic facts (e.g. Handelsblatt, Süddeutsche, Tagesspiegel), and noting it represented a struggle between moderates and radicals within the party. However the Welt write-up included a bit of editorial comment:

“As unemployment in France rises ever higher, just like the budget deficit, while President Francois Hollande’s popularity falls ever lower, the breakout attempts of the governing socialists become increasingly desperate.” 

Bild, which normally isn't shy of stirring up controversy looks to have completely ignored the issue at least online – although it did strike back by reporting on a French comic strip mocking Hollande. FAZ, which can usually be relied upon to come down like a ton of bricks on anything smacking of fiscal irresponsibility, also didn't give the story that much coverage, although its co-publisher Günther Nonnenmacher had a rather wistful piece in which he claimed that that it was symptomatic of the way Germany was becoming increasingly isolated in Europe. This was also the tone adopted by two retired SPD politicians who had a guest piece in Süddeutsche in which they argued that:

“There are markers that some German will react [to this foreign criticism] as was standard in the days of the Weimar republic. We may fall into a spiral of snivelling self-indulgence and coming increasingly into conflict with a justified criticism from outside. Instead let us try to understand why others are reacting how they are reacting.”

Likewise the response from politicians was quite muted, with few senior coalition politicians speaking out although the SPD’s former foreign minister Frank-Walter Steinmeier accused Merkel herself of having strained Franco-German relations.

So what does this tell us? Well clearly the German media and politicians are unusually introspective and cautious not to stir a nationalistic argument, but that’s hardly news. More interestingly is the degree of relative indifference.

This speaks volumes about the changing power balance between the two countries.

Not everyone in François Hollande's party cares about Franco-German diplomacy...

French President François Hollande's Socialist Party will hold its 'Convention on Europe' in Paris on 16 June. Several working papers are currently being prepared as a basis for discussion among party members and supporters at the Convention. One of them has been leaked to Le Monde. And believe us, it contains some pretty strong stuff.

Two caveats before we start:

• We learn from the official website of the Convention that the papers do not reflect party policy "at this stage".

• The draft published by Le Monde could still be tweaked before the Convention.

Nevertheless, it does give a sense of the mood within the party. These are arguably the most 'explosive' excerpts:

"The communitarian project is today wounded by an alliance of circumstance between the Thatcherite rhetoric of the British Prime Minister - who only conceives a devalued à la carte Europe - and the selfish intransigence of Chancellor Merkel - who cares about nothing but the savings of depositors across the Rhine, Berlin's trade balance and her electoral future. In this context, France has today the only genuinely European government among the EU's big member states."

"Democratic confrontation with the European right means political confrontation with the German right. Franco-German friendship is not the friendship between France and Chancellor Merkel's European policy."

"[Former French President Nicolas] Sarkozy had imposed a certain practice: not Franco-German friendship, but France's alignment to Germany."

The document concludes the party should stand behind President Hollande and support him "in his arm wrestling against the austerity Chancellor [yes, it's Angela again] and the European Conservatives."

It's hard to imagine the French government or Hollande himself publicly endorsing this document, but the sense of frustration is palpable and points to the widely recognised relative decline of French influence over both the direction of the 'Franco-German motor' and the EU more widely. It signals the mood within Hollande's party is becoming increasing hostile to Mrs Merkel, and that the party wants the President to be tougher in confronting the German Chancellor. Not a call Hollande can keep ignoring forever. But also a fight, deep down, he knows he is probably not going to win.

Conflict of interest (rates): clamour for ECB rate cut grows but Germany remains wary

The last few days have seen a shifting of consensus in the ECB rate cuts debate.

Recent economic data in the eurozone has been particularly bad, with private sector activity slowing more than expected. However, potentially more importantly, this effect has been seen in Germany and some of the stronger northern countries as well.

In response to this data most banks and analysts shifted their expectations and now forecast an ECB rate cut in May or June.

The thinking goes that, a slowing economy in these countries (and therefore lower inflation) will give the ECB more scope to cut rates without fear of it having disproportionate effects on the stronger economies. After all, the ECB is meant to find a balance that suits all countries (although it rarely does, hence the flaw of one-size-fits-all monetary policy).

As always on central banking issues though, Germany remains the key player.

German Chancellor Angela Merkel has now waded in to debate about possible ECB action. Speaking at the conference organised by Sparkassen association this morning, Merkel said:

"The ECB is obviously in a difficult position. For Germany it would actually have to raise rates slightly at the moment, but for other countries it would have to do even more for more liquidity to be made available and especially for liquidity to reach corporate financing."

