The Ecofin meeting of European finance ministers scheduled for Wednesday has been cancelled, as markets await a critical crisis response package from European leaders.
Back-to-back summits of European Union and eurozone heads of government will still go ahead, as policymakers and politicians try to thrash out the details of an agreement that will put a floor under spiralling confidence in the single currency and the EU’s economic stability.
The main European markets slid after the announcement, and safe haven assets, including the German bund, saw strengthening demand.
A disagreement between Germany and France over the continued role of the European Central Bank (ECB) in buying sovereign bonds from private sector holders is among the most critical impasses to bridge before the “grand plan” to resolve the debt crisis is revealed tomorrow evening.
Other proposals for bolstering the firepower of the eurozone’s mechanisms for managing the knock-on effects of a sovereign default include using financial engineering tricks to boost the size of the European Financial Stability Facility (EFSF), which currently stands at €440 billion (£380 billion). Some in the markets have suggested that upwards of €2 trillion would be needed to
“If the EFSF is increased in size either by using leverage or accounting tricks such as those used in the US mortgage market prior to the financial crisis, then any initial positive market response is likely to prove short lived,” Carl Astorri, global head of economics at Coutts said.
“To draw a line under the crisis once and for all, the ECB’s balance sheet needs to be put on the line. Such an approach currently remains off the table due to German objections.”
The run up to the meeting has also been marred by serious disagreements between policymakers and market participants over the size of the funds needed to recapitalise the eurozone’s banking sector, and over the scale of the “haircut” on Greek debt that the private sector must swallow in order to bring the country back towards sustainability.
France and Germany have clashed over this as well, with the German government more keen to crystallise losses in the private sector in the near term than the French, who are searching for a voluntary agreement with the public sector carrying some of the risk. The French banks are large holders of Greek sovereign debt, and are likely to be more exposed than their German peers.
Italy, which is struggling to pull itself out of the mire of slow growth and unsustainable debt levels that engulfed Greece, Portugal and Ireland, threw a further spanner in the works on Monday night.
Raising the retirement age – a reform demanded by other EU states as a condition of continuing support of the Italian bond market – did not make it through Prime Minister Silvio Berlusconi’s increasingly divided cabinet.
While a default in Greece, however painful, would ultimately be manageable for the eurozone, Italy, the third largest economy in the single currency area, would cause deep, and possibly irreparable damage.