Spain back under the spotlight soon?

We haven't blogged on Spain for a bit, but a couple of interesting developments have caught our attention today. Spain will presumably disclose its final deficit figure for 2012 shortly, and everything seems to suggest that Madrid will let its eurozone partners down once again.

Spanish Industry Minister José Manuel Soria (pictured) told a conference this morning that Spain's public deficit for 2012 will be somewhere around 7% of GDP - higher than the target of 6.3% of GDP agreed with the European Commission.

It is also probably not just a coincidence that Soria's words came just before the European Commission put out its latest update on Spain's compliance with the conditions attached to its bank bailout. The content of the report was not entirely new to us (and the readers of our daily press summary), given that a draft was leaked to El País last week. The document reads,  

Fiscal consolidation advanced in the third quarter, but the 2012 deficit target will likely be missed.

Most importantly, it adds,

The 2012 deficit target for the regions of 1.5% of GDP can...still be within reach for the regional level as a whole, but risks are substantial and a number of regions will most likely exceed their target.

You won't hear us say this very often, but well done to the European Commission for making the right prediction. Of course, we (and others) warned of the risk of several Comunidades Autónomas overshooting their deficit target as early as last July.

Anyway, Catalonia (Spain's wealthiest region) has just announced that its deficit at the end of 2012 stood at 2.3% of GDP - with the overall target for Spanish regions fixed at 1.5% of GDP. With the wealthiest region missing its targets, and few others likely to undershoot theirs to pick up the slack, it seems unlikely that the overall target will be met.

A day of bad news for Spanish Prime Minister Mariano Rajoy and his government - not least because Spain had already obtained a relaxation of its deficit target for this year. The risk is that, once the official deficit figures come out, Spain could face fresh pressure from the markets. Before complaining about being "underrepresented" in the EU institutions (see Spanish Economy Minister Luis de Guindos remarks from this morning), the Spanish government should probably do more to regain its credibility vis-à-vis its eurozone partners. Top EU/eurozone jobs would surely follow.

Will the pound really take a beating from the UK's debate on Europe?

Ahead of David Cameron's incredibly hyped speech, a bit of a foreign exchange side-debate has developed with some analysts suggesting that sterling could weaken significantly as talk of the UK leaving the EU increases uncertainty, while the eurozone starts to recover. Are such fears valid?

 

·         As we have pointed out repeatedly in recent days, the debate is not yet about a straight in or out - but whether the UK should seek new EU membership terms.Unfortunately, currency markets (notoriously volatile) may not capture that, even if businesses do.

·         In our view, if you're a currency analyst, there are more important issues that could drive sterling lower than the intensified EU debate, including the threat of a triple-dip recession, loss of the UK’s triple-A rating, continuing to miss debt and deficit targets and the election campaign in 2014/2015. Ultimately, we’d expect currency markets to take the lead from the UK’s wider economic policy than just the UK-EU issue.

·         As we discussed in detail in our outlook for2013, there is still a lot of uncertainty in the eurozone, particularly with the Italian elections and the fact that the structural flaws have not been solved. The ECB is also still providing copies amounts of liquidity with a very loose monetary policy. Although, the latter has helped strengthen the euro at times, we think there is a limit to how far this can go. During the crisis, the repatriation of assets from abroad by banks and firms in the eurozone has propped up the currency, as the situation improves slightly this may slow. These factors combined could cap any substantial strengthening of the euro.  

·         Although sterling has weakened in recent days, other indicators of safe haven flows, such as UK borrowing costs and the London property market, have continued to suggest that there is still very strong demand for UK assets.

·         Given that safe haven flows have continued for some time, sterling may be inflated above where it normally would have settled, as such any change may simply be a correction to the norm as markets turn more positive.

·         Currency strength is significantly determined by central bank action these days. With the US Fed planning to keep policy loose for the foreseeable future (and keen to have a weak dollar) and the ECB of the same mind-set, sterling may continue to be seen as an attractive option. The Swiss National Bank will also have to unwind its massive foreign currency reserves at some point, given that a significant amount of this is in euro it could weaken the currency.

·         In terms of impact on the UK, a weaker pound could aid the UK in terms of boosting exports. However, given our reliance on imports and the fact that a weaker currency could also see an increase in borrowing costs for the UK a decrease in foreign demand for our assets, the overall impact may not be positive. Sterling has devalued significantly since the start of the financial crisis with the boost to exports being minimal.

There is a good chance that sterling could weaken this year, which may not be good for the UK economy. However, the impact of a potential EU referendum in 2-3 years’ time on the currency should not be overstated. There are plenty of other more pertinent arguments to focus on both for the UK-EU debate and the analysis of sterling.

"Single Market yes. Federal Europe No"

As we argued here, though there has been quite a bit of noise from the business community over recent weeks, few interventions are actually dealing with the sharp end of the policy debate, e.g. what is the greatest threat to business: Trying to artificially lock in the status quo - and risk voters throwing out the baby with the bathwater; or seek a new deal that will put the UK's relationship with the EU on a sustainable footing? Car manufacturers, for example, rightly warn that Britain leaving the EU would be bad for their industry. However, they fail to explain - as do many of the usual suspects - how to square UK public opinion and further eurozone integration, with continued EU membership. To wish away the debate - saying that it causes "uncertainty" - is hardly credible, since for so many different reasons, the debate is happening any way, whether we like it or not.

