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EEA could be right place for UK in Europe
David Cameron’s veto of the new EU fiscal arrangements should reopen the debate on the UK’s relationship with the EU. Euro zone membership is politically inconceivable but unless the tone of the debate changes it is likely to be treated by other members as a pariah or even a traitor. There is an alternative – the European Economic Area.
The EEA was established in 1992 as a sort of half-way house between full membership in what was then called the European Community and total autonomy. EEA countries participate fully in the common market and have to follow the EU rules and regulations which keep markets free. But they do not participate in the governance of the Union. As far as other European matters go, they can more or less pick and choose whether to participate.
It’s not a bad economic deal, but the group has shrunk as its founding members joined the EU. The EEA today is only Norway, Lichtenstein and Iceland, with Switzerland legally out but practically in. The UK would be a natural. By leaving the EU, it would save most of its annual 10 billion pound contribution, a sum which could rise by 50 percent if irritated members carry out their threats to its rebate. UK governments would have less at stake in arguments with continental governments they don’t really understand.
Of course, outside the EU, Britain would have even less influence on European decision-making. That decline would be felt in financial markets: euro bond and currency trading would probably migrate to inside the euro zone. But then again, the current arrangement is artificial. Strictly euro business would probably leave London anyway. In higher value-added businesses such as global finance and asset management, London will stay strong as long as the City keeps its skills edge.
The challenge would be to make the transition to the EEA amicable. But it is worth making an effort to keep the benefits of the EU’s large market while minimising costs, friction and bureaucratic meddling. Quietly and non-confrontationally, the EEA should be Britain’s goal.
Euro debt toxic in central Europe too?
Hungary — and to a lesser extent Poland — have been suffering from their exposure to the economies and banking systems of the euro zone.
But if it was just about the quality of these sovereign credits, their dollar bonds would have fallen as hard as their euro debt.
Investors say there could be several issues at play, including worries about the volatility of the single currency, its direction — with last week’s EU summit only increasing the dollar’s strength — and even whether the euro will still exist in the same form, with all the headaches that could mean for anyone holding euro-denominated contracts.
“We avoid euro-denominated debt, it’s cheap and getting cheaper,” Sergio Trigo Paz, global head of emerging fixed income at BNP Paribas Investment Partners, told Reuters Investment Outlook Summit 2012 last week, when discussing how the firm was making plans for a possible euro zone break-up.
The spread between Hungarian euro and dollar bonds due 2020 widened by as much as 70 basis points in the past few weeks, though the gap has closed in a little today as investors check out the implications of the EU summit.
For Polish euro and dollar bonds due in 2019, the spread has widened by around 40 bps.
Many cash-strapped European banks and fund managers, who are more likely to hold euro-denominated debt, have also been forced to pull out of riskier assets, and this may also be causing the underperformance of the euro debt.
Agnes Belaisch, emerging market strategist at Threadneedle, says:
“The asset base for these euro bonds are European investors, mostly bank asset managers and pension funds, they are mostly deleveraging. This affects credits that work and credits that don’t work.”
Without “bazooka,” Europe still vulnerable
But the plan agreed by all EU states except Britain to pursue stricter budget rules and a stronger fiscal union did little to soothe bond markets. Ten-year Italian yields rose as far as 6.8 percent, prompting the European Central Bank to intervene in the secondary market, and German Bunds rose more than 100 ticks on the day.
Among the short-falls, the capacity of the euro zone’s bailout fund was capped and it was not granted a banking license. For now, this puts more pressure on the European Central Bank to help contain the crisis by stepping up bond-purchases. The bank however has repeatedly resisted a bigger crisis-fighting role and last week dampened expectations that it could ramp up a program which has tried to keep borrowing costs affordable. The legal basis of a new accord to enforce debt and deficit rules also still needs to be worked out.
Analysts at Societe Generale:
The outcome of the EU summit may be good enough to keep the holiday season from being spoiled by nasty market disruptions. But we fear that it is not the bazooka that can carry us to the wall of Q1 supply with much confidence.
The euro zone’s funding needs are estimated at more than 800 billion euros next year, and 215 billion euros for Italy alone.
Charles Diebel, head of market strategy at Lloyds Bank says:
The euro zone coming up with a plan to move towards some form of strict Maastricht (fiscal limits) is a step in the right direction but what you don’t have is the ECB support and likewise you don’t have this move towards a transfer union, which ultimately I still think is going to be necessary for it to be viable.
There are some lingering hopes that if things get bad enough the ECB could change its mind and step up bond-purchases. The central bank slashed such purchases in the run-up to last week’s summit, data showed on Monday. It has capped the maximum purchase of sovereign euro zone debt at 20 billion euros a week for now, ECB sources told Reuters on Friday.
But lofty expectations have gotten markets in trouble before.
“It’s amazing how investors are always hoping for the best. I can’t believe that they get punished so many times and don’t get it,” Nicole Elliott at Mizuho said.
Now the question is whether the EU summit was enough to stave off the mass downgrade on sovereign ratings threatened by Standard & Poor’s, including those of France and Germany.
Comments by S&P’s chief economist that time was running out for the currency bloc to resolve its debt problems and that it might take another financial shock to get it moving were not particularly reassuring.
Sheltersu 