It seems there is finally a deal by Eurozone leaders to drastically restructure the recently approved Spain’s €100bn bank recapitalization plan, allowing banks to tap the EFSF/ESM directly.
After hours of deadlock, the agreement finally arrived among the EU leaders around 5am Brussels time, in a reportedly very tense ambient. It was an unscheduled emergency meeting, forced to be called by the EZ growth pact boycot from Spain and Italy, that were demanding the continent's permanent bailout fund to recapitalize struggling banks or they wouldn't accept a Euro €120 bln growth pact.
EU President Herman Van Rompuy said banks can be recapped directly with aid funds, calling it a "breakthrough". However, changes will not occur immediately, as leaders have first to agree on the set up to a joint banking supervisory body led by the ECB, expected in December.
Van Rompuy said the proposal ‘needs unanimity’ and would only occur under ‘strict conditions’. A general long-term plan for a tighter budgetary and political union is also agreed. Van Rompuy added that a first report on euro road map integration will be issued in October.
Bloomberg also reports that dropped a requirement that officials meeting in Brussels agreed to drop the condition that emergency loans to Spanish banks give their governments preferred creditor status. That means that ESM loans to Spain to shore up its banks won’t have senior status, likely to help ease fears of Spanish government bondholders.
According to Sean Callow, currency analyst at Westpac: "Agreement has been reached to allow the bailout funds EFSF and ESM to be tapped by countries that aren’t formally signed to lending programs which have strict conditions (Italy and Spain come to mind!). This is a clear backdown by Germany despite Angela Merkel now publicly welcoming the decision. What has yet to be specified is what conditions will apply – surely Spain can’t just tap the fund at will?!"
The Euro has passed through the roof, peaking around 1.2625 after trading on a extremely soft tone below broken support 1.2450 for almost 24h.
"So definitely some good news for risk markets here though it is not the “big bazooka” – the EU leaders did not place stress on the possibility of Euro bonds (Italian PM Monti tried to talk it up though). EUR/USD should indeed be higher, though the scale of the bounce, from 1.2450 to as high as 1.2628, has obviously been accelerated by the huge overhang of EUR shorts and dismally low expectations for the summit" adds Mr. Callow.
EU summit working on urgents measures for Spain & Italy
EU summit headlines dominated price action through the first day of EU summit talks. Amid the endless cascade of rumours and counter-rumours, we focus on the most credible headlines and the ones with substance behind.
One of the growth agenda agreements widely reported was the Euro area mobilisation of €120bn to boost growth: 55bn may be coming from EU funds, 60bn from EIB and 5bn from other sources. However, Italy and Spain have boycotted the agreement, saying they are not prepared to sign off on the 120B euro growth package until a bond buying deal is in place.
French President Francois Hollande and other European leaders have been holding an unplanned emergency meeting to reach common ground on how to lower the borrowing rates of Italy and Spain.
One option, said to have been rejected by the Germans, "was to use the temporary bailout fund to absorb excessive Italian and Spanish borrowing costs. Italy would be guaranteed an interest rate of, say, 4%. If the markets charged Italy more, the bailout fund would soak up the difference" reports the Guardian.
According to Adam Button, analyst at Forexlive: "Negotiations could grow tense in the day ahead but the euro has avoided a sharp fall so far."
Rumors, which may appear to be quite reliable, were also swirling that EU leaders may be actively talking over the idea of using the EU bailout funds to purchase sovereign bonds at auction, or in the primary market.
“If adopted, this would be a watershed move in European policymaking, but investors are concerned that—given the limited firepower of the bailout funds—such bond-buying wouldn't have much effect” notes Business Insider analysts.
The tactics of deploying EU bailout funds to purchase sovereign bonds at the primary market may help contain surging Italian and Spanish bond yields problem, which as a reminder, continued to rise Thursday.
According to Peter Spiegel, journalist at the FT, “the simplest plan, officials said, would be using the eurozone's €440bn bailout fund to directly buy Spanish or Italian bonds on the open market. Officials said the focus of deliberations had shifted to purchasing bonds on the primary market—essentially buying bonds directly from governments as they acution them."
While this would be more effective in terms of reducing borrowing costs and buying time, Megan Greene, Director of European Economics at Roubini Global Economic and specialising in the eurozone crisisit, suspects “this is unlikely to buy enough time to draw a line under the eurozone crisis for three reasons.”
The three main reasons, according to Megan, are: “Limited the arsenal available in the EFSF/ESM for bond purchases is only EUR400bn once you earmark EUR100bn for the Spanish bank bailout. Secondly, there is a problem with subordination. Third, there will be conditionality imposed in exchange for EFSF/ESM primary market bond purchases.”
Spanish 10-year yield hits 7% once again
Spanish risk premium exceeded 550 points in the European morning, just ahead of the crucial EU summit. The yield on the country's 10-year bonds rose to 7%, which is considered a psychologically significant level above which debt becomes unsustainable.
The increase in Spanish borrowing costs reflects investors' lack of confidence that EU officials will be able to adequately address the debt crisis woes at the two-day meeting. Direct recapitalization of the distressed Spanish banking sector is one of the points on the summit agenda and until EU's decision on this issue is made known, bond markets will continue pressurizing the country.
Yields rise at Italian debt auction
Italy held a bond auction on Thursday during which it sold 5.423 billion worth of 5- and 10-year government bonds, meeting the target.
The yield on the benchmark 10-year bond reached 6.19%, in comparison with 6.03% seen at the last auction. The demand was weaker than previously. 5-year yields witnessed an increase to 5.84% (vs 5.66%) but the bid to cover ratio was 1.54, in comparison with the previous 1.35.