IDEAglobal: Eurozone Aims For ECB Supervision Role Deal In December

Eurozone leaders are now masters of positive PR, which was shown in the statement and press conferences after last night’s EU summit. However, a deal seems to have been brokered to see the ECB’s banking supervision role start at some stage in 2013, which will soothe fears of backsliding by Eurozone leaders. The absence of hints on the timing of Spain’s ESM request could disappoint some though.

1. ECB’s banking supervision role. In the end Germany and France met halfway with the European council statement noting “the objective of agreeing on the legislative framework by Jan 1 2013, with implementation taking place in the course of 2013”. The ECB is to supervise all 6000 banks eventually, though on a day-to-day basis this will be done by the national regulator, which satisfies Germany and France. IDEAglobal would still feel a “full agreement” is not a done deal for the Dec 13 meeting and the fallback would be an “in principle” deal, with the “full agreement” in Q1 2013. Tough negotiations remain regarding the list of banks and political accountability of the ECB. ECB President Draghi also apparently provided guidance to EU leaders that it would take 6-12 months to get the ECB operational in its supervisory role, which suggests H2 2013 for the actual start up – German Chancellor Merkel acknowledged this in the press conference. However, this is better than the 2014 that Pres Draghi had suggested last Saturday. From a market viewpoint, the delayed timetable is less important than the fact that Eurozone leaders have agreed to maintain momentum on the ECB’s banking supervision role.
2. ESM and direct loans. France President Hollande’s positive PR spin that direct loans to banks could occur in Q1 2013 is overdone. Germany will not allow this to happen until the ECB supervisory body is up and running in H2 2013. Agreement could not be reached and this has been pushed to the Dec EU summit. Reports suggest a potential compromise on legacy assets would be to split assets between the ESM and national funds.
3. Spain and Greece. Nothing of major significance in the official statement on Spain, although during the press conference EU Commission President Barosso said any Spanish aid package would not really need extra conditionality. No hints or comments so far from Spanish sources, which is understandable ahead of Sunday’s close Galicia regional election. Spain should now pass the Oct bond redemptions with ease, while bond yields are now coming down to levels not seen since the post-Dec 2011 LTRO hype. This makes the need less pressing for Spain to request an ESM loan, despite EU pressure. One dimension could be Greece, as some governments want to link all aid packages together for parliamentary approval. The separate statement on Greece makes clear that the Eurozone is strongly biased towards keeping Greece in the EMU-17 for now and striking a deal. The agreement to revise the second EU/IMF loan package could come at the Nov 12 Eurozone finance ministers meeting. Before then the next week could see some disappointment setting in because Spain is too slow in requesting aid, after which Spanish aid speculation could return.
4. Eurozone common budget and completing EMU. The official statement made clear that the ‘Big 4’, led by President of the European Council Van Rompuy, will present a specific and time bound roadmap for completing EMU. The Interim Van Rompuy report cornerstone is a limited common Eurozone budget, with a desire to set a timetable also for a common Eurozone resolution fund and enhanced economic cooperation. However, the ‘Big 4’ has proposed Eurobills, but Germany will block this before the German general election in Sep 2013. IDEAglobal would not expect any new big quick commitments from Germany generally before the election, as Chancellor Merkel is now focused on avoiding accidents that could hurt her re-election chances.
5. Two-speed Europe. The desire to move towards completing EMU apparently produced a lot of difficulties between the EMU-17 and the other ten EU members. Chancellor Merkel is now on record as suggesting a two-speed Europe is likely. Tensions will now occur in the next five weeks before the Nov 22-23 EU summit that is due to finalise the 2014-20 EU budget. While the UK and others will complain loudly about this, a two-speed Europe is actually positive for financial markets in the medium term as it allows the EMU-17 to built out institutions in the long run.

The initial market reaction has been positive, as the ECB supervision role deal is seen to keep institution building broadly on track. Reflection on the medium-term thrust of the Eurozone could be a supportive short-term factor, but tough negotiations by finance ministers will raise questions in the coming weeks. However, the timing of any Spain aid request remains the critical near-term issue, given the financial market fear of the ECB OMT mechanism. The risk is that next week sees some stalling from Spain and this could produce a corrective widening in sovereign spreads after the recent sharp narrowing.