SLI’s Milligan reads the tea leaves of the EU’s latest summit
Andrew Milligan, head of Global Strategy at Standard Life Investments believes that whatever solutions the EU’s leaders opt for, their handling of the financial crisis will still be seen as poor.
If European policymakers were playing a grand game of golf they would currently be knee-deep in the rough, with no line of sight to the green. As anyone who has had the misfortune of being in such a predicament will know, the options are extremely limited. Either you can gamble on a miracle shot or you can muddle through, play out sideways and hope things will look a little better from the fairway. The latter option is what we can expect during the forthcoming EU Summit.
Certainly, this appears to be the growing expectation among market participants. Equity markets have recently been trading in a fairly tight range, with the trend downward if anything as pessimism encroaches. Spreads on Euro-zone government debt also provide few clues that a significant policy change lies ahead, with Spanish and Italian yields creeping higher. Finally, the US dollar index has edged upward in a sign that risk appetite remains muted.
Investors would be wise not to misinterpret the current market pause as a sign that some stability has returned. In fact, there will be extremely important issues in play over the next few days, with the outcome of the EU Summit potentially providing the longer term investor with useful indications about the direction of European integration. Conversely, failure to reassure global investors on the Euro-zone’s future plans could have very serious consequences, plunging markets back into the difficulties witnessed in recent months.
So what are the key areas to watch? Indeed, what would markets like to see to demonstrate that politicians are ahead of the curve?
The most well flagged outcome from the Summit is likely to be the announcement of a Growth Compact, probably around €120-130 billion in size, ostensibly to relaunch investment and create jobs. This has been championed by French president Francois Hollande in an attempt to redress the balance between ‘austerity’ and ‘growth’. Will it be enough? We doubt it will have a major effect. The package is largely a redirection of existing EU structural funds and unlikely to be large enough to change the prevailing sense that austerity is not working – countries are ceding growth without any quid pro quo improvement in their finances. Instead, investors are keen to see more significant action either in terms of size or in terms of agreeing more realistic austerity programmes. Official growth assumptions are woefully optimistic and, while a focus on boosting underlying growth is helpful, an extension of the timeframes of austerity programmes is also required.
The Summit is also likely to have a headstart on the thorny issue of a financial transaction tax. This was discussed at the June 22 mini-summit and, although agreement among all 27 EU nations was out of reach, there were at least nine member states willing to sign up, the minimum required to kick off preparatory work on the legislatory process. So we can expect a dotting of ‘i’s and crossing of ‘t’s on this later this week.
There is less certainty about what progress will be made on the more difficult topics of financial stability and European integration. Progress on a permanent rescue mechanism has been painfully slow with the €500 billion European Stability Mechanism (ESM) likely to be delayed beyond its scheduled July 1 appearance. More importantly, there still appears to be a significant division between France and Germany on the possibility of extending the firepower of the ESM, say to buy bonds in the secondary market or inject capital into banks directly. France remains a proponent of granting a banking license to the ESM so that it may access additional ECB liquidity. However, Germany is nervous about agreeing an open ended structure, and providing any hints that it might be willing to give ground on debt mutualisation – something they have guarded against in case it is interpreted as a step on the way to Eurobonds.