EU summit: what has changed and what hasn’t

The recent EU summit, in many ways, has achieved “a lot and nothing”, says Dan Morris, global strategist at JP Morgan Asset Management.

The main change has been the proposed agreement for most of the EU members to increase fiscal co-ordination and to impose sanctions on those countries that do not abide by the rules.

The EU leaders may have agreed to this but Morris suggests this may be more difficult to implement. Morris says: “The hope is that this will suffice to convince institutional investors to buy eurozone sovereign debt again. Given previous experience with the Stability and Growth Pact, and the inevitable uncertainly as the exact details are negotiated between now and the target adoption date of March, it is unlikely to do so.”

As Morris notes, “more forceful measures, such as eurobonds or unlimited ECB bond purchases, remain politically inconceivable. What hasn’t changed is that it will be a combination of ECB support for banks and sovereigns, plus individual country progress on reform and austerity packages, which will determine how markets move over the next several months.”

The ECB has been more active in aiding the banking system than in helping sovereigns, says Morris. For example, the ECB is promising liquidity for three years and easing collateral requirements. “Purchases of sovereign debt have actually declined since the latest round began in August, but encouragingly there was still a sharp drop in Italian and Spanish government debt yields. Trading volumes for the debt of troubled eurozone countries have been very low, meaning that even a small amount of purchases (or sales), can have a dramatic affect on yields.

Morris says the ECB strategy has depended in part on the ability of countries like Spain, Italy and Belgium to return their yields to normal without major intervention measures. The strategy has been vindicated recently as the yields of these countries have returned to more manageable levels.

The EU summit has raised questions about the nature of the relationship between the UK and the EU, and the potential impact on its economy and its financial sector, says Morris.

He said: “Some envision a relationship more like the one that Switzerland currently has with the EU. From an economic perspective, Switzerland does not seem to have suffered unduly since the launch of the euro. The country’s GDP has expanded at a faster rate on average over the last ten years (1.8% per annum vs 1.4% for the UK and 1.1% for the eurozone).”

Switzerland’s equity market has done only slightly worse than the UK’s (10% less), but substantially better than the MSCI EMU index (a 24% outperformance since December 2001). Uncertainty about regulation and market access may become a drag on foreign investment and sentiment.

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