Which is why this piece by John Longworth, the director general of the British Chambers of Commerce, was so timely. He writes:

What may surprise some in the Westminster bubble is that the view from the coal face is different from the one trotted out by some high-profile captains of industry and the chief executives of multinationals. In fact, it doesn't follow either the classic Europhile or Europhobe lines [ a point we made here - OE remark]. Britain's business community, many of whom export, wants to see real and substantive change in our relationship with the European Union. While four out of five insist that they want to remain part of the European single market, an even larger number say they are against further integration and transfers of power from Westminster to Brussels.

The prime minister's preferred approach of "renegotiation and referendum", then, is an option that chimes with the thinking of many pragmatic businesspeople whose primary interest in the European debate is ensuring that they can trade, hire, export and flourish. Forty-seven per cent of our members, a large plurality, think this is the right approach. In the simplest terms, a settlement that supports their business interests would simultaneously safeguard the UK's economic interest. It is premature to talk of extreme solutions to Britain's European question.

Yet maintaining the status quo, which both Europhiles and approximately one-quarter of companies favour, is simply not a viable option. Europe is changing. Britain cannot expect the EU to simply stand still while it navel-gazes and debates its future involvement. Nor can it just seek to negotiate favourable reforms within the club's existing rules, because the club's rulebook is changing. If Britain does nothing to renegotiate its position now, it will be dragged down the road of ever-closer union in the wake of the Eurozone. That raises the spectre of an "in/out" referendum in future that no pro-European campaign could realistically hope to win.

Similarly, Lord Wolfson - Chief Executive of Next - in the Sunday Telegraph:

I have listened carefully to the arguments of certain business people who oppose the renegotiation of our position in Europe. All their fears revolve round the loss of the single market. They rarely espouse the need for more regulation, less democracy or wider EU powers over our justice system. Implicitly, they argue that these burdens are the price we must pay for remaining in the EU. They claim it is risky for the Prime Minister to even try to negotiate a better deal for Britain. They assert that the uncertainty of renegotiation will undermine our economy. This is nonsense. Investors already know that British support for the EU is fragile. Unless we call time on the process of EU aggrandisement, democratic opposition will make our place in the EU even more uncertain. In the real world, very little investment is lost as a result of this so-called uncertainty, because it is already a fact of life. These scare tactics are all too familiar to me. They were the same threats used by the same people when they urged us to join the euro. I remember their warnings of economic isolation and ruin.

 He concludes:

Those Europhiles who argue that we must either accept a federal Europe or lose our place in the EU unwittingly act as recruiting sergeants for their opponents who say we should leave. Before adopting either extreme, we should at least try to negotiate a middle way – an EU that the majority of us would be happy and proud to be a part of. The message is clear: single market yes, federal Europe no.

Spot on.

Will the EU follow France into the Malian desert?

"We are all with you"

Le Monde's cartoonist left a clear image - France's President Hollande rushing off into the Malian desert while the rest of the EU sits behind and pontificates.

France has a history of interventions in Francophone Africa and mostly they are primarily of regional importance. This time though it seems France is trying to fry a bigger fish: the biggest concentration of Islamic fundamentalists in West Africa. So should this be just a French responsibility or should they expect help from the EU? (NATO will always be a second choice for France) Well, evidently the French media feels others in the EU are not pulling their weight.

EU states have a history of under-investment in their own security and failing to help in multilateral actions. In Afghanistan the USA's allies invariably left it with the lion's share of the heavy lifting and in Libya, in the EU's neighbourhood, big states such as Poland and Germany decided to sit it out. 

But the French are clearly beginning to feel Mali should be different. The Economist quotes French conservative opposition leader, Jean-François Copé, saying “for now, our country is alone at the front.” And on Channel 4 News Former French foreign minister Bernard Kouchner said:

"The British people for such a mission are our closest friend. We need them. For the time being we are alone. I beg you don't leave the French alone. This is a common mission, this is a common threat, we are all fighting extremism."

A reasonable enough plea - though he sort of spoiled his case by adding that in his view "part of the reason" Britain was dragging its heels was because of the Conservatives' sceptical attitude to EU membership, when in fact, Anglo-French defence and foreign policy cooperation is widely seen in Conservative circles as exactly the type of issue and network-based approach that European cooperation should be more geared towards. Also, that a former French foreign minister is begging for the UK's assistance only serves to highlight how important the UK's military and clout is in terms of lending the EU geopolitical credibility. It also says something about the perpetual fear in some circles of the UK being "isolated" in Europe...

How long France will take to complete its operations in Mali is unclear, but the longer it drags on, help in the form of training and logistics as promised by the UK, Germany, Spain, Belgium and Denmark may not be enough. So will this end up becoming a European operation? One thing remains clear: as ever, when it comes to defence and security capabilities, co-operation and political will are far more important than politicians grand designs for European "state" building.

Is the SPD in crisis?

A new Stern-RTL poll out yesterday, widely reported in the German media, has Angela Merkel’s CDU on 43%, and the SPD, the main opposition party on only 23% - its lowest since July 2011 and equal to the actual share of votes won in the 2009 elections. Not being able to better this after a spell in opposition would be seen as disastrous, and could suggest Germany’s longest serving political party is in long term decline:

SPD vote share since re-unification

Equally worryingly for the party, its Chancellor candidate (German parties don’t have fixed ‘leaders’) Peer Steinbrück gets absolutely thrashed in head to head polling with Merkel, only winning 18% to her 58%. This has led to other senior figures in the party having to deny speculation that he could possibly replaced. Notwithstanding the confusion and mixed signals this would cause, the SPD doesn’t really have a credible ‘Plan B’ - Steinbrück – a successful Finance Minister during the 2005 – 2009 Grand Coalition – easily won the nomination ahead of other potential nominees.

