Europe blunders into a blind, and dangerous, alley

The interests of the City of London were defended – for now – but Brussels summit did not draw a line under eurozone crisis
Herman Van Rompuy and Angela Merkel
European council president Herman Van Rompuy and German chancellor Angela Merkel speak during the eurozone crisis summit at EU headquarters in Brussels. Photograph: Eric Feferberg/AFP/Getty Images

Europe is sleepwalking into a prolonged depression. The prospect of 2012 seeing the start of the break-up of the eurozone is a real one. Financial markets are already starting to pick apart what looks like the latest, if more sophisticated, attempt to kick the can down the road. Britain has isolated itself on the fringes of the European Union, perhaps the most significant development at a summit that assuredly did not draw a line under the crisis in the single currency. But at least the interests of the City of London were defended. For now.


The markets, frankly, were always absurdly optimistic about the outcome for the summit but, even so, it could still have had positive results. Three things were needed to make it a success: there had to be a strategy for growth that went beyond calls for ever-greater austerity and long-term structural reform; there needed to be a real commitment from member states to put their public finances in order; and the ECB had to show a willingness to do whatever was necessary to bring down bond yields in the troubled periphery of the euro area.


The fiscal pact is ferociously deflationary in its conception. Europe is going to have its own balanced budget rule, so beloved of US fiscal conservatives, which will prevent countries from running a budget deficit of more than 0.5% of GDP once the state of the economic cycle is taken into account. This gives them a bit of wriggle room to run budget deficits in recession, but not all that much because deficits will not be allowed to go above 3% of GDP, no matter how tough conditions get. This is a purely arbitrary ceiling and is much lower than the current deficits for a host of eurozone countries.

There's more, however. Countries will be obliged to get their debt levels below 60% of GDP, and the plan is for them to reduce annually their gross debt by one 20th of the difference between the current level of national debt and the 60% limit. As James Nixon of Société Générale notes, this may yet prove to be the most draconian of all the new rules.

These curbs would seriously restrict the freedom of action of individual countries to run independent fiscal policies, which is why Angela Merkel proposed them in the first place. Berlin's idea is that the single currency would be better off if everybody played by one set of rules, German rules.

The big question is whether countries will abide by what amounts to a toughened up version of the existing stability and growth pact when they have not done so in the past. Some of the smaller countries, such as Finland, have already expressed reservations about the proposed mechanism for triggering sanctions against countries deemed to have broken the rules, while Nicolas Sarkozy has no great desire to have wait for Merkel's approval before enacting the French budget. There will be much haggling before a deal is finalised and the markets will inevitably be on high alert for any sign of backsliding.

Finally, there's the role of the ECB. In advance of the summit, its new president, Mario Draghi, said that if the participants put Europe's fiscal house in order, "other elements" would follow. The assumption was that this meant the ECB expanding its balance sheet to buy unlimited amounts of Italian and Spanish bonds, mirroring the quantitative easing programmes of the Bank of England and the US Federal Reserve. Draghi said on Thursday, however, that this was not what he had in mind.


We have what Steen Jakobsen, chief economist at Saxo bank, calls "extend and pretend": the "grand plan" is not yet in place, but a new deadline of March has been set for delivering one.



Jakobsen said: "I foresee a "cardinal's meeting" in 2012, meaning that following a major drop in the stock market the EU will close the bond markets for a week or two and work out who is in, at what price, and what the loss is."




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