The fiscal compact that the leaders of most European Union countries agreed on last week to bring some order to the euro area was broadly in line with expectations. While it may eventually be seen as a first step towards true fiscal union, it is more like a pistol than the long-awaited big bazooka.
The compact amounts to little more than a strengthening of the previous Stability and Growth Pact. The fact that the rules will be enshrined in a separate intergovernmental agreement rather than as amendments to the EU treaty is both positive (approval is likely to be relatively quick) and negative (the rules are likely to have less teeth).
While the UK has been cast as the villain of the piece (because it vetoed treaty change), the real disagreement was between Germany (for treaty change) and France (against). Despite his public anger, French President Nicolas Sarkozy must be rather pleased with the outcome.
The big question now is whether the agreement will be sufficient to stabilize sovereign-bond markets in the euro area. The answer is probably not. A limited fiscal agreement of this nature is not sufficient for Germany to acquiesce to common bond issuance (i.e., Eurobonds). Nor, for the time being, is there likely to be any material change in the European Central Bank’s (ECB) stance.
The hope must presumably be that a hodgepodge of different schemes will add up to a meaningful amount of money to support sovereign-bond markets. The schemes include leveraging the European Financial Stability Facility (which provides temporary assistance to euro-area countries), advancing and possibly expanding the European Stability Mechanism (the EFSF’s successor) and putting additional funds at the disposal of the International Monetary Fund (perhaps with contributions from other countries).
All of this will probably not be enough to resolve the crisis, given the funding wall facing euro-area sovereigns and banks, deep investor skepticism and the recent proliferation of event and implementation risks (including the possibility of across-the-board sovereign downgrades).
The one bit of unambiguous good news came from the ECB, with its bold moves to support euro-area banks. These measures should reduce the risks of a catastrophic bank failure and a full-scale credit crunch in the euro area, as I explained in more detail in European Central Bank Still Reluctant to Support Euro-Area Sovereign Debt, December 9, 2011.
Some commentators have also speculated that the new measures will allow banks to raise their holdings of government bonds, thereby delivering indirect support for sovereign debt.
This is unlikely to be the central bank’s intention. It would both conflict with the ECB’s main aim—to support the supply of credit to the real economy at a time when banks need to deleverage—and represent monetary financing via the back door, violating the spirit of the Maastricht Treaty.
Moreover, it could easily backfire. An increase in the banking sector’s exposure to (risky) sovereign debt would only reinforce investor concerns about a negative feedback loop between the two.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Darren Williams is Senior European Economist at AllianceBernstein.