"If we want to get back to a bearable interest rate level, then we have to get over this internal division of the euro zone."

In a country where central bank independence is worshiped, politicians usually stay well clear of commentating on monetary policy, so Merkel's comments are quite extraordinary. Perhaps they were prompted by increasing noise coming out of the French government over what it sees as the need for the ECB to take a more activist approach, despite a genetlemen's agreement between the two governments not to discuss ECB policy in public.

German ECB board member Joerg Asmussen also weighed in yesterday saying:

"Monetary policy is not an all-purpose weapon for any kind of economic illness…Due to impaired monetary policy transmission, the pass-through of rate cuts to the periphery would be limited, and this is where they are most needed.

At the same time, rate cuts would further relax already unprecedentedly easy financing conditions in the core. This is not per se a problem – but interest rates that are too low for too long can eventually lead to distortions. In particular:

• to a misallocation of resources, which ultimately leads to lower potential growth,
• to excessive capital inflows into a number of emerging economies with exchange rate effects and credit risks,
• and to reduced incentives for governments, banks, and corporates to adjust."

For numerous reasons, it seems that a rate cut should not be taken for granted after all. Asmussen is  right that given the broken transmission mechanism and market fragmentation, any cut will have limited effect on the economies where it's meant to provide a boost. But more importantly, there is still a view in Germany that lower rates could have a harmful effect particularly by pumping up an asset and property bubble – similar to those seen when newly low ECB rates were introduced in the south during the euro's creation.

That said, the wave of voices calling for some ECB action is growing, particularly given the wider debate on austerity. It will be tricky to balance this with the demands of the northern countries.

Once again the ECB finds itself stuck as the main player in an increasingly political debate.

The Anglo-German axis is stirring up emotions

The political repercussions of the recent EU budget agreement - when London and Berlin stood on the same side and Paris took itself out of the game - are still reverberating.

Yesterday, Former French Environment Minister Jean-Louis Borloo told French radio RTL that the prospect of the Franco-German axis in Europe being replaced by an Anglo-German axis

“is extremely worrying. This means that we’re probably turning our back on the great European ambitions…This is an extremely important political and diplomatic shift.” 

Which is of course code for: 'France fears that the EU is becoming less French'.

Meanwhile, in a debate in the German Bundestag this morning, the SPD’s Chancellor Candidate Peer Steinbrück criticised Angela Merkel for engaging in an “unholy alliance” with David Cameron over the EU budget. He said,

“if you want more Europe in the future [Germany] needs partners who see its future in Europe.” 

FDP faction leader Rainer Brüderle immediately fired back, however, saying that,

“I am glad that our Chancellor Angela Merkel negotiated [in Brussels] and not Peer Steinbrück who sometimes is described as a diplomatic neutron bomb.” 

We shouldn't read too much into this stuff but, clearly, the changing Berlin-Paris-London dynamic is certainly stirring up emotions...

European press on the EU budget deal: Behold the birth of the Anglo-German axis

The agreement on the next long-term EU budget (which we analysed here) has been extensively commented on by newspapers across Europe. The main political story was clearly German Chancellor Angela Merkel siding with David Cameron, rather than French President François Hollande - which ultimately made the balance swing towards the group of member states calling for further cuts to EU spending. 

We have written about the need to cultivate the Anglo-German axis (particularly in light of Hollande's election as French President) several times in the past - see our recent analysis of David Cameron's EU speech, this letter we wrote to the FT, several articles in the Telegraph - and many other places. While Merkel's decision to side with London shouldn't be overstated - this is a pendulum after all - it was interesting to note the reaction in the European press.  

Let's start from Germany.

Die Welt's Foreign Editor Clemens Wergin says that even though the EU budget has been reduced for the first time in history, the big chunk of money earmarked for farm subsidies "remains the symbol of the backwardness" of EU spending. He also notes, "The UK does not stand on the margin of the EU anymore, but proved to be an important ally of the Germans."   

Süddeutsche Zeitung's Brussels correspondent Martin Winter points out that the fact that other EU leaders made an effort to satisfy Cameron's demands show that "the EU wants to keep the British at its centre."

FAZ's Brussels correspondent Hendrik Kafsack argues that the new EU budget "does not deserve the attribute 'modern'", as most of it's still spent on agriculture and structural funds in Southern member states.

