As a key EU summit wrapped up in Brussels on Friday, German Chancellor Angela Merkel and French President François Hollande hailed a new deal that will allow eurozone bailout funds to recapitalise banks directly by bypassing national governments.
AFP - After 18 disappointing summits since the start of the debt crisis, Europe’s leaders appeared Friday to have finally come up with a set of short-term measures and long-term plans that show they are serious about restoring confidence in their currency union.
Leaders of the 17 countries that use the euro agreed they will let funds intended to bail out indebted governments funnel money directly to struggling banks as well. They said the move will "break the vicious circle" of bank bailouts piling debt onto already stressed governments.
European Council President Herman Van Rompuy called it a "breakthrough."
Global stock markets and the euro rallied hard.
The decision is a victory for Spain and Italy, whose borrowing costs have risen to near unsustainable levels despite their efforts to cut spending and reform their labor markets.
In Germany, Chancellor Angela Merkel is likely to face a grilling from a skeptical German Parliament later. Heading into the summit, Merkel had stuck to her line that any financial help from Europe’s bailout fund must come with tough conditions, so a separate decision allowing countries that have reformed their economies easier access to bailouts, without such stringent conditions, was widely seen as a defeat by the German press.
Merkel insisted the funds would still only be released when it was clear countries were undertaking serious reforms.
"We remain completely within our approach so far: help, trade-off, conditionality and control, and so I think we have done something important, but we have remained true to our philosophy of no help without a trade-off," Merkel told reporters in Brussels.
Van Rompuy dismissed talk that Merkel had lost in the negotiations.
"It was a tough negotiation," Van Rompuy said. "It took hours yesterday. And you can’t summarize this in winners and losers."
In addition, the leaders of the eurozone countries authorized the EU bailout funds to buy bonds of countries in order to reduce the interest rates the markets charge.
Leaders of the full 27-member European Union, which includes non-euro countries such as Britain and Poland, also agreed to a long-term framework toward tighter budgetary and political union, though those plans will require treaty changes and won’t be realized for years.
The scale of the moves were unexpected and provided investors a reason for optimism, even as analysts cast doubt on the plans’ feasibility and noted that some fundamental problems with the common currency remain.
"I think the elements we put together will reassure the markets," said Eurogroup President Jean-Claude Juncker.
Mario Draghi, the head of the European Central Bank, was similarly optimistic.
"I’m actually quite pleased with the outcome of the European Council," said Draghi. "It showed the long-term commitment to the euro by all member states of the euro area. But also it reached tangible results in the shorter term."
He cited in particular the waiver of the ESM’s preferred creditor status for Spain and the future possibility of using ESM for direct recapitalization of the banks, which is something that the ECB had advocated for some time.
But he said strict conditionality was essential to the program’s credibility.
Stocks around the world surged Friday, with markets in countries on the front line of the crisis doing particularly well. Italy’s FTSE MIB and Spain’s IBEX indexes each rose 3 percent.
Perhaps more importantly, the yield on Spain’s 10-year bond dropped by 0.32 percentage points to 6.58 percent. Italy’s was down by 0.14 percentage points to 5.94 percent. Both countries have seen their rates edge toward the 7 percent level which is seen as unsustainable over the long term.
The importance of recapitalizing banks directly from the bailout fund became evident this month when Spain was offered €100 billion ($125.6 billion) for its shaky banks. Previously the bailout loan would have to be made to the Spanish government, which would lend it on to the banks. The prospect of having that debt on the government’s books spooked investors, who began demanding higher interest rates to reflect the risk of a Spanish default.
Lending the money directly to the banks avoids putting more debt on the government’s books.
Analysts remain skeptical about whether the moves will be enough to fix Europe’s debt crisis, especially as the amount of money available to help in the crisis - some €500 billion - is dwarfed by the amount of debt across the continent. Italy alone has outstanding debt of €2.4 trillion.
"These steps are the obvious ones to take to try to restore some confidence in the market in the short term," said Gary Jenkins, managing director of Swordfish Research in London. "Alone, they do not solve the underlying problems but they might buy a bit of time, which is probably about the best they can do right now."
Though welcoming the measures that were taken, analysts think more will have to be done.
"If the aim is to ease tensions on the Italian and Spanish bond market on a more sustainable basis, we probably will need to have more assurance on the fire power," said analyst Carsten Brzeski of ING in a note.
Brzeski said more liquidity support from the ECB "looks inevitable" and may come as soon as Monday.
As well as trying to fix the euro, the EU leaders also agreed to devote €120 billion in stimulus to encourage growth and create jobs, though half of it had already been earmarked and it includes only €10 billion in actual new commitments. France had pushed for the growth package, arguing that austerity measures are stifling growth and making things worse.
They also agreed to give the ECB new powers to oversee the bailout funds by July 9, and to oversee big European banks by the end of the year.
For the longer-term, the 27 leaders of the EU agreed on "four building blocks" of a tighter union - but postponed specifics until a study due in October. The building blocks, which include sharing debt in the form of jointly issued Eurobonds, were laid out in a sweeping document presented by Van Rompuy and colleagues before the summit.
It was unclear, however, whether the general agreement on the tighter union included any commitment on eurobonds from Germany and other stronger economies that have firmly opposed sharing debt with more profligate countries such as Greece.
One key factor in the negotiations was that French President Hollande appeared to turn against Merkel and lobbied instead on behalf of the southern states frustrated at the failure of austerity measures to solve their problems.
"The best way to get other people to move is to move yourself," he said.
Germany and France have been the traditional drivers of European policy, but the Socialist Hollande and conservative Merkel differ over how to tackle this crisis.
But Hollande declined to take credit.
"No one can say I won or I lost," he said. "What was at stake was Europe. That’s who won."