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Eurozone crisis

Dec 27 2011 09:59 Reuters

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Brussels - After two years of turmoil that has shattered confidence in the economics and politics of European monetary union, it would be rash in the extreme to suggest an end is in sight.

But through the pall of gloom that has hung over Brussels for months, vague whispers can now be heard in the corridors about a corner possibly being turned if several tricky elements come together in the months ahead.

At this point they are purely speculative musings, laden with multiple ifs. And it remains far easier to list all the potential pitfalls and obstacles that lie ahead than it does to identify the possible bright spots.

But the combination of the European Central Bank's provision of three-year liquidity for banks averting a credit crunch, the fact yields on Italian and Spanish 10-year bonds have fallen, the first steps towards deeper euro zone fiscal integration and the pure fatigue in markets after such a long period of all-consuming crisis may point to some relief ahead.

Mark Mobius, the Franklin Templeton fund manager known as something of a contrarian, went as far last week as to put a date on an end to the mayhem. That was stepping out on a limb, but it suggests that those attempting to take the pulse of the crisis may be beginning to shift their prognosis.

"The European crisis isn't as deep and terrible as people think," Mobius, who oversees $50bn in emerging market investments, told Brazil's Valor Economico newspaper, saying he expected Europe's crisis to be over by June 2012.

"Nations there are in a process of negotiations and that takes time," he said.

European policymakers are not as bold as that. They have learnt over the past two years just how dangerous it is to make overly positive policy pronouncements.

But the progress in getting 26 of the EU's 27 countries to back tighter fiscal rules for the eurozone - Britain remains outside - and the fact Mario Draghi, the ECB president, is positive about what is being called a new "fiscal compact" has given some officials room to feel slightly more optimistic.

If the unlimited three-year liquidity that the ECB offered this week - of which banks snapped up €489bn - can help unfreeze lending, if Portugal, Ireland and Italy can stay on top of their structural reforms and Spain keeps up its efforts too, if eurozone leaders can finally put together a meaningful firewall against the crisis using their bailout funds and help from the IMF, and a frightening amount of government debt refinancing early in the year is overcome, then...

"If we manage the first 6 months of 2012 without major accident things will look better," one senior euro zone policymaker told Reuters.

That is the tentative on-record view too.

"The path is long, longer than we expected," Herman Van Rompuy, the president of the European Council and the chairman of EU summits, said in a video message this week.

"But let there be no doubt, there is a fundamental political will to move forward as a union. We have a moral duty to continue this mission," he said, announcing that EU leaders would next meet on January 30 for their 17th crisis-fighting summit, this time to focus on a growth strategy.

Mostly dark

One notable improvement in sentiment is the fact that diplomats and EU officials no longer speak quite so freely about the break-up of the eurozone, a possibility that was on everyone's lips only two months ago.

While Greece - the crucible of the debt crisis - remains a serious concern, and the chairman of Royal Bank of Scotland said on Thursday he thought a small country could still leave the eurozone, the commitment to new fiscal rules has created a renewed sense of unity.

The first top-level meeting to work on the details of the fiscal compact - which EU leaders hope to be in force by March - was held this week and was a chaotic affair, diplomats said, with clear tension between eurozone and non-eurozone countries.

But there appears to be a genuine desire to keep the 17 eurozone members and 9 non-euro countries in lockstep in pushing for stricter budget deficit and debt rules, and intense efforts are being made on all sides to get Britain to join up too, with Berlin and Brussels keen for London's buy-in.

"If you look at the intergovernmental agreement, I don't see why it can't be extended to 27 countries and integrated back into the EU fold," said one eurozone diplomat, referring to the fiscal compact and the need to get Britain onboard.

"It's going to be a very delicate dance and there's no certainty that it will come off, but there are efforts being made on all sides and it would be a good beginning to 2012 if a way could be found to get the agreement at 27, not 26 and 1."

Firewalls and France

The other big question mark hangs over the firewall needed to ward off market attacks on weak eurozone debtors.

At the moment the eurozone has the European Financial Stability Facility, a €440bn fund that has so far been used to bail out Ireland and Portugal and will be used to provide assistance to Greece under its second aid programme.

The EFSF is scheduled to be replaced by the European Stability Mechanism, a permanent crisis-resolution fund, in July next year, although final details concerning the structure and functioning of the facility remain to be agreed.

If the ESM, which will have a capacity of €500bn, comes into force in July and agreement can be reached on giving it a banking licence as France wants - a big if - then it is possible that the positive political undertones of the fiscal drive will be underpinned by stronger financial support.

By then it is also possible that a way will have been found to release €150bn from eurozone central banks to the IMF to bolster its arsenal, with the possibility of up to €50bn more from other European countries - Russia, India and others.

That would bolster the IMF's resources, potentially allowing it to lend money back to needy eurozone member states with IMF terms and conditions attached. But again, there remain more doubts than certainties about whether the plan can work.

"We're working on a multi-pronged strategy that brings together a new fiscal framework, more intense political commitments and a bigger firewall," said a senior EU official directly involved with tackling the crisis.

"I'm not saying we're there yet, but we've got the right materials in place now. We just need to build it."

While positive murmurings are audible, no one wants to put too bright a view on the outlook. There are at least two very dark clouds hanging in the middle distance: the state of the eurozone economy and French presidential elections.

Expectations are that the eurozone will slide into recession in the first quarter of next year, making it even harder for struggling countries to get their finances in order.

And President Nicolas Sarkozy faces an electoral test the polls suggest he will fail.

How he handles policy in the run-up to the April 22 election, what happens to France's triple-A credit rating before then, and how Paris and Berlin - the powerhouses of the eurozone - deal with their differences, may determine the region's future.

Francois Hollande, the Socialist candidate who is ahead in the polls, has already vowed to renegotiate the terms of the EU treaty deal if he is elected to include a stronger role for the ECB and the creation of joint eurozone bonds - both red lines for the Germans which could strain their alliance.

However, with Hollande's popularity slipping, the electoral outcome is far from certain.

"France and Germany are like two big rams locked in one another's horns," said the eurozone diplomat, emphasising that how Sarkozy and Chancellor Angela Merkel interact and play off each other was perhaps the biggest imponderable of 2012. 

europe debt crisis  |  markets  |  euro
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