Die Welt's Brussels correspondent Florian Eder and Silke Mülherr note that together "Cameron and Merkel were able to enforce an austerity budget [on the EU]", while the paper's London correspondent Thomas Kielinger says that "Angela Merkel is the trump card in the British hands."

Der Spiegel Online's Carsten Volkery describes the deal as "a triumph for the budget hawks" noting that "the [German] Chancellor backed Cameron and covered him against attacks" from Hollande and other leaders.

A very interesting comment from the Netherlands. Dutch journalist Fokke Obbema writes in De Volkskrant,

"French President Hollande explicitly positioned himself as the leader of Southern Europe [at the EU summit]. That makes it even clearer why it would be undesirable for the Netherlands if this other historic event - the exit of an EU country - were to happen. Without Great Britain, the balance of power between North and South within the EU would be disturbed."

From a French perspective, Cameron and Merkel fighting side-by-side in Brussels is far from good news - as it means that the Franco-German axis is under pressure. Le Figaro's Brussels correspondent Jean-Jacques Mével says David Cameron hit a "master stroke" at last week's summit. He writes,

"A man can take credit [for the cut in the next long-term EU budget]: David Cameron, whom many saw as already marginalised within the EU, following his decision to ask the British by 2017 whether they want to stay in the [European] Union or not. On the contrary, he goes back to 10, Downing Street, as a winner – for the frustration of French and Italians."

Interestingly, he also notes that the talks have confirmed the "paralysis" of the Franco-German axis. 

An editorial in French business daily Les Echos argues,

"Budget talks have been held hostage by a country, the United Kingdom, which is not sure that it will still be part of the [European] Union tomorrow. David Cameron had come to sabotage Europe’s general interest – and he managed to do so. Noted. But, in this case, let’s get to the bottom of things: given that the club at 27 is doomed to powerlessness, strategic reflections need to happen at the eurozone level. Yet, one would need to repair [France’s] relations with Germany for that. Because this is the other lesson from the Brussels drama: the Paris-Berlin axis is not responding anymore." 

The Anglo-German couple didn't go unnoticed in other Mediterranean countries either. Italian Professor Mario Deaglio writes in La Stampa,

"The pro-rigour Germans, in agreement with the British for once – the Berlin-London axis has in fact replaced, at least on this occasion, the traditional Berlin-Paris axis – and with the help of some Nordic countries, have pushed through the principle that the EU budget can be cut too. The word 'austerity', so far unknown, will start hovering over Brussels [EU] buildings."

Claudi Pérez, Brussels correspondent for El País, writes,

"The EU seems distracted. It walks between the old and the new regime…In the midst of this paralysis, Berlin (with London’s support) accumulates power, and a withdrawal towards the national or the intergovernmental [level] is noticed. And austerity policies remain firmly installed in the driving seat."  

And now a voice from Poland. According to Dziennik Gazeta Prawna, the outcome of the EU budget summit is proof of "a substantial shift in the balance of power in Europe", with France, once the most influential country of the Union, "finding itself on the defensive". Interestingly, the paper argues,

"The Union will head towards the free trade zone dreamed of by the British and supported by the Germans rather than the 'solidarity-driven federal structure' wanted by Paris...There is no doubt that, by imposing cuts, Germany has shown its economic strength. Berlin's dictate will be even harsher, while abundant transfers from Brussels may turn out to be only a nice memory if the Franco-Spanish-Italian-Polish club fails to improve its competitiveness."

Cameron's EU speech: The only way is up?

When it comes to Europe, the UK government can make your head spin. Cameron's EU speech is now officially scheduled for Friday 18th Jan, after several twists and turns.

The speech was originally scheduled to take place at the end of last year but with the controversial EU budget negotiations taking centre stage and the anniversary of Cameron’s veto setting an adversarial tone it was pushed into the start of this year (the official line was that Cameron was looking to consult more closely with his EU partners).

After the turn of the year, the guessing game over the timing and location resumed, with the government keen to invoke the spirit of Thatcher’s 1988 speech in Bruges. Eventually, it was settled. 22nd January in the Netherlands.

Unfortunately, that date turned out to be a bit of a disaster: the 22 January 2013 is the 50th anniversary of the signing of the Elysee Treaty. Unsurprisingly, the French and German governments were none too happy with the timing, given that it clashes with a major landmark in Franco-German conciliation (so much for further consultation with European partners - or rather 2 minutes worth of Google-research). 

