The fate of the European Union continues to hang precariously on the edge as the European Council, constituting the heads of state, prepare their first summit of the year today, 30 January.
The official agenda is focused on striking a balance between more austere fiscal measures for nations with unsustainable levels of debt and policies that will help revive the economic growth across the 17-member Euro area. The summit marks another in the series of attempts by Euro area leaders to reign in the perpetuating crisis that has spread malignantly across the members of the single-currency zone. The fear of recession has continued to build after Standard and Poor’s credit rating agency downgraded 9 Euro area governments, most notable among the downgrades were Austria and France which lost their top-tier AAA ratings. S&P’s then continued to hack away at the security and the hopes of reform by downgrading the European Financial Stability Fund (EFSF) to AA+. The Euro area economy is widely expected to suffer a mild recession this year as governments cut spending to balance their budgets. In France, Sarkozy has implemented what man have called a “Robin Hood” tax, which has increased sales taxes and levies on financial incomes to fund a 13 billion Euro cut in payroll charges. The increase would amount to 1.6% points and bring the rate of tax on most goods and services to 21.2%
“There will be a lot more talk about growth and austerity. That’s helpful in the long run and could help prevent a future crisis, but it doesn’t solve the current one.” – Jennifer McKeown, economist at Capital Economic in London
EU leaders will discuss today the latest draft of the fiscal compact and two final unresolved questions on the draft resolution. According to the draft, the European Court of Justice (ECJ) will be empowered to impose sanctions in fiscally wayward countries under a new accord that has been supported by the majority of the EU countries. The ECJ may impose on the country a lump sum or a penalty payment appropriate in the circumstances and shall not exceed 0.1% of its GDP. The draft also says that if a country wants to borrow from the Euro area’s permanent bailout fund, the European Stability Mechanism (ESM) after March 201, they must first ratify the fiscal compact, which will be activated after ratification by the national parliaments of 12 countries. The agenda for today’s summit also deals with whether non-Euro countries that have signed the pact will be allowed to participate in meetings where Euro-area issues are discussed, which has been a highly critical issue with the UK and David Cameron. Another question is whether sanctions will be implemented when countries fail to meet the pact’s requirement on debt-to-GDP ratio.
“The outlook for economic growth in Europe in 2012 is not a healthy one and consensus forecasts for earnings-per-share growth likely do need to be adjusted downwards.” – Ian Scott, chief global strategist at Nomura Holdings Incorporated in London
The draft suggests that there have been tentative signs of economic stabilization in Europe, but financial market tension continues to weigh on the economy. European stocks headed for the biggest 2-day drop since November amid concerns about the meeting of the region’s leaders. Sadly, even EU officials have voiced skepticism about the EU initiatives. BNP Paribas SA tumbled 5.8%, Royal Phillips Electronics NV dropped 2.%, Hochtief AG sank 5.4% and Stoxx Europe 600 Index retreated about 1% to 25.93, which is the largest 2 day slip since November 23rd. In Brussels, home the EU summit, union strikes in transport and other public services ground the entire country to a halt. It is the first general strike since 2005 and the first since 1993 launched jointly by the country’s 3 main unions, which are all aggravated by public spending cuts of more than 12 billion Euros for 2012. Moreover, the summit comes amid ongoing uncertainty over Greece. Greek officials took exception to a proposal sponsored by Germany, that would effectively give the EU the power to veto Greek pending plans in return for aid. German Finance Minister Wolfgang Schaeuble warned that Greece must show Europe it is capable of implementing fiscal reforms or Greece may not receive a second bailout totaling 130 billion Euros, which is necessary for the country to avoid a default this spring.
“We seem to limp from one summit to save the Euro, to another. It is prudent in the face of this uncertainty to take a more defensive stance toward the Euro. There is pretty decent chance that in the first half of this year, we’ll have a lot of $1.20” – Simon Derrick, chief currency strategist at Bank of New York Mellon Corporation in London
Among the criticism facing the EU, US Treasury Timothy Geithner has escalated pressure on Germany to strengthen firewalls, such as the EFSF/ESM, against future recession. Both Geithner and David Cameron suggest that a credible effort would be a precursor to increased IMF support for the region. Nevertheless, Merkel has resisted calls for boosting the size of the region’s rescue funds, insisting that a long-term commitment to fiscal discipline and a patient approach toward improving competitiveness and restoring confidence are crucial to solving the crisis. So saying, Germany has served as the supporting structure for the ailing Euro for years now and still stands on a top-tier AAA rating, as well as a long history of fiscal recession and re-cooperation, suggesting that its approach has been tested and been successful. Though the summit may not yield any major breakthroughs on the discussion for the rescue funds, many leaders may find themselves shielded as a result of last month’s large injection of liquidity into the European baking summit by the European Central Bank (ECB). Banks took up nearly half a trillion Euros in 3-year loans in the long-term refinancing operation, a move that has helped face bank funding worries.