Tags: Merkel | Sarkozy | Cure | Euro

Merkel and Sarkozy Offer No Miracle Cure for Euro

Wednesday, 17 Aug 2011 03:32 PM

 

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New Franco-German proposals to boost fiscal convergence in the euro zone got a cool response from other member states on Wednesday and failed to convince investors the bloc's debt crisis was closer to being solved.

Traditional German ally Austria criticized plans announced by Chancellor Angela Merkel and French President Nicolas Sarkozy on Tuesday to move towards an "economic government" in which euro states agree to give up sovereignty over economic policy.

And Ireland reacted skeptically to a pledge by Berlin and Paris to press ahead with a harmonization of their corporate tax rates in hopes that other euro members would follow suit.

A separate proposal, to write German-style "debt brake" rules into national constitutions across the 17-nation currency bloc by mid-2012, faces big hurdles given that Sarkozy himself is struggling to secure a parliamentary majority for such a plan at home.

Finland's finance minister questioned whether such a rule would work at all and said she was "not too excited" about making changes to her country's constitution.

Before the meeting some investors had held out hope that the leaders of the bloc's two biggest economies would take bolder steps, such as agreeing to joint euro zone bond issues or boosting the size of their rescue fund.

But both governments had made clear in the run-up to the Paris summit that neither of these steps was under serious consideration.

By avoiding bold short-term solutions, Merkel and Sarkozy left responsibility for warding off any new market attacks to the European Central Bank (ECB), which has bought up tens of billions of euros in bonds from weakened debtors like Italy and Spain to prevent the zone from breaking apart.

"I think the crisis in fact is likely to get worse before it gets better despite the announcements that we had yesterday," Jacques Cailloux, chief European economist at RBS, told Reuters Insider television.

"The ECB is trapped here," Cailloux said. "So I think we could end up having 150 billion euros to 200 billion euros ($215 billion to $290 billion) of Spanish and Italian bonds on the ECB balance sheet in the next month and a half."

Euro zone leaders agreed a month ago to give their rescue mechanism the power to buy bonds, but that decision must be approved by national parliaments before it can take effect.

TOO LITTLE TOO LATE

Some of the steps unveiled at the news conference in Paris on Tuesday would have seemed almost revolutionary as recently as a year ago.

Merkel bowed to longstanding French calls to hold regular meetings of euro zone leaders and appoint a symbolic president, or spokesman, for the bloc -- steps that are bound to widen the divide between euro "ins" and "outs" in the 27-nation EU.

But in the midst of a crippling crisis that has threatened to engulf big countries like Spain, Italy and France, the announcements were criticized by many as "too little too late".

"There is little in the way of concrete measures in these decisions," said Wolfgang Leoni, chief investment officer at Sal. Oppenheim. "This is exactly what the markets don't want."

The reaction on Wednesday was subdued. The euro edged up against the dollar, pushing above the $1.45 mark for the first time in three weeks.
Spanish and Italian 10-year bond yields hovered near 5 percent, more than a percentage point below where they stood before the ECB first intervened in the markets earlier this month.

But economists said markets could test the resolve of European policymakers again within weeks. Both Spain and Italy held out hope that Merkel and Sarkozy would change their minds and embrace joint euro bonds.

"Markets are looking for a magic bullet and that doesn't exist," said Julian Callow, an economist at Barclays in London. "Instead of a magic bullet we have more of the same. Governments are trying to cut their deficits, that is eating into demand and driving economies weaker."

Data on Tuesday showed the German economy, Europe's biggest and for the past year the most vibrant, barely grew in the second quarter.

CONTENTIOUS DEBATES

One worry is that the Franco-German proposals re-open a number of contentious debates within the EU, further sapping investor confidence.

Merkel and Sarkozy vowed on Tuesday to press ahead with long-stalled plans for a financial transactions tax. But the UK has long opposed this, and moving ahead without the City of London could end up hurting the financial sectors in Frankfurt and Paris.

Irish Finance Minister Michael Noonan said he would insist that any such tax apply to all 27 members of the EU, not just the 17 that share the euro.
Looming elections in key euro zone member states -- Spain votes in November and France in the spring -- could also complicate implementation of the proposals announced by Merkel and Sarkozy.

France's Socialists have strongly opposed the government's plans to introduce a balanced budget rule to the constitution, threatening to turn it into a campaign issue.

On Wednesday Francois Hollande, the leading Socialist candidate to challenge Sarkozy in next year's vote, urged a national debate on the issue.

© 2014 Thomson/Reuters. All rights reserved.

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