Following on the tradition of previous EU summits, last week’s event proved to be a letdown for those who have been hoping for the Germans and the ECB to start working on an effective solution that would give immediate gratification to the financial markets. What they got instead was a roadmap to a political long term solution based on a moderate relinquishment of sovereignty to ensure that failure to abide by the budget rules would have ‘automatic’ consequences. The problem is that such an outcome would have been great nine, six, and maybe even three months ago, but with today’s degree of scepticism, it is far from clear that these political horizons will satisfy anybody, let alone the markets, which indeed reacted negatively.
No wonder that Cameron chose to use the veto red button that is meant to be there for leverage not to be actually used. By using the veto Cameron has basically lost the leverage. Just like the US Republicans have found lawyerly ways to go around the automatic government expense reduction agreement to protect for example, defence, the EU, with Sarkozy’s leadership, will find crafty ways to go around the UK veto while at the same time marginalising his British cousins. But Cameron thought that if there is a time to be wary of more Europe, it is now! Who wants to jump into a sinking ship? This is not a good sign…
Just as we discussed last week, Monti has delivered a tough but fair budget which comprises both tax savings and incentives (the deductibility of the horrible IRAP tax is certainly welcome and long overdue). Has he done enough? Probably not, but in only just over a couple of weeks in office, this can be considered a very serious achievement.
Interestingly, Monti has described his Emergency Budget as a Save Italy bill. While Monti couldn’t say it given that he needs their votes, the last famous times that parliament voted save-something bills was to save Berlusconi’s TVs from being put off the air. This time, Monti said, we need to save Italy, and indirectly, the entire Euro endeavour. Will it do the job? Well, the markets clearly liked it a lot, sending the infamous BTP-Bund spread well below 400bps from a high of nearly 550bp four weeks ago.
But the ball is now back with Sarkozy and Merkel, and later on this week with the other Euro zone members, who will need to show Draghi that they have done all they can on the political front and give him a green light to use the Bazooka, given that, this must be made clear, he is the only one who has the technical means to execute instantaneously. The method is probably the one we have discussed before: a SSB style statement saying that the ECB will not tolerate yields on certain government bonds to trade above a stated limit.
We would like to add one caveat to this. While the SSB’s methods have worked brilliantly, and just the announcement worked its magic, Draghi knows that at this late stage in the crisis he must be ready to confront the market for real if he is tested. This test will probably come at some later stage, when some hiccups will start emerging on the political front. Let us hope that this weekend will see serious and actionable decisions.