(In May 19 column, correct spelling of Peterson Institute in sixth paragraph)
By Mike Dolan
LONDON, May 19 (Reuters) – The inevitable caveats aside, this week’s Franco-German campaign to pool European Union debt to help those countries worst hit by the COVID-19 crisis changes the political and financial game and goes well beyond the pandemic.
In one fell swoop, the proposal addresses the long-term blow of the coronavirus, latent concerns about European fragmentation and overreliance on the European Central Bank (ECB) for economic support.
Financial markets, drunk from the pandemic shock and rattled this month as Germany’s top court questioned the validity of the ECB’s bond purchases, suddenly sat up and took notice.
Sovereign borrowing costs on the periphery of the eurozone fell, blue-chip euro stocks jumped 5% in their biggest daily gain in two months while the euro staged its highest jump in a day against the “safe haven” Swiss franc in eight months.
But if the proposals become EU policy after the bloc’s executive presented its plans on May 27, they should have bigger effects than a curious bull day on the stock markets.
Jacob Funk Kirkegaard of the Peterson Institute for International Economics in Washington described the move as Europe’s long-awaited “Hamilton moment” – a reference to first US Treasury Secretary Alexander Hamilton’s decision in the 1790s to ensure that the central government assumed the debts of individual states after the American Revolutionary War and sold treasury bonds to finance them.
“It’s a really, really big deal. Both in debt mutualisation and in common spending, a taboo has been broken – it’s not something the German government was prepared to do before,” he said. he declared. “It’s a precedent and gives the EU project a whole new set of powerful tools.”
On Monday, French President Emmanuel Macron and German Chancellor Angela Merkel proposed a 500 billion euro ($550 billion) recovery fund offering grants to EU regions and sectors hardest hit by the pandemic.
The leaders, whose deals traditionally pave the way for deals with the EU, proposed that the European Commission borrow on behalf of the entire bloc and spend the proceeds to top up the 2021-2027 EU budget, which already amounts to one trillion euros.
“A purely grant-based system marks a more substantial and powerful transfer of resources than funding that is largely loan-based,” Morgan Stanley told clients on Monday. “Timing and targeting can help better mitigate the risk of a southern collapse without adding to their considerable indebtedness.”
Investors and financial analysts have been following this saga for months, with initial calls from France, Italy, Spain and others for centralized pandemic aid funding from the sale. of common eurozone debts – the so-called coronabonds – seemingly wiped out by resistance in Berlin, Vienna and The Hague last month.
Germany’s apparent U-turn, albeit under the guise of EU-wide borrowing and not just single currency area members, was the “flip side” for investors.
For generally skeptical markets, early reactions were ‘ifs’ and ‘buts’, calls for more detail on the split between borrowing and fund contributions, doubts over the spending schedule and mistrust vis-à-vis the machinations of European politics in progress until the May 27 presentation.
“There is still opposition within the EU and the magnitude is relatively small,” warned Paul Donovan, chief economist at UBS Wealth Management. But he said “markets focus on principle rather than scale”.
There was no disguised market awareness of the importance – mainly in potentially avoiding an acrimonious slide into euro disintegration through lack of solidarity, but also in addressing the sticking points of integration of the euro which existed before the pandemic and which will resonate well beyond.
“For the first time, the EU allows some kind of debt pooling,” Japanese bank Nomura told clients. “It could be a great moment to possibly reduce the risks of a break between the EU and the euro.”
It is a coup for pro-integrationists, like Macron, who have long argued that the euro can only be sustained in the long term if a single monetary policy and central bank are complemented by fiscal policy and a common treasury authority.
The pandemic has only sharpened this view.
It’s also potentially a big win for ECB chief Christine Lagarde in her mission to get euro members to rely more on fiscal policy to spur growth in the bloc than on the single engine. almost exhausted from the monetary policy of the ECB.
While €500bn may seem small compared to the trillions in global pandemic relief, it still represents 3.5% of EU annual output and is intended for future fiscal stimulus rather than to instant healthcare or lockdown relief – likely targeting existing priorities such as greener energy and the digital transformation of the European economy.
Moreover, the AAA-rated Commission, backed by all 27 EU members, can probably borrow for free in the bond markets – or at least near Germany, where 10-year bond yields are minus 45 basis points. .
Bonds can also act as a long-sought common “safe” asset in Europe and be eligible for purchases by the ECB as part of its quantitative easing operations.
“Essentially, it will relieve the ECB of being the sole safety net for the markets, which should give investors a little more comfort in re-engaging in European risk and not fearing increased issuance as much as we are. about to get peripheral countries,” said Mohammed Kazmi, portfolio manager at UBP ($1 = 0.9151 euros) (By Mike Dolan, Twitter: @ReutersMikeD; Editing by David Clarke)