EU Summit: not an especially convincing set of measures. Market uncertainty remains

The EU summit (8 and 9 December 2011) announced the establishment of a new "fiscal compact". This agreement contains the following key elements:

• In principle, government budgets must be balanced or in surplus; more specifically the annual structural deficit cannot exceed 0.5% of nominal GDP. Should a country breach the 3% deficit ceiling, there will be automatic consequences. This includes sanctions proposed or recommended by the European Commission. These “sanctions” have not yet been specified.
  
  
• All plans to issue national debt by member countries must be reported in advance. The rule that government debt cannot exceed 60% of GDP still applies.
  
  
• Member countries that have excessive deficits (in terms of the rules) will have to submit an economic programme that details the structural reforms required to correct the deficit on a sustainable basis. The implementation of the programme, and the country’s budget plans, will be monitored by the European Commission.
  
  
• The rules regarding the maintenance of fiscal discipline has to be introduced into each country’s legal systems at a constitutional level.
  
  
• The Court of Justice will be responsible for verifying if the fiscal rules have been breached.
  
  
• The current European Financial Stability Facility (EFSF) will be phased out in mid-2013. In the meantime, the EU will continue to ensure the financing of the ongoing EFSF programmes as needed. This applies especially to Ireland, Portugal and Greece. The leveraging of EFSF will take place according to the two options agreed by the Euro group on 29 November 2011. The ECB will act as an agent for the EFSF in its market operations.
  
  
• The implementation of the eurozone's permanent bailout fund, the European Stability Mechanism (ESM), has been brought forward to 2012, and will run alongside the existing fund (EFSF) for about a year. The ESM will get €500 billion in funds paid in by euro-area countries relative to the size of their economies.
  
  
• The adequacy of the size of the EFSF/ESM will be assessed in March 2012.
  
  
• Voting rules in the ESM will be changed to allow emergency decisions to be passed with an 85% qualified majority, and not a 100%.
  
  
• Euro area and other EU states are aiming to loan up to €200 billion to the International Monetary Fund (IMF) to support their contingency funds. A final decision will made within 10 days.
  
  
• All 17 euro-area nations and six other EU states outside the euro area have agreed to the deal. Initially, four countries objected, including Sweden, Hungary, Czech Republic and the UK. However, only the UK has refused, outright, to sign the agreement (the other 3 countries have agreed pending parliamentary support). The new treaty is due to be finalised in March 2012,  after which it will have to be ratified by all participating countries.

The agreement is not especially convincing. A number of crucial details have not been announced, for example what ‘sanctions’ will be imposed if a country breaks the fiscal rules; the proposed size of the ESM is underwhelming; the deal will only be signed in March next year; and there is no expanded role for the ECB. The key test, however, will be the reaction from the various bond markets. If European bond yields continue to spike higher, the deal could unravel very quickly, forcing the major participants (Germany and France) to react more forcefully. All eyes on the Italian, French and Spanish 10-year bond yields.

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