In spectacular fashion, European Union (EU) leaders have announced the creation of a €750 billion stability package designed to stop the precipitous fall in market confidence. This comes on top of the €110 billion bailout for Greece, which was approved by both eurozone leaders and the IMF over the weekend.
At the same time, the European Central Bank (ECB) took unprecedented action by announcing it will be purchasing government bonds through secondary markets, as well as providing additional liquidity through its longer-term refinancing operations. Also, in a coordinated move with other central banks, the ECB will restart the dollar swap line.
Of the €750 billion mechanism, €250 billion is coming from the IMF, €440 billion is being guaranteed by eurozone members, and €60 billion is from an existing non-eurozone member guarantee scheme (funded by all EU members), which is now being extended to eurozone members. Details on funding and implementation remain thin, but we believe funds will not be raised until member states run into trouble in the same way as Greece.
In our view, the actions announced over the weekend tick all the boxes and make an explicit statement to markets that European governments are prepared to go to extraordinary lengths to defend the single-currency union. At the time of writing, the EuroStoxx 50 index was up nearly 9% on the day, while ‘normality’ (upward slope) has returned to government bond curves of peripheral countries.
However, the structural problems within the weaker eurozone members remain, and serious repair work is now needed to restore credibility to Europe’s fiscal framework. We expect tougher new rules on fiscal management to follow with stricter implementation of the excessive deficit procedure. There is still the thorny issue of the conditions to be attached to the support.
What about Greece ? There is still a significant probability that Greece (as well as Portugal and Spain) will not be able to implement all of the required fiscal tightening measures. However, we believe that eurozone members will probably soften the conditions of support loans rather than leave them to fend for themselves. If any doubt remains, the €860 billion of aid announced so far is large enough to bailout Greece, Portugal and Spain over three years twice over. This is a very bold move in the face of potential catastrophe.
Important Information : The views and opinions contained herein are those of Azad Zangana, European Economist, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. For professional investors and advisors only. This document is not suitable for retail clients.