The poll highlights Merkel’s remarkable electoral resilience and highlights the extent to which she is seen as a safe pair of hands during a period of huge economic and political uncertainty. It remains to be seen how the SPD will respond to this dire polling, for instance, could it be tempted to more strongly differentiate its eurozone policy which rhetoric aside has been relatively close to that of the government?

Of course we still have a long way to go till September, and plenty could happen in the meantime, especially given the low growth forecast for the coming year. Equally, given the country’s electoral system, a change of a couple of percentage points for any of the parties could produce radically different government constellations; a continuation of the CDU-FDP coalition, another Grand Coalition, a SPD-Green coalition, even a CDU-Green coalition has been suggested. The result will be significant for the rest of Europe including the UK, as Merkel is more likely to be sympathetic to EU reform than the SPD or Greens.

This Sunday’s regional elections in Lower Saxony will be an interesting forerunner as in a reflection of the national trend the CDU – led by the popular half-German half-Scottish David McAllister – is clearly in the lead, but in the absence of a coalition partner, with the FDP below the the 5% threshold, power could pass to a SPD-Green coalition.

Do Ed Miliband and David Cameron actually agree on Europe?



An emerging cross-party consensus on EU reform?

On Europe, Labour doesn't exactly shy away from turning the debate into a discussion of "Tory splits". Ed Miliband had another go in Wednesday's PMQs, perhaps a vintage attack inspired by a folk memory of the advantage Labour gained from the Maastricht rebellions twenty years ago. He said: "When it comes to Europe, it is the same old Tories: a divided party, and a weak Prime Minister."

It has been less clear, though, what Labour would actually do differently - to put it mildly. In the past, Ed M has also attacked the Conservatives for endangering the single market and jobs. In one such attack:

"Can he confirm that what he actually proposed was to unpick the existing rules of Lady Thatcher’s Single European Act as regards the internal market? Given that those proposals would have changed 25 years of the single market, why did he make them in the final hours of the summit?"

But this morning on the BBC's Today Programme, behind the bluster, the big news is that he actually agrees with David Cameron (and a laterday Clegg) on more than anyone perhaps would like to admit: 

Miliband said he wanted "change Europe" to "better reflect our interests." Who could object to that? He also said:

“I think we are moving to a more flexible Europe, a more flexible EU. Why do I say that? Because we will have some countries in the euro, Britain’s not going to be joining the euro, won’t be joining the euro if I’m Prime Minister, and therefore by the nature of it, we’re going to have some countries that are in the euro and some countries that are out. That makes, what I would call, a more flexible European Union.

"It’s a more flexible European Union. That needs to be reformed urgently to work in Britain’s interests." 

This is almost exactly what Cameron says. Zero difference. But absolutely right. 

He also supports the Government's "referendum lock";

"Clearly there is legislation on the books which we don’t propose repealing, which says if there is a transfer of powers to the EU then there would be a referendum. If there is a transfer of powers, there’s legislation on the books that says there would be a referendum."

Like Cameron, he also thinks that the UK needs to repatriate powers:

"Other areas, let me give you other areas. Regional policy, the way that a national government can have an industrial policy. I think there are areas where Britain actually needs some powers back."

Reforming regional policy is a great area to target, so well done Ed. Bringing 'powers back' in order to have an "industrial policy" would, as he has accused the Tories of doing, clearly mean unpicking the single market - and is an open invitation to the French to let the state aid flow - so perhaps not the greatest idea. But let's not split hairs...
  

Disagreements? Well:

“The debate here is between essentially those who say reform Europe and the European Union to change it to work in our interests, and I fear the Prime Minister’s strategy which is leading us towards exit, which would cause real damage to our economy.”

"I think in some areas, and this is a difference from this government - I say, for example, the European Arrest Warrant, which is something where Europe cooperates with the European Union, that helps our country... "

But he is only able to cite one policy example - the EAW - where he takes a different view to the government. And even here, from the Government's point of view, the real question is reform of the EAW and the jurisdiction of the ECJ post 2014, and whether to opt back into this particular measure.

Leave aside the current shouting match - and look at the bigger picture of Britain's role in the world and Europe - and this a country far more united on the need for anew relationship within the EU than the politicians would dare to admit.

A new angle to UK-EU trade?

The WTO and the OECD yesterday announced the release of a new set of trade data. This data tries to pin down the “value added” from trade rather than just the gross figures. Essentially, this means the data tries to track where the final demand for an exported product/service comes from, thereby netting out trade which simply contributes to the production line of the finished good/service.

The data provides an interesting new contribution to the UK-EU debate on trade. Notably the figures highlight that, under the value added approach, US trade looks more important to the UK than European countries. The Guardian questions whether this could aid the calls for the UK to exit the EU.

Superficially it may, but looking at the data more deeply, we think not. As the WTO/OECD note:

“This suggests that UK exports to other EU countries are at least partly intermediate services and inputs that are then further processed and shipped to other countries (in particular to the US).”

So, although the US is the source for the ‘final demand’ we still have to export our products or services to other countries in the EU for them to take advantage of this demand. Being a member of the EU and the single market plays a big role in allowing us to do this. The real question is, would the UK still be able to access this final demand from the US if it left the EU?

Well, it’s almost impossible to say. One thing that seems certain though, is that, since many of these exports are intermediate ones, there is no guarantee that we would still be able to export them outside the EU even if the final demand remains from the US (this point is hinted at by Ian King in the Times).