This is hardly impressive handling of a delicate topic (we can’t help but think back to our ten lessons which we outlined following the UK veto in December 2011, with two of the top three being - get in early and communicate effectively.)

The good thing is that, following all the interventions from near and afar - and all the hyperventilating from all sides - there's no way Cameron can now try to manage the reactions to his speech; he lost control of that long ago. So he might as well forget the choreography, and instead set out what he actually believes in, keeping in mind that it needs to work for both the UK and Europe if it is to work, and articulate his genuine vision for the future of Europe.

Hopefully, it can only go up from here.

François wants to chat...

Ahead of tomorrow's EU summit, French President François Hollande has decided to give a lengthy interview to several European dailies (including the Guardian, Italy's La Stampa, Spain's El País and Germany's Süddeutsche Zeitung). The full interview - the first major foreign interview since Hollande was elected last May - is due to appear in tomorrow's print edition of these papers, but is already available on Le Monde's website.

The French President made some interesting remarks about Germany's role in the eurozone crisis:

The return to growth involves mobilising funds at the European level – which is the [growth] pact we adopted [at the EU summit] in June – but also improving our competitiveness, and, finally, coordinating our economic policies. Countries running a [trade] surplus must stimulate their internal demand through salary increases and tax reductions – this is the best expression of their solidarity.

Well, Germany is not mentioned here, but the reference is obvious...

Hollande also said,

We all take part in solidarity, not only the Germans! The French, the Germans, as well as all other Europeans within the framework of the European Stability Mechanism [the eurozone's permanent bailout fund]. Let’s stop thinking that there is only one country paying for all the others. This is false! Nonetheless, I know our German friends are sensitive about surveillance. He who pays has to control. He who pays has to sanction. I agree. But budgetary union must be completed by the partial mutualisation of debt: through the Eurobonds.

And then something specific about German Chancellor Angela Merkel,

She is outspoken, she says things…This saves time. And I have the same attitude…Indeed, we are not in the same time scale. I was elected five months ago, and the Chancellor has her elections in ten months – but this does not lead us to defer choices.

The language used is certainly diplomatic, but the message to Berlin is clear. First, Germany should bear in mind that there are other countries paying for eurozone bailouts. Second, that debt pooling remains high on France's agenda.

Hollande also addressed the issue of UK-EU relations,

I would like a United Kingdom fully engaged in Europe, but I can’t decide for the Britons. I’ve noticed that, for the moment, they want to be rather in retreat. The Britons are bound by agreements which they signed up to. They can’t detach from them. They now at least have the merit of being clear. The eurozone, the budgetary union: they are not in them. I do not intend to force them.

He added,

I’m in favour of monthly meetings of eurozone heads of state and government…This Eurozone Council will allow us to better coordinate economic policies and make, country by country, the appropriate decisions. It’s not about excluding the other countries: those who want to join the eurozone will be associated to our debates. Certain countries do not want to – it’s their choice. But why would one need them to come and tell us how to run the eurozone?

Finally, some thoughts on the next steps of European integration,

France defends the idea of ‘integration with solidarity’ [intégration solidaire in French]. Every time we take a step towards [greater] solidarity, the union – that is, the respect of common rules – must progress too.

Political union is for later. It is the stage which will follow budgetary union, banking union, social union. It will give a democratic framework to what we will have achieved in terms of ‘integration with solidarity.’

This is not new, but a clear indication that France and Germany are on opposite sides with regard to whether surveillance or solidarity should come first.

It is also rather telling that the democratic framework or political union underpinning Hollande's vision "is for later"...

'Communication problems' between Angela and François?

A bit of mystery ahead of this evening's meeting between German Chancellor Angela Merkel and French President François Hollande. A French diplomatic source told AFP yesterday that, before their working dinner, the two leaders will make a short statement to the press, but will take no questions from journalists.

However, the source went on to suggest that Hollande was quite keen to hold a proper press conference, since he "has not talked about Greece for a long time and wants to communicate." But apparently his request fell on (Merkel's) deaf ears.

Needless to say, the diligent Steffen Seibert - the German Chancellor's spokesman - moved swiftly to clarify that the decision not to open the floor for questions had been made "by mutual agreement". Hollande's office also stressed that the chosen format mirrors the one used during Merkel's previous visit to Paris at the end of June.

Mystery solved? Maybe, but the fact remains that Hollande has reportedly planned a separate press conference at the French Embassy in Berlin after his dinner with Merkel. 

