Can Big Eurozone Stimulus Save the Day?
Eurozone Finance Ministers meet tonight for what increasingly feels like a “make or break” moment for the EU; they will be discussing the bloc’s joint response to the economic impact of Covid-19 lockdowns.
The hope is that Finance Ministers will be able to endorse a list of measures worth some EUR 540bln, which could then be signed off on by Eurozone leaders later in the week.
One measure where analysts expect there to be agreement is that the euro-area bailout fund, called the European Stability Mechanism (often referred to as ESM), should offer credit lines worth around 2% of Eurozone GDP to each of the bloc’s members. EU countries have agreed that this cheap debt should come with few strings attached (i.e. no pressure for the debtors to engage in austerity once the crisis is over) and will focus mainly on money going to virus-related spending.
However, more fiscally hawkish countries such as the Netherlands and Austria, who are keen to push hard for sustainable government spending, want there to be some conditions relating to the long-term fiscal health of countries. I.e. these provisions would likely pressure heavily indebted countries such as Italy into adopting a more “fiscally responsible” path in the long-run. Unsurprisingly, Italy and other countries who this would affect are not happy about these suggestions and a fierce debate on this topic is raging as we speak.
Another measure expected to get the green light is a European Commission programme that would give up to EUR 100bln in loans to countries facing rising unemployment.
However, the most heated discussion surrounds an emergency fund proposed by the French government; their plan would see roughly 3% of the bloc’s annual GDP raised via the issuance of joint debt instruments in an effort to mutualise the cost of the crisis.
In other words, these would be the highly touted coronabonds we have been hearing so much about. The idea of such a debt instrument would be to ease the pressure on highly indebted nations such as Italy (and also Spain and France) whilst reducing the risk of another backlash from bond investors (like we saw in 2010-12).
Many of the more fiscally hawkish northern European nations, such as Germany, do not support such proposals. They fear that they end up out of pocket for what they see as “fiscal irresponsibility” in Southern Europe.
Can a compromise be found?
Eurozone Finance Ministers may want to include some reference to the potential for coronabonds in the final agreement as a means of bringing hard-hit nations such as Italy on board with the rest of the measures where there is broader support (such as with the ESM and Commission jobs proposals). That way, the tough decision would be left to the respective leaders of the Eurozone countries.
Markets expect some kind of fudge, like the one outlined just above, that would bring the big stimulus package one step closer. Should this come to fruition, it would likely be a risk sentiment/EUR positive.
However, should the Eurozone Finance Ministers fail to come to some kind of agreement, this will likely be a negative for sentiment, just as wrangling and delay by the US Congress to deliver stimulus package three was a few weeks ago.
The most pronounced market reaction would likely be in the bond markets; Italian BTPs (10-year debt) and Spanish Bonos (also 10-year debt) would likely be vulnerable to a sell-off. Failure of the EU to come together in times of crisis such as these to support its more vulnerable members would threaten the long-term political stability of the bloc.
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