A final interesting point is that the increase in value added exports to the US seems to occur for most large EU countries. Why this is, is not entirely clear. To us, it seems that it could be motivated by specialisation within the EU, with EU members producing various component goods and services which are then combined into final exports to the US. If this is the case then this seems a positive result to us, as it surely increases the cost competitiveness of exports from the EU (including the UK).

From the perspective of the UK/EU debate this 'value added' data is another interest metric to add, although at the moment it offers little more conclusive evidence than what we currently have. The bigger benefit comes in broader terms, as the FT notes, providing further support for free trade. With protectionist forces flaring up during the eurozone crisis, countries would do well to keep that in mind as well.

Don't say MPs don't do detail on Europe




 

Too often the UK's political discussion of the European Union is conducted by politicians, on all sides of the debate, whose strong opinions are complemented by an absence of any real understanding of or willingness to engage with the detail of individual EU policy areas. A sterile and noisy debate that ends up characterising people as 'Pro' or 'Anti'. Well today we saw something different - a group of MPs actually engaging with the nitty gritty of the EU's individual policy areas and it makes for interesting reading.

Earlier today the EU Fresh Start Group of around 100 Conservative MPs launched their manifesto - and you can't accuse them of not dealing with the substance. The manifesto sets out a blueprint for a new relationship for Britain within the EU which the group hopes will be taken on as Government or Conservative Party policy. So what does it contain?

Much of what they wish to do can be done within the EU treaties. For instance they wish to see and list significant and specific reforms to areas such as the CAP, CFP, EU budget, regional policy as well as an end to the domestic 'gold-plating' of EU regulation. All this could be done without changing the EU's rulebook. In addition, they have identified five areas where EU treaty change would be required. These are:

• An emergency brake on financial services.
• Devolution of social and employment law to the national level.
• A UK opt-out from policing and criminal justice measures not covered by block opt-out.
• A single market safeguard.
• The abolition of the second European Parliament seat.

There will be the usual refrain that 'none of this is achievable' and 'they will say no'. The truth is that we don't know how much of this will be picked up by the government or eventually accepted. But it's absolutely extraordinary that the same people who used to moan about MPs not engaging with policy on Europe, now complain about Fresh Start conducting the exercise.  

Let the best argument win.

What happens now? Well the publication and work is perfectly timed to feed into David Cameron's EU speech to end all EU speeches now due for 18 January in the Netherlands. No 10 today called the Fresh Start contribution "interesting." We will wait and see.

David Cameron with the "Fresh Start" MP Andrea Leadsom

Token negotiations risk an indecisive Yes or even a weak No

Given all the talk about an EU referendum, with many on both sides attempting to pre-judge the outcome, we thought this letter by Nigel Smith in today's FT was worth flagging up. Mr. Smith is unusually well qualified to comment on this area given that he chaired the cross-party campaign for a 'Yes' vote on Scottish Devolution in 1997, advised the Northern Irish referendum in 1998 and chaired the UK Euro No campaign between 2002 and 2004.

Here is the letter in full:

Sir, Gideon Rachman’s view that a British referendum on Europe would “strongly resemble” the last one in 1975 and would be likely to produce the same result is flawed (“Don’t panic – Britain would vote to stay in the EU”, January 3). Does he really think that another token renegotiation will produce the same decisive Yes to Europe as it did in 1975 – a 67 per cent majority – a result that has carried a doubting nation through 40 years? 

Roy Jenkins, the senior cabinet member leading the Yes side, shuddered with embarrassment at the tokenism. But it worked as the hinge for a reversal in opinion partly because a sceptical public feared a No vote would trigger an economic crisis and partly because the blanket support of the media for staying in Europe made them unwilling to expose the charade. The idea that tokenism will again go unchallenged after 40 years’ experience of the EU is not tenable. 

Mr Rachman also sets great store by the three main party leaders being on the Yes side – despite Europe being littered with examples where voters have rejected their elites in referendums. Even in 1975, in a more deferential age, opinion moved in favour of his “fruitcakes” on the No side. Because Yes started in the lead, with 74 per cent supporting renegotiation, it could afford a little erosion in support. There is no prospect of the next referendum starting with the same level of support for tokenism.

Given these differences, token negotiations risk an indecisive Yes or even a weak No. The latter would have the negotiators scampering back to Brussels for the substantive negotiations they should have conducted in the first place and, of course, another referendum. There could hardly be a worse prospect, but the record shows it to be a typically EU approach to referendums.

If the EU and Britain decide on renegotiation then it must be substantive in nature and transparent in process. This approach will also prove educative for the public so that, even if negotiations deliver little change, the referendum that follows will be honest and informed, and the consequences of a No vote clear. 

Nigel Smith, Glasgow, UK

Why you cannot define business opinion on Europe in terms of ‘Eurosceptics’ vs ‘Europhiles’

On his Telegraph blog, Mats Persson argues:

Ahead of this week’s EU speech by David Cameron, journalists are searching high and low for businessmen and women to go on record on the vexed question of Britain’s European future. Alas, there’s no simple answer that makes for good radio or TV. Though broadly reflecting sceptic sentiments amongst the public, the business community is split and largely undecided, and as always it depends on the sector, size and position of a given firm. One thing is clear though: there’s absolutely no way the UK debate on Europe – among business or other groups for that matter – can be defined using the binary Eurosceptics-v-Europhiles logic that some in the media still cling on to. It’s far more fluid than any fixed pro or anti campaign.

A poll published yesterday by the British Chambers of Commerce is a case in point. Of BCC members, only 9pc of firms want closer EU integration, 12pc want to leave the EU altogether, 26pc want the status quo, 6pc are unsure. But here’s the interesting part: a full 47pc want "a looser relationship…but with the UK remaining a member of the EU".