Will a common position on Greece be easier to agree on than the format of a press conference?

Showdowns that will define Europe's future

In today's Telegraph, we argue:

'It will not be the case that the south will get the so-called wealthy states to pay. Because then Europe would fall apart.” Thus spoke Horst Köhler, former German president, finance secretary and IMF head, almost two decades ago. 

Köhler’s remarks are worth pondering. A series of multi-billion-euro bail-outs – and more to come – have now planted a north-south political divide at the heart of the European project. Taxpayers in Europe’s north resent underwriting their southern neighbours, while voters in the south are equally frustrated at having austerity imposed upon them from abroad. As has been noted repeatedly, this is the greatest tragedy of this crisis: a project that was meant to bring people together, now risks driving them further apart. Alas, events in the eurozone this autumn could further exacerbate this tension. There are at least five key stand-offs to watch over the next few months:

Greece v Germany: Greece managed narrowly to escape running out of money today by raising almost 4 billion euros in short-term debt. But Athens will face an excruciating autumn. On almost every count, Greece is miles away from meeting its EU-mandated austerity targets, which raises the questionof whether Germany – or the IMF – will pull the plug on the country in October when its next progress report is due.

Though there is still scope for muddling through, almost any outcome will lead to rising political tensions. If Germany sticks to its guns, the popular disillusion in Greece will grow massively. If Berlin gives in, it faces a serious backlash from the country’s public – a majority of which wants to kick Greece out.

Spain v the North: Amid continued problems, Spain could possibly request EU cash as early as September. But the country is simply too big for a Greece-style bail-out, while Madrid would not accept having its economic policies fully decided in Brussels and Berlin. Instead a third way must be found involving less money and softer conditions, probably with heavy and controversial ECB involvement. The North will dislike such an arrangement – particularly cheap ECB money going to Spain – but may give in for fear of worse.

The bail-out funds v national democracy: On September 12, Germany’s constitutional court will rule on whether the eurozone’s permanent bail-out fund – the European Stability Mechanism (ESM) – is compatible with the country’s “basic law’, following a host of complaints. Though unlikely, should it strike it down, the markets will go absolutely crazy. Regardless, the ruling will leave a bad taste in Germany and shows how the ESM is becoming an increasingly toxic issue, with southern and northern politicians disagreeing fundamentally on its size and whether it should be given a direct credit line to the ECB.

The Dutch v Europe: September 12 will also see another example of national democracy reasserting itself: the Dutch elections. Geert Wilders, leader of the super-populist PVV, is seeking to turn the campaign into a referendum on Europe, hoping to tap into the Dutch anti-bail-out mood. At the same time, the Dutch socialists – currently leading in the polls – have vowed to resist both the EU fiscal treaty and further transfers of power to the EU without approval in referendums. A divided Dutch parliament and more assertive government will almost certainly make eurozone politics even more complicated.

Germany v France: This autumn will also see negotiations over whether the eurozone will take the next big leap towards an economic union, with an October EU summit tasked with providing a “road map” for more integration. Ideas include a banking union (with a single supervisor and joint backstop) and collective government borrowing in the form of eurobonds. The issues are tremendously complicated, subject to a cobweb of disagreements and will take years to clear away. But importantly, this could widen the gap between Germany and France, with the two disagreeing fundamentally on the order of events. Berlin wants a political union first, meaning greater German control over others’ finances in return for underwriting them – while Paris wants to press ahead with stronger bail-out mechanisms, via the ECB and others, leaving the oversight for later. The Franco-German axis is not about to break, but maintaining it will become increasingly difficult.

So how should Britain respond to all of this? Simple: try to control what it can control and leave the rest behind. The UK is right to seek to buffer up against a potential euro meltdown. It is also right to look for ways to ensure that further eurozone integration – such as a banking union – is not detrimental to Britain or the single market. But the UK government needs to stop giving unwelcome advice on the need to turn the eurozone into a “debt union” or for the ECB to start spraying the Continent with cheap money – both options effectively involving Angela Merkel completely running over her own voters.

The eurozone crisis has unleashed some seriously unpredictable political forces. EU leaders may have to choose between maintaining the euro and maintaining national democracy as we know it. In either case, we have no idea how voters – in the North and South alike – will respond.

