Investors are urging the European Central Bank (ECB) to reclaim the lead in crisis fighting after euro-area governments delivered relief to the bond markets of Spain and Italy on Friday.
By addressing flaws in their bailout programmes, moving toward a banking union, and trying to break a negative loop between troubled sovereigns and lenders, leaders sparked the biggest rally in Spanish bonds and the euro this year.
Whether the gains continue may depend on the willingness this week of ECB policy makers to reward political progress with greater crisis-fighting steps of their own. Governments must also avoid their past mistake of declaring victory too soon as investors press them to move faster on binding the 17-nation euro region more tightly.
“The ball is very much in the ECB’s camp,” Gilles Moec, co-chief European economist at Deutsche Bank AG in London, said in an interview with Bloomberg Television. “The statement creates an environment in which it makes it easier for them to take more unorthodox decisions.”Stocks jumped along with Italian bonds after 13 1/2 hours of talks ended, with leaders paving the way for cash-strapped lenders to tap Europe’s bailout fund directly once they establish a single banking supervisor. Until now, they had to get aid through their governments, piling pressure on already beleaguered national coffers. The Frankfurt-based ECB will play a role in the new supervisory body, officials said.
The euro’s guardians also agreed to drop a requirement that taxpayers get preferred creditor status on emergency loans to Spanish banks. Other steps included agreeing to use rescue funds to stabilise markets in certain conditions.
“There is pressure on the financial markets, that cannot be denied,” German Chancellor Angela Merkel told reporters in Brussels on Friday. “There was an interest here to find solutions. My task was to see to it that the solutions respect the procedures and rules that we have.”
Establishing the bank monitor and allowing the bailout fund to recapitalise banks could take “several months or perhaps a year,” she later told Germany’s lower house of parliament in Berlin.
The euro surged the most this year against the dollar, rising as much as 2 per cent to $1.2693. Spain’s 10-year yield plunged 61 basis points to 6.33 per cent after hitting a euro-era record of 7.29 per cent on June 18. The Stoxx Europe 600 Index climbed the most in seven months, increasing 2.7 per cent to end the week at 251.17.
Summits have proved false starts before. The euro weakened against the dollar in the seven days following four previous such meetings, according to a report last week by Valentin Marinov, head of European and Group of 10 currency strategy at Citigroup Inc. in London.
“There was a good reaction, but I don’t know if this series of provisions will be enough,” Italian Prime Minister Mario Monti said. “Many European decisions in the past were thought to have been enough, but then that’s not how it worked out. I see more content than many other times in the past.”
The latest measures are aimed at luring investors back into markets and breaking a vicious circle in which the woes of the banks reinforced those of the sovereign and vice versa, fanning a crisis which last week claimed Cyprus as its fifth victim. They also aim to soothe bondholders spooked by the terms of a Spanish banking bailout that sapped the feel-good factor created by Greece’s election of a pro-bailout coalition government.
“If we never had the issue of seniority for bailout funds, and if we had created direct bailouts for banks ages ago, perhaps that would reduce the scale of the crisis,” Kit Juckes, head of foreign-exchange research at Societe Generale SA in London, said. “The damage to international confidence in European bonds has been done and won’t easily be repaired.”
Attention now turns to the ECB, which has acted following political progress before, buying bonds after the establishment of bailout programmes in 2010 and giving banks unlimited three-year loans following last year’s pledge to enact fiscal discipline.
“I am actually quite pleased with the outcome of the European council,” ECB President Mario Draghi told reporters in Brussels on Friday. “It showed the long-term commitment to the euro by all member states of the euro area.”
Draghi chairs the ECB’s next policy meeting on Thursday amid speculation officials will lower their benchmark interest rate by at least 25 basis points to a record low 0.75 per cent as the economy hovers near recession. They may also cut their 0.25 per cent deposit rate to discourage banks from parking excess liquidity at the ECB.
As well as providing some economic support, lower interest rates would also help embattled lenders in the so-called periphery by making the central bank’s emergency loans cheaper.
An unresolved issue is whether Europe’s permanent bailout fund, due to come into force in July, will get a bank licence that would allow it to tap the ECB. That would help ramp up the power of a kitty now dwarfed by the size of the bond markets that leaders want them to rescue, allowing it to buy debt in an “unlimited and indefinite fashion,” Marchel Alexandrovich, an economist at Jefferies International Ltd. in London, said.