Over the last few days, several business leaders have warned against the consequences of the UK leaving the EU, but very few have addressed the sharp end of the actual policy debate. A letter from Roland Rudd of Business for New Europe, for example, called on the UK to “lead” in Europe (surprise, surprise). But though these types of interventions are often written up as “Europhiles” challenging “Eurosceptics”, what they in fact show is how far the centre of gravity has moved (there’s no talk of more EU integration, as in the past, and certainly no talk of joining the euro, which Rudd used to passionately argue for). Also, they tell us very little. Most business people would have no problem agreeing with the “completion” of the single market, more trade deals, securing market access etc. Or, as the Rudd letter put it, “a strong reformed EU with Britain at the heart of it”. But what does this mean exactly? You’d be hard pressed to find a business person calling for “an unreformed EU with Britain at the margins”.

Remember, in policy terms, the UK quitting the EU isn’t actually on the table, as David Cameron has said several times and repeated on the Today programme this morning. Apart from Ukip (with no MPs), no party with national significance argues for it, so a "better off in" business letter misses the point (at least for now). Instead, the key question is: which is a greater threat to the trade benefits currently enjoyed by business in Europe? A new EU-UK deal or the status quo?

Here, Rudd’s lot will say that any “wholesale renegotiation” will be rejected by EU partners (as it means a “lower-cost membership”, etc) and, subsequently EU membership will be rejected by the British electorate in a referendum as expectations have been raised too high.

But there’s another way to look at it: given that around half of the British people favour the UK leaving the EU absent a new deal in Europe, it is, in fact, the “do nothing” option – not renegotiation – that is the biggest threat to the UK’s EU membership. Continue with EU membership despite the will of the British people and there may soon come a day when the electorate throw out the baby – the market access, free movement, mutual recognition, behind-the-border liberalisation etc – with the bathwater (the high non-trade costs around EU membership).

There are two other factors that should make business nervous of the “do nothing” option: First, further eurozone integration – not least via banking union – means that the status quo isn’t an option in Europe anyway. The prospect of a new “club within a club” has clear implications for business. The UK has to negotiate to secure existing rights, at least. Secondly, and most fundamentally, the EU simply needs reform to bring it up to speed with the global business environment: returning labour market laws closer to the shop floor, less EU micromanaging in environmental laws, ending the recycling of regeneration cash in Europe – riddled with opportunity costs for business – ending growth-destroying farm subsidies, and securing safeguards against investment-diverting measures in financial services, would, for example, all genuinely help business in Britain and beyond. That will require a new deal in Europe – not tinkering at the margins. It will also require a debate focussed on policy, not clichés.

This is a very complicated debate, as the interaction between UK domestic politics and eurozone politics continues to produce an exceptionally fluid and emotional debate. To expect business people – who after all have a business to run – to have a firm view of a proposition that has not yet been made, is pretty unrealistic. But please, don’t make the mistake of thinking that this is a debate between two distinct camps. And that largely goes for the debate as a whole.

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.

Why national interests still rule in Europe

In an interview with Estonian daily Postimees, the country's bow-tie wearing President, Toomas Hendrik Ilves, said that he is opposed to the idea of directly electing the President of the European Commission (something the Germans are quite keen on). He gave the following justification:

"A directly elected President would always be either French, or Portuguese, Spanish, Italian or Romanian, as these nationalities find it easier to learn French... If Europe had direct Presidential elections, no candidate would ever come to Estonia to campaign for Estonian votes."

Ilves also argues that the European Parliament should acquire a second chamber in which nation states would receive equal representation, and where issues such as EU foreign policy could be decided. This serves as a useful reminder that for all the EU federalists' talk of supranationalism, the rationale for many small and medium size EU states to proceed with further integration is to maximise their impact on EU decision making. The art is to exert as much influence as possible over an area of pooled competence on one hand, while securing institutional safeguards to avoid being circumvented by the bigger states on the other.

A bit more on the 'EU speech to end all EU speeches'

David Cameron, interviewed on Radio 4's Today programme, has given some more details about his forthcoming big EU speech to end all EU speeches (well...). So what should we expect? Here are some key excerpts:

He said a new EU settlement "is not something we should be frightened of, it is something we should embrace."

He believes there's a "real chance" of it happening and that

"The Dutch and German Prime Ministers have both been making arguments along those lines."

That he floats Germany is interesting. He was not to be drawn on what exactly the referendum would be on or when:

"We will have a new settlement and  then will put that to the British people in a very straightforward way so that they can give or not give their consent to those changes"

But what if the reform-sceptics - on all sides - are right and reform is not on the table, would he ever consider leaving the EU?

"If you are saying to me, would Britain collapse if it left the European Union? No, of course not. You could chose a different path. The question is what is in our national interest and I have always been very clear it is in our national interest as a trading nation to be in the single market but not like Norway just accept all the rules of the single market pay for the privilege of being part of it and as it were be governed by fax from Brussels."

This is all familiar stuff: Cameron thinks the UK is better off in (he's been saying that for ages), is committed to the UK public being given "fresh consent", implicitly via a referendum, and he denies all charges of "blackmailing" or inadvertently risking the UK's EU membership via renegotiation.

Draghi getting ahead of himself: are we really seeing a “normal situation” in eurozone financial markets?

In his monthly press conference on the 10 January 2013 ECB President Mario Draghi struck a relatively upbeat tone on eurozone, in particular arguing that the eurozone was returning to a “normal situation, from a financial viewpoint”. Don’t get ahead of yourself there, Mario.