 

No, Germany has not blinked first over debt-pooling…

People have once again been getting rather excited over a media report today. This time it is an interview which German Finance Minister Wolfgang Schäuble gave to the WSJ in which he said:

"We are willing to go as far as we need to in order to get a sustainable agreement in Europe,"

The WSJ took this as such:

His comments indicate that Germany is more flexible than many observers in Europe think after Chancellor Angela Merkel told German lawmakers early this week that there would not be full mutualisation of European debt in her lifetime. German lawmakers who were present have said that Ms. Merkel's comment was made in jest and that media have exaggerated its significance. Mr. Schäuble's comments seem to support this view.

Now, we don’t dispute that Merkel likely made her comments mostly in jest and that people also read too deeply into them. But equally, Schäuble's comments don't mark a significant switch in the German position – not least because the German Finance Ministry has already denied that to be the case, but also because in the very same interview Schäuble also said:

"We have to be sure that a common fiscal policy would be irreversible and well-coordinated. There will be no jointly guaranteed bonds without a common fiscal policy."

"We cannot separate liability (for public debt) from the competence to decide on fiscal policy. This would be to ignore the most basic lessons of the crisis. As soon as we have a joint EU fiscal policy, we can consider joint liability—the sequencing is key."

That all sounds very par for the course in terms of the German government’s approach to debt pooling. The important part here is the sequencing. Germany has always said it will support further integration and even potentially some form of debt pooling, but only if it first gets strict budget rules and clearly enforced fiscal constraints to ensure any risk sharing is not taken advantage of. Note: that's 'see you in court' enforced - not the current half-baked fiscal rules.

Clearly, the kind of institutionalised budget discipline that the Germans have in mind is hugely difficult to achieve. Remember, Van Rompuy's proposal for fiscal and banking union was cut it in half before publications - at the behest of the French - precisely because it included too strong language on budget discipline and loss of sovereignty over spending decisions. EU leaders have consistently failed to institute binding budget rules - think the original Stability & Growth pact, the watered down fiscal treaty, missed Spanish targets (with Madrid failing to control spending even in its own regions) etc. etc. Therefore, as we pointed out in a recent briefing, we think that to actually get by the first step of Germany's vision of a more integrated Europe will be hugely challenging.

Furthermore, as we reported this morning, this sequencing is also one of the dividing points between the German and French governments. France wishes to see risk sharing and debt pooling as soon as possible with political union later – i.e. debt mutualisation now (either directly or through the ECB) with greater conditions and oversight later on. So although they do sound as if they agree on the ends – more Europe and shared commitments – France and Germany very much differ on how to get there and in what order.

We’d also note that in terms of the "willing to go as far as we need" comment, German ministers have said similar things before, i.e.:

"We need more Europe…We do not only need a currency union, we also need a so-called fiscal union - that is, more joint budget policy."

-          German Chancellor Angela Merkel, 7 June 2012

“It is small-minded to reduce Europe simply to questions of finance…We must have the ambition to do more than simply protect the status quo.”

-          German Finance Minister Wolfgang Schäuble, 17 May 2012

Additionally, as today’s leader in Handelsblatt shows, aptly supported by the poll in today’s FT, Germany is willing to support more Europe but not at any cost and especially not without the right conditions and controls.

In other words, this game of chicken (as it seems to have been termed), still has a long way to run.

Quotes of the Crisis

The eurozone crisis can't be accused of one thing - providing good quotes from politicians or commentators, most notably some of the comments from Slovakian MPs when that country was debating whether to approve an extension of the EFSF.

This morning as part of our daily look through the European press we found another couple of examples that we thought were worth sharing with a wider audience.

Firstly, in the IHT, we have the ever outspoken Hans Werner Sinn, President of the IFO Institute, rebuking US politicians including President Obama for their stance during the crisis:

“Some critics have argued that Germany, having benefited from the Marshall Plan, now owes it to Europe to undertake a similar rescue. Those critics should look at the numbers…Greece has received a staggering 115 Marshall plans, 29 from Germany alone, and yet the situation has not improved. Why is that not enough, Mr Obama?”

Secondly, we have Alexander Dobrindt, the General Secretary of the CSU lambasting the leadership of the opposition SPD for travelling to Paris to meet with French President Francois Hollane in order to discuss a common approach to the eurozone crisis, who said that:

"This grotesque pilgrimage is certainly not the German interests, but at most in that of the Socialist International.”

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

In today's Telegraph, we argue:

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

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

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

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

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

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

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

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

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

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

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

Germany

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

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

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

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

Austria

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

France

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

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

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

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

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

Spain

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

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

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

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

Italy

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

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

UK

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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