November 24, 2011 / 2:28 PM / in 6 years

Analysis: Some draw hope from rare German weakness

BRUSSELS (Reuters) - Wednesday’s failed bond auction in Germany may mark the moment the penny dropped for Berlin. That, at least, is the hope of some of its European partners.

While Greece, Ireland and Portugal have had to suffer the ignominy of taking bailouts from the EU and IMF, and Spain, Italy and France are now firmly in the firing line, Europe’s most powerful economy has remained above the fray.

But the inability to sell nearly 40 percent of the bonds offered at an auction of 10-year Bunds has suddenly revealed a chink in Germany’s armor, with implications not just for the markets, but for the politics of Europe’s debt crisis too.

At one level the auction was not so bad -- no other euro zone country can sell 10-year debt at a yield below 2 percent in the current environment, and if a few more basis points had been offered the 6 billion euros of bonds would have sold without a hitch -- but at other levels, deep problems lurk.

The very image of German debt management superiority has been called into question, and by extension so have some of the more rigid positions that German Chancellor Angela Merkel has adopted over the course of the debt unrest.

Other euro zone states -- most particularly France -- will now feel emboldened in challenging Germany’s resistance to ideas such as the European Central Bank playing a more direct role in firefighting the crisis and to jointly issued euro zone bonds.

French President Nicolas Sarkozy met Merkel and newly appointed Italian Prime Minister Mario Monti in the French city of Strasbourg on Thursday, with the ECB’s role at the heart of discussions.

“All the pressure is mounting in one direction, and that’s for Germany to reduce its opposition to large scale ECB intervention and on eurobonds,” said Sony Kapoor, the managing director of Re-Define, an economic think-tank.

”This doesn’t force Germany’s hand yet, but it definitely puts additional pressure on, given the slow moving economic contagion that we’re witnessing.

“Slowly but surely, the myth of German economic invincibility is starting to be questioned.”

In the corridors of Brussels, there was poorly concealed delight at Germany’s auction setback, although officials who said they hoped it would spur Berlin into action also acknowledged that Merkel was not easily moved and did not expect any sudden or dramatic change of course.

That has become the critical issue. In the slow-motion train-wreck that is the European debt crisis, how much longer are markets and other onlookers going to have to wait until a dramatic, decisive intervention is launched?

Critical dates have come and gone. There was originally the hope that July 21 would deliver a “comprehensive package” of measures to resolve the problems in Greece and build a ‘firewall’ around Ireland and Portugal to prevent contagion.

Then October 26 arrived and Greece’s package had to be renegotiated, while a decision was also taken to ratchet up the euro zone’s EFSF bailout fund, leveraging its 440 billion euros to around one trillion euros to help protect Spain and Italy.

A month on, both the second Greek package and leveraging of the EFSF are unresolved.

The next summit of EU leaders is on December 9 and expectations are already mounting that it might deliver a ‘big-bang’ moment. But to listen to Merkel and read between the lines of what is emerging from Berlin, such an early breakthrough looks unlikely.

“I don’t think December 9 is going to deliver anything concrete and there’s going to be another round of deep disappointment in financial markets,” said one exasperated EU official involved with drawing up solutions to the crisis.

“The situation is not good, and that’s clearly intended as understatement. If nothing does get done on December 9, then I think we’re talking about weeks before it starts to get very bad indeed -- Christmas is probably a good bet for meltdown.”


With Germany insistent that changes to the EU’s treaty -- its fundamental set of laws -- are now essential if there is to be a long-term solution to the problems, European policymakers now find themselves battling on two major fronts.

They are trying to craft immediate crisis-response mechanisms, such as scaling up the EFSF, to calm pressure on sovereign bond markets, while also looking at how to reshape the very framework underpinning the 55-year-old European project.

While those are discrete goals in terms of timeframes, they are intricately linked. Without clear commitments on treaty change, Germany appears unwilling or unprepared to give ground on any of the more immediate steps other euro zone states want to take, even if Berlin has not said so explicitly.

“Germany has made up its mind -- it wants treaty change and it is doing everything it can to push for it as rapidly as possible,” said an EU official involved in the negotiations.

“It’s fine for Germany to talk about wanting very limited treaty change, but it’s easier said than done. Believe me, it’s much easier said than done.”

Not only are many euro zone member states deeply reluctant to get bogged down in the legal and political wrangling that inevitably accompany such a move, but non-euro zone states are also very hesitant, even if they would be unaffected by it.

Britain, for example, will not want to pass up the opportunity to reassess other aspects of EU law it is unhappy with, particularly on employment and social policy.

The upshot is that leaders are getting drawn into complex debates about longer-term structural changes at a time when impatient markets -- largely made up of the investors countries rely on to finance their debts -- want a quick crisis response.

“Although euro area policymakers have a lot of meetings in the coming weeks, there is nothing on the agenda at the moment which would represent a step-change in crisis management,” JP Morgan economist David Mackie wrote in a research note, arguing that the euro zone ultimately needed to adopt euro area bonds or face break-up.

“Exactly how the region will construct the institutional infrastructure to support euro bonds remains to be seen, but this is where the discussion is likely to go in the coming weeks and months,” he said.

Even the European Commission, which published a long-awaited study on the feasibility of euro bonds this week, does not expect the issue to be resolved any time soon.

The EU commissioner for economic and monetary affairs, Olli Rehn, said the bonds would only make sense once the 17 countries in the euro zone were on the same page in terms of economic governance and stability. That could be years. Without such underpinnings, the bonds would quickly become junk, he said.

Investors may not have that long to wait, and are more likely to be inclined to sell their holdings of euro zone debt and look elsewhere. If they do, it will push yields ever higher across the board -- not just in Portugal, but in France, Belgium, the Netherlands, Austria and even Germany.

That will leave everyone’s eyes turning to the one European institution that might be capable of stepping into the breach for as long as it takes to right the ship -- the ECB.

Writing by Luke Baker; editing by Janet McBride

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