True, he also warned against a slowdown in fiscal consolidation and structural reforms due to political complacency, but hinting that we’re now back to a normal finacial market situation seems particularly premature.

Firstly, to state the obvious, the ECB is still massively propping up the financial system in the eurozone. The ECB balance sheet stands at a massive €2.96 trillion up from around €1.5 trillion at the start of 2008. The ECB’s liquidity provision to banks across Europe has slowed in recent months but it remains exorbitantly high, to the point where many banks (particularly in struggling countries) are almost exclusively relying on the ECB for funding. In fact ECB exposure to the PIIGS totalled €1.08 trillion in November 2012. This is by no means normal (or at least shouldn't be).

There is also still significantly limited activity in the interbank lending market, with overnight volumes still near record lows (click graph to enlarge).

Data from the BIS also highlights that longer term bank lending and investment from stronger to weaker states continues to be dramatically below its peak (click to enlarge).

There are many other indicators, such as the limited lending to both businesses and households across the eurozone and the divergence in borrowing costs within different economies (for corporates as well as sovereigns).

Still, the situation in the Eurozone has clearly improved. Some factors, such as the capital outflow from southern to northern countries, have stabilised while others, such as the outflow of deposits from certain banking systems, have shown positive improvement. But we are still miles from being in what many would regard as a “normal situation”.

So when can we expect a “normal situation” to return? Well, with interbank channels having been absent for so long it is hard to expect a rapid turnaround. The ECB is also not expected to exit its massive liquidity provision anytime soon (and even when it does, it will likely be a gradual process), so this will continue to dictate the market. Plenty of other factors (economic growth, unemployment, social stability) also continue to fuel imbalances in the eurozone, so don’t expect cross-border lending or investment in struggling eurozone economies to return to pre-crisis level in the next few months or even years.

This is where the banking union is supposed to come in. However, as we have noted before, the current plans don’t a cross border backstop or a cross border resolution structure for failing banks, for example, so won’t really help in that respect.

Unfortunately, Draghi’s prematurely upbeat comments may have the perverse effect of encouraging the kind of political complacency which he warned about later on in his press conference.

Osborne's "reform or bust" remarks only get a page 10 hit in Die Welt

A month or so ago, David Cameron suggested, for the first time, that UK exit from the EU was "imaginable". Today, in an interview with Die Welt, and as we reported in our press summary, his Chancellor, George Osborne, has been far more explicit. Here's the relevant bit:

"I very much hope that Britain remains a member of the EU. But in order that we can remain in the European Union, the EU must change."

He added:

“I want to be an active part of a reformed EU. Europe and the UK need each other and our economies are very closely intertwined…More than half of British exports go to the EU, we sell more to Nordrhein-Westfalen than to India”.

“There are areas where we want the EU to do more. We want the internal markets for services, for digital services and for energy to be advanced and finally completed…We have plenty of ideas for Europe, but often it is frustrating that these ideas are not implemented. And we would wish that Germany would support us more strongly to push forward these ideas.”

Osborne's remarks are intellectually honest and reflect where the vast majority of his party and the British public stand, but it is also the first time that the Government has been so explicit in stating that the UK might face no alternative to exit if the EU proves unwilling to reform and meet the concerns of a country that has refused to embark on the euro project.

It is also a good thing for other EU politicians to understand where the UK, and particularly David Cameron, is coming from. But there is a balancing act here. As we've seen from the widely reported comments by Gunther Krichbaum, Chairman of the German Bundestag’s European Affairs Committee, Germany is very sensitive to the perception that it's being "blackmailed" into granting the UK specific concessions. As we mentioned in our previous blog posts, this is why pitching Cameron's EU speech as good for Europe, not solely the UK, is vitally important.

But the most interesting part of the Osborne / Krichbaum remarks, is the contrast in the media reactions in both countries to the interventions. This speaks volumes for the esteem in which each country views itself relative to the reality. Krichbaum, an important but largely domestic political figure, got a front page hit in the Times:

Osborne, the UK Chancellor, was buried on page 10 in Die Welt (in the economic section), despite issuing what could be seen as an ultimatum.

It shows that the UK at large needs a dose of self-confidence. The British audience should not be surprised if German politicians say they won't be blackmailed. This is both a long-standing German diplomatic stance (they won't be blackmailed by France, Spain, Italy, etc either) and pre-negotiation posturing. 

It also shows that it's time for everyone to breathe and calm down.

Could the Netherlands provide the beginnings of a coalition for EU reform?

Interestingly, if today's report in the Sun is correct, David Cameron seems to have enlisted Dutch Prime Minister Mark Rutte's support for, at least some, of his EU agenda, due to be spelled out in his widely-anticipated speech in Rutte's homeland in just over a week's time.

The paper reports that Rutte will back Mr Cameron’s "campaign for a repatriation of money and power to EU member states." Now, there isn't much detail to go on here - and the risk is that unrealistic expectations are being raised - but it's not the first time that the Dutch Prime Minister has voiced a desire to start a discussion about slimming down the EU's powers. In an interview with the FT late last year, Rutte said, "What we want to do is have a debate at the level of the 27 [member states] whether Europe is not involved in too many areas which could be done at the national level."

Rutte hasn't yet set out exactly what areas he wants to look at and he is keen to make the case for reform of at the level of 27, rather than a UK-only deal. Also, the nature of the 'grand coalition' between his liberal VVD party and the Dutch PvdA labour party may not allow him to go as far as he might wish. But Rutte is smart enough to know that since the UK cannot be expected to give up its existing opt-outs, the only solution is for the EU to do less.

