Infected by a festering European divide
Increasingly, officials believe the only way to stop a Greek exit triggering major financial meltdown is through a forceful display of eurozone solidarity. But there's little sign of consensus on the horizon.
European financial markets were rattled overnight, as investors worried that increasingly frosty relations between Berlin and Paris will hamper European efforts to deal with the rapidly worsening European debt crisis.
Unlike previous summits where the German and French leaders met in advance to hammer out a common stance, there was little sign of unity in Brussels overnight. Investors now worry that the relationship between new French president Franois Hollande and German Chancellor Angela Merkel – already dubbed "Homer” in financial markets – is turning out to be fractious and unproductive.
Indeed, as if to highlight his distance from Merkel, Hollande held a meeting with Spanish leader Mariano Rajoy before the pair travelled to Brussels.
The difficult "Homer” relationship is cause of great concern at a time when Greece is edging ever closer towards an exit from the eurozone. Countries such as Italy and Spain are facing higher borrowing costs, as investors worry about contagion from a Grexit. At the same time, an increasing number of banks in southern eurozone countries are unable to raise fresh capital and are facing growing liquidity problems.
Many banks are frozen out of capital markets at a time when they are bleeding deposits, as nervous citizens rush to transfer their money into banks in Germany, Switzerland or the United Kingdom.
An increasing number of European officials believe that the only way to prevent a Grexit from triggering a major financial meltdown is to organise a forceful display of eurozone solidarity. As a result, Paris is arguing in favour of eurobonds (debts guaranteed by all eurozone countries), which would allow countries such as Italy and Spain to lower their borrowing costs. Meanwhile, Rome is pushing for a guarantee on all eurozone bank deposits, while Madrid wants to change the rules so that the eurozone's bailout fund can lend directly to banks.
But Germany, with the support of the Netherlands, Finland and some smaller eurozone countries, remains deeply hostile to these ideas.
With no sign of a political consensus on the horizon, markets now believe that the European Central Bank has little choice but to launch a major liquidity program to try to stem the banking crisis in southern Europe. Markets know that unless the ECB acts soon, the situation is bound to get worse.
Some investors are tipping that the ECB will restart its LTRO (long-term refinancing operations), again flooding the European banking system with hundreds of millions of euros in cheap loans. For those banks that have run out of eligible collateral the ECB might relax its lending standards, or else it will allow central banks to provide "emergency liquidity assistance” to troubled banks, as it did with Greece.
Alternatively, the ECB could launch another bond buying spree, buying up tens of millions of euros in Italian and Spanish bonds, in order to reduce the borrowing costs for these countries.
Finally, the ECB may decide to cut its main interest rate, which is currently sitting at 1 per cent. Although this would have little effect on the economy, it would offer interest rate relief to banks that are heavy borrowers from the ECB.
But others argue that the benefits of a major ECB program will likely prove short-lived. They argue that unless a way is found breach the divide between Paris and Berlin, the eurozone's financial crisis will continue to fester.
Unlike previous summits where the German and French leaders met in advance to hammer out a common stance, there was little sign of unity in Brussels overnight. Investors now worry that the relationship between new French president Franois Hollande and German Chancellor Angela Merkel – already dubbed "Homer” in financial markets – is turning out to be fractious and unproductive.
Indeed, as if to highlight his distance from Merkel, Hollande held a meeting with Spanish leader Mariano Rajoy before the pair travelled to Brussels.
The difficult "Homer” relationship is cause of great concern at a time when Greece is edging ever closer towards an exit from the eurozone. Countries such as Italy and Spain are facing higher borrowing costs, as investors worry about contagion from a Grexit. At the same time, an increasing number of banks in southern eurozone countries are unable to raise fresh capital and are facing growing liquidity problems.
Many banks are frozen out of capital markets at a time when they are bleeding deposits, as nervous citizens rush to transfer their money into banks in Germany, Switzerland or the United Kingdom.
An increasing number of European officials believe that the only way to prevent a Grexit from triggering a major financial meltdown is to organise a forceful display of eurozone solidarity. As a result, Paris is arguing in favour of eurobonds (debts guaranteed by all eurozone countries), which would allow countries such as Italy and Spain to lower their borrowing costs. Meanwhile, Rome is pushing for a guarantee on all eurozone bank deposits, while Madrid wants to change the rules so that the eurozone's bailout fund can lend directly to banks.
But Germany, with the support of the Netherlands, Finland and some smaller eurozone countries, remains deeply hostile to these ideas.
With no sign of a political consensus on the horizon, markets now believe that the European Central Bank has little choice but to launch a major liquidity program to try to stem the banking crisis in southern Europe. Markets know that unless the ECB acts soon, the situation is bound to get worse.
Some investors are tipping that the ECB will restart its LTRO (long-term refinancing operations), again flooding the European banking system with hundreds of millions of euros in cheap loans. For those banks that have run out of eligible collateral the ECB might relax its lending standards, or else it will allow central banks to provide "emergency liquidity assistance” to troubled banks, as it did with Greece.
Alternatively, the ECB could launch another bond buying spree, buying up tens of millions of euros in Italian and Spanish bonds, in order to reduce the borrowing costs for these countries.
Finally, the ECB may decide to cut its main interest rate, which is currently sitting at 1 per cent. Although this would have little effect on the economy, it would offer interest rate relief to banks that are heavy borrowers from the ECB.
But others argue that the benefits of a major ECB program will likely prove short-lived. They argue that unless a way is found breach the divide between Paris and Berlin, the eurozone's financial crisis will continue to fester.
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