July 2, 2012

Last week’s EU Council brought decisions determining the European agenda for the upcoming months. Beyond the important agreement on banking issues the Eurogroup stated that (i) ESM loans to Spain will not be senior and (ii) MoUs for the future support of countries via primary and secondary market interventions will take their content from the European Commission’s country recommendations. The EU President was asked to develop the presented report on the future of EMU into a specific and time-bound road map with the next interim report due in October. Finally, the “Compact for growth and Jobs” was agreed.

The summit is another step towards restoring euro-area credibility and stability. Aligning conditionality of MoUs in the context of primary and secondary market interventions with the content of the European Semester should improve the consistency of economic policy surveillance. However, it is a softening of conditionality in the sense that it refers to an agenda that needs to be implemented anyway and so far is more of a qualitative nature than one with clear quantitative targets (apart from fiscal items). What should also not be forgotten is that primary and secondary market intervention by EFSF/ESM has the major downer that their current liquidity reserves are known. The Ecofin council on 9 July now faces a huge agenda including (1) determining conditionality for bailing out Spanish banks and – in case spreads continue to widen – possibly for Italy (2) discussing the roadmap for upgrading EMU, (3) bringing major decisions on how to operationalize the EUR 120 bn growth programme. While the numbers attached might be biased to the upside as there is some double counting, it is positive that non-financial efforts to improve the growth potential such as the single market or structural reforms form a large part of the Compact. Finally, and not to forget, the EcoFin has to deal with Greece’s request for softening of the adjustment programme. While the ECB is likely to “reward” the summit results with a 25 bp rate cut – reflecting the weakening of euro area economy – and might hint at its preparedness for further non-conventional monetary measures this week, the German Bundestag / Bundesrat has approved ESM and Fiscal Compact already last Friday. However, the Constitutional Court will be swamped with further complaints on ESM in particular.