The VVD's manifesto suggested that:

“The VVD wants a liberal Europe. That means that the European government should be small, economical and efficient. Not more Europe but a Europe which works…The VVD has a lot of criticism towards Brussels bureaucracy: the regulation-obsession, wasting funds and inefficiency.”

On the budget the VVD say:

“Spending needs to be brought back to less than 1% of GNP in order to make the EU more efficient, modern, and effective. In the new EU budget for 2014-2020, the biggest part is still reserved for agriculture and cohesion funds, almost 800 billion euro. The VVD wants to shift this in favour of investment and innovation.”

Indeed the PvdA could also be persuaded by Rutte and Cameron to look at the balance of powers between the EU and national governments, if the following from their website is anything to go by:

"In the new Europe there shouldn’t be all kinds of rules under the pretext of the internal market, but we’re going to regulate things at the proper level. Some things the Netherlands can better deal with itself ."

Some European political figures, such as Gunther Krichbaum, Chairman of the German Bundestag’s European Affairs Committee, have been quick to dismiss any attempt by the UK to "blackmail" the EU and seek, new UK-specific opt-outs. This is, of course, the public German diplomatic position, so no surprise. However, if presented as an effort to reform Europe and make it work better, putting new emphasis on the EU's "subsidiarity" principle (discredited in the UK but which still holds sway in Germany), Mr. Krichbaum and many of his colleagues instantly become far more receptive. This shows that if Cameron is able to pitch his argument in terms of "this works for Europe, but by the way it works for the UK too", he could enlist the support of leaders in other European capitals, but without antagonising the home crowd. Getting the language in the PM's speech on this issue right will be vital. 

Silvio's new(ish) electoral pledge: Renegotiate the fiscal treaty

Silvio Berlusconi yesterday stepped up his anti-austerity rhetoric another notch. During a quite heated exchange with Italian journalist Maurizio Belpietro on public broadcaster Rai Uno, Berlusconi made a new(ish) electoral pledge: renegotiate the European fiscal treaty.

Here is a translation of the most interesting bits (the full video, in Italian, is available here):

Belpietro: "There's a fiscal treaty which has been signed and ratified by Italy too..."

Berlusconi (interrupts): "No, no, no. We need to go and negotiate with the European Commission. And [we need to] negotiate without getting down on our knees before the European authorities."

[...]

Belpietro: "So would you overturn that agreement? Would you renegotiate it?"

Berlusconi: "Absolutely. Even at the cost of another vote [on the fiscal treaty] in the Italian parliament."  

Given Il Cavaliere's notorious obsession with 'the Communists', it is perhaps slightly ironic that he is now basically using the same arguments as the Socialist François Hollande during last year's French presidential campaign. As we stressed in previous blog posts, though, for the average Italian a promise to fight back EU-imposed austerity remains a powerful argument - and that is something which Berlusconi is well aware of.

Another unwanted record in the eurozone...

Yesterday’s unemployment figures from Eurostat made a surprisingly big splash in the European press today. We say surprising since for anyone following the crisis this has been a longstanding and deeply concerning trend in the eurozone.

Eurozone unemployment reached a record high of 11.8% in November (up from 11.7% in October), while youth unemployment reached the staggering level of 24.4%, meaning almost a quarter of young people in the eurozone are out of work.

Looking deeper at the data, there are a few important points to consider:

The current trend runs counter to the majority of forecasts by the Commission and the IMF. We’ve discussed this before with regards to Greece, but it also holds for Spain, Portugal and many others. Although the pace of increases in unemployment is slowing, it has not yet stopped and with austerity set to continue across the eurozone it seems unlikely to do so at any point this year. Despite this, many of the forecasts show unemployment stabilising at or near current levels – this data highlights that this remains unrealistically optimistic.

There remains huge divergence between the stronger and weaker countries. With Austria posting unemployment of 4.5% compared to Spain’s 26.6%, the talk of the eurozone crisis being over seems rather pre-emptive. Fundamental divergences remain between the countries, with no clear mechanism for correcting or managing them yet being discussed at the highest level.

The increase in long term unemployment is becoming increasingly concerning. In the second quarter of 2012 it reached 5.2% in the eurozone, but topped 13% and 10% in Greece and Spain respectively. This has the ability to significantly harm the potential productivity of these economies and become a significant drag on (already low) economic growth. As with the wider figures it drives home the need for strong structural reforms, particularly to education and retraining programmes.

It’s also worth keeping in mind that this is happening at a time when growth is stagnating and public spending is falling sharply, meaning that the fall in standards of living for many people could be substantial – as we have pointed out before this has the potential to be a toxic mix in what is already a very politically divisive crisis.

Greek bond buyback fallout continues

As we noted in this morning’s press summary, there have been some interesting developments with regards to the Greek banking sector.

Kathimerini reported that, according to unnamed bank officials, the bank recapitalisation may now need to be larger than the scheduled €27.5bn. The reason for this is twofold:

• First, the level of non-performing loans in Greek banks topped 24% of all loans at the end of 2012. This is a staggering amount. Keep in mind the Spanish banking sector, which has been the focus of so much uncertainty, still has non-performing loans equal to around 11% of all loans. Greece once again is in another league here.
• Secondly, as we warned at the time, the bond-buyback had a detrimental effect on the Greek banks. Even if they did not take substantial direct losses on the bonds they submitted, they have lost out in terms of future revenue (the interest from the bonds). This is reported to amount to around €1.5bn this year.

As FT Alphaville highlights, this seems a fairly clear-cut case of the negative trade off which we highlighted at length in the run up to buyback.

