A show of EU solidarity?

Angela Merkel stated ahead of Thursday’s critical EU summit that she believes that Germany should be ready to make far larger contributions to the EU budget and that extra funding should be provided in the spirit of solidarity but for a limited period.

Her comments came as EU finance ministers sought a final agreement over the signing off of a €540bn emergency fund to protect European workers, businesses and support countries worst hit by the Coronavirus pandemic.

Italy had wanted the package to be as large as €1.5tn and that the repayments would not be linked to specific nations. With France lined up alongside Italy and Spain in pursuing this strategy there were heightened concerns of a major fall out would threaten EU stability. Mrs Merkle’s words were therefore well timed.

The EU Covid-19 emergency package averted an immediate crisis but did expose some stark differences between nations. The northern bloc rejected any move towards joint debt and fiscal transfers.

A deal was agreed on Thursday on the original proposal of €540bn but without any finger pointing in an act of European solidarity. In the end joint Corona bonds didn’t get debated and now appear to be off the table for the time being. The question appears to be whether the payments to stricken nations will be treated as grants, effectively handouts, or loans that need to be repaid.

The responses of Northern bloc countries wanting to protect their budgets from perceived fiscal recklessness in the South is entirely logical. As is the desire by the Southern bloc to request fiscal support given the single currency’s relative weakness has helped prop up the export markets of large exporters like Germany whilst putting additional pressure on struggling nations such as Italy. It is no one’s ‘fault’ that this impasse exists but no one expects to see a strong joint European fiscal response unless the economic damage increases
It came as no surprise that the ECB is left carrying the ever-increasing debt off the Eurozone nations and protect against a run on the Italian bond market.

ECB Chair Christine Lagarde had previously warned EU leaders of ‘doing too little too late or the Eurozone GDP will contract by 15% this year’. Mrs Lagarde has also highlighted the different approaches of member governments and the economic dangers this could bring. The economically stronger northern block is spending up to 14% of their GDP on support packages in order to achieve a swift recovery. The weaker southern block simply does not have the economic head room to do this and are spending as little as 1% which will impact upon their own recoveries.

Despite this and previous support packages, Italian sovereign bond yields have been rising over the last couple of weeks despite equities becoming more buoyant. This is because there are many knock-on impacts of the EU and Eurozone response on the political backdrop in Italy. Domestic tensions are already high given the perception that the Northern bloc are focused on their own economies but not the wider European communities.

If support was to be dragged out further this could make Italian citizens question the value of the Euro in particular. Whilst it has provided Italy with meaningful stability, the lack of a free-floating currency has meant the nation has lacked a release valve for economic pressures putting more pain on the domestic economy.

The huge devaluation in sterling that the UK saw post the EU referendum provided much needed support to the UK economy, if the UK was part of a currency bloc more pain would need to be borne domestically.
It is for these reasons that we have not held any direct European fund holdings within any of our portfolios for at least the past year.

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