By Emma Charlton
BRUSSELS (MNI) — While this weekend’s unprecedented raft of
measures crafted by European policymakers is likely to alleviate
short-term market pressure on the Eurozone, it does not address the
underlying problems facing the currency bloc: debt, deficits and
competitive imbalances.
After 11 hours of intense negotiations, European Union finance
ministers said early Monday they had agreed a Eurozone support package
worth more than E720 billion — E60 billion put up by the European
Commission, E440 billion in bilateral loans from the Eurozone countries
and at least another E220 billion from the International Monetary Fund.
No one has yet asked to use this money, the policymakers said, and
if they did, it would be lent with very strict conditions.
In tandem, the European Central Bank said it would buy government
and private debt on the dysfunctional European markets, restart the
long-term refinancing operations it had been phasing out and reinstate
dollar-denominated foreign exchange swap line with other major central
banks.
“These are the kind of bold measures we’ve been waiting for,”
analysts at Danske Bank said in a note to investors.
With these moves, European policymakers hope to assure markets that
they are equipped to deal with the sovereign debt crisis in the Eurozone
and will not let the euro currency fall apart.
While the initial market reaction was positive, with the euro
rising 1.6% against the dollar in early trading, several questions
remain unanswered: whether the ECB can undertake such drastic action
while retaining its credibility and independence and whether the
measures address the longer-term issues within the currency union. Or do
they just postpone a bigger problem?
“The package is a clear signal to the markets about the willingness
of defending the euro,” said Niels From, a strategist at Nordea Bank.
“However, it is not the solution to all the problems in the Eurozone –
it eases the pain and buys time, but it doesnt heal.”
He and other economic commentators say healing the 16-nation
currency bloc can only be achieved via long and painful efforts to
reduce government debt, a process likely to take not months but years.
Reducing differences in competitiveness is also key for long-term
stability, economists said.
Alongside Sunday’s announcement, both Portugal and Spain — which
have been singled out by markets as growing concerns in recent weeks —
said they would propose additional measures to cut their government debt
before the next meeting of finance ministers on May 18.
“More has to come across the full euro region,” Nordea Bank said in
a note to investors. “On the top of this, of course, it is important for
the markets to see last night’s measures being effectuated ASAP.”
Central to the problem is that none of the announced measures
address the fundamental issues of competitive imbalances and huge debts
and deficits. In fact, simply propping up the system could make things
worse.
At a meeting Friday in Brussels, EU leaders said they would tighten
the budget rules and try to cajole member states to follow them more
closely, as well as monitor deficits and competitiveness more closely.
But they stopped short of saying how and when this would happen — a
process that is likely to take several more rounds of intense
negotiations.
Another issue is the role of the European Central Bank, which as
recently as last Thursday shied away from the suggestion that it could
buy government bonds on the secondary market.
This is the third time this year the central bank has reversed
policy, changing its mind on its minimum credit threshold for
collateral, saying it would keep it at BBB- until the end of 2010 and
apply a range of graduated haircuts from that start of 2011. It had
previously said it would revert the threshold to A- by the end of the
year.
Just a week ago, the central bank said it would suspend applying
the minimum credit rating threshold for marketable debt instruments
issued or guaranteed by the Greek government after previously stressing
that it would not give special help to any one Eurozone member.
European Central Bank President Jean-Claude Trichet has framed
these U-turns as positive, saying the central bank is merely reacting
quickly to a rapidly evolving situation. But some in the market say the
moves erode the central bank’s credibility and independence.
The ECB said its new policy was aimed at improving the link between
its instruments and financial markets and would not affect its
independence or its key target of anchoring consumer price inflation
just below 2%.
But just a few months ago the central bank’s more hawkish members
were arguing against such a move. Executive Board member Juergen Stark
warned it would be a sure road towards inflation over the medium term.
There is an evident risk that such extraordinary moves will
eventually have some kind of inflationary impact.
How the markets react in the medium and long term remains to be
seen. One thing is sure: Monday’s package is the beginning — not the
end — of a painful road of adjustment for all the Eurozone countries.
“This morning [policymakers] have clearly succeeded in stabilising
the situation,” said Jordan Kotick, a foreign exchange strategist at
Barclays Capital, in a note to investors.
“However, until we see the Eurozone yield spreads actually reverse
trend, this remains a volatile situation,” he said. “The market is
scrambling to reinstate positions jettisoned last week.”
–Brussels: 0032 487 (0) 32 803 665, echarlton@marketnews.com
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