Needless to say, it is not make or break and the marginal effect of the buyback is still positive, albeit fairly small in the scheme of the Greek crisis. Fortunately, there is an additional €5bn set aside for such ‘unexpected’ increases in the bank bailout, so the additional cost should not disrupt the bailout programme.

We would note as a final point, that this may not be the end of the story (not just because the non-performing loans are likely to increase further) but also because we are yet to find out what impact the bond buyback had on the Greek banks’ ability to access liquidity (an issue we discussed in detail here). Again it may not be make or break, but we suspect it could be a further negative factor for Greece to deal with - something it hardly needs.

The Coalition's mid-term review on Europe: Bland and blander

Yesterday saw the publication of the Coalition's 'mid-term review', the aim of which was to "take stock of progress in implementing the Coalition agreement" and to set out the government's objectives for the remainder of its period of office.

The Europe section of the review was arguably the blandest part of what was a very bland document overall. So hardly exciting. The government highlighted the "referendum lock" on future treaty changes, disentangling the UK from the eurozone bailouts, and establishing the single European patent as its "achievements" (the first and third are genuine achievements). Like all UK governments in recent decades, it also stressed the need to remove the burden of unnecessary regulation and to secure a tough EU budget settlement.

As ever, the differences within the parties on Europe - though you wonder if they aren't sometimes more perceived than real -  mean that the Government seems unable to set out a 'grand vision'. As the Sun noted in its leader today, 'Europe' remains the "elephant in the room". To be fair, the Labour party, which has the luxury of the purity of opposition, has also failed to set out where, exactly, it wants the UK in Europe.

In other words: we're all still waiting for Cameron's EU speech...

Scotland and the EU: The borderline issue

Not that we ever intended to wade into this debate, but how various separatist/independence discussions interact with the EU treaties has always fascinated us. 

Which is why in January lastyear we wrote a piece entitled "Would EU law introduce border controls with Scotland?", in which we pointed out that an independent Scotland would have to apply for EU membership and that if it did so it would not have the benefit of the UK's opt-outs from the Euro or Schengen, the implication of the latter being possible border controls. 

Open Europe 11 January 2012:

The implications of this seem to have been picked up by the bright sparks in the FCO who briefed the newspapers accordingly:

"The potential side-effects of Scotland breaking away are outlined in a Foreign Office memo leaked to The Mail on Sunday"

Daily Mail 6 February 2012: 

The problems Scotland would have staying within the EU did not go unnoticed in Spain where Catalonian independence was begining to bubble. We wrote about it in Spain here and here.

By now the cat was fully out of the bag - a Sunday Times article came to an obvious conclusion:

The rest as they say is Scottish history...

 



With a final confirmation coming from the Commission on 6 December 2012:

Monti's candidacy set to make Italy's election season a rollercoaster ride

Last month, the Economist used the Oscar-winning exhortation, "Run, Mario, run" to urge Mario Monti to "come out fighting" in the Italian general elections. Detto, fatto. Monti has put his boxing gloves on and entered the ring. On Friday, he unveiled the logo for his new list (probably not the most exciting one, as you can see from the picture).

However, in what is a high stakes game for Italy's future, Monti's candidacy may ultimately turn out to be more divisive than initially thought - particularly since Italian voters do not seem particularly receptive to his reformist message. 

Democratic Party leader Pier Luigi Bersani had initially claimed he was willing to broadly continue with the reforms initiated by Monti's government, and be "open and generous" towards other centrist, pro-reform forces. However, Monti has now become the leader of those centrist forces - and a rival in the race for Italian Prime Minister. As a result, the Democratic Party is now focusing its efforts in stressing the differences, rather than the similarities, with the 'Monti agenda' - and is strengthening its ties with the smaller left-wing SEL party, which wants a "radical change" in the economic policies implemented by Monti's technocratic government

It is hard to see such a coalition making significant progress in opening up Italy's labour market - something which should top the agenda of the next Italian government, if the economy is to do more than simply run to stand still.

As we have mentioned before, Italy's complicated electoral law is going to play a key role in determining the final outcome of the elections. The rules for the lower chamber of the Italian parliament basically establish that the winner takes it all - and guarantee a solid majority of seats for the party/coalition which gets the most votes. Monti and his centrist bloc are currently polling at 14-15% - well behind the centre-left coalition (on 38-39%) and even the centre-right coalition between Silvio Berlusconi's PdL party and Lega Nord (on 26-28%). Therefore, Monti's clout in the Camera dei Deputati is likely to be marginal. 

However, there are different rules for the Italian Senate - the upper chamber. Italy's electoral law establishes that seats in the Senate are assigned on a region-by-region basis. More specifically, the party/coalition which gets the most votes in a specific region automatically wins 55% of the seats up for grabs in that region. This means that, even with almost 40% of votes nationwide, the centre-left coalition led by Bersani could have a majority in the lower house but fail to secure a majority in the Italian Senate.

And this is where Monti could still potentially have some decisive influence - he knows he might end up being the kingmaker in the Italian Senate (which has equal powers to the lower house). Monti has effectively ruled out working with a government with which he does not agree "on at least 98% of policies", but this could yet prove to be a pre-negotiation tactic designed to entice the Democratic Party to the centre ground.

To sum up, the arithmetic of the polls and Italy's complex electoral rules mean that the outcome of Monti's jump into the fray remains far from certain. His candidacy has injected some much-needed economic reality into Italian political debate - which has in turn increasingly made him a focal point of opposition from both the left and right. Yet, he might still wield influence in the formation of the next government.