What do we get when the leaders of the European Union combine their powers? More budget rules!
Last Friday, 26 of the 27 member nations of the European Union agreed to new fiscal measures. If you do the math, you’ll see that only one didn’t join the bandwagon.
The party pooper? The United Kingdom!
According to Prime Minister David Cameron, British leaders decided to veto the proposal as they believed that it was not in favour of the U.K.’s best interests.
Because there wasn’t a unanimous decision, the new budget rules will have to be implemented as an intergovernmental agreement and not as an amendment to the EU treaty. Basically, nations who agreed to the proposals have to pinky swear that they will keep their deficits to just 3% of their GDP. Those who exceed the limit will be fined unless members are feelin’ nice and vote to let it go.
However, because the new fiscal measures will not be written into the EU treaty, this means that the European Commission and European Court of Justice won’t have a hand in punishing the delinquents. This has many market participants skeptical as to whether these rules can successfully be implemented.
Leaders also hustled up the launch of the ESM bailout fund from 2013 to 2012. In July next year, the 500 billion EUR fund will replace its temporary predecessor, the 440 billion EUR European Financial Stability Facility. European nations will then stop tapping into the EFSF for bailout by the beginning of 2013.
Now, before you get excited about the two funds operating at the same time with a bigger combined capacity, you should know that policymakers agreed to cap the combined amount of both funds at 500 billion EUR for now. EU leaders will have another chance to increase the fund in March, when they will meet again and vote.
There were also some suggestions to give the ESM a banking license which would allow it to borrow money from the ECB. However, Germany decided that it was its turn to play party pooper and shot down the proposal. Meanwhile, everyone agreed to the idea of handing over 200 billion EUR to the IMF in order for the financial authority to purchase European bonds.
The markets seemed to have reacted well to the news that came out of the EU summit, as higher yielding currencies rallied up across the board. The comdolls all posted 100-pip gains, while the euro bounced back after Thursday’s poor showing.
However, the euro’s gains didn’t completely erase its earlier losses. By the end of the day, EUR/USD managed to post a mere 31-pip gain, even after it had been trading above the 1.3400 handle earlier in the London session. This goes to show that there is still some uncertainty in the markets and investors weren’t totally happy with the results of the EU summit.
In truth, it is only natural that investors remain cautious. Even if only ONE country rejected the new fiscal proposals, it means that the EU cannot enforce its members to conform. This could lead to questions of how effective the agreement will actually be and could dampen market sentiment.
In addition, there is also the possibility that ratings agency S&P may not be pleased with the results of last week’s summit. Remember, S&P recently warned of the possibility of multiple debt downgrades should European nations fail to get their acts together.
For now, we can probably expect more choppy trading to finish off the year. It’s actually starting to look very similar to what we saw in late 2010. Should we see any more positive developments on this new fiscal agreement, then perhaps we may see a euro rally to kick off 2012.