The national governments’ response to the euro crisis was stuck under the weight of political and legal constraints, with a lull which could well extend beyond the summer. The ECB is the only institution which could unlock the situation. We think that Draghi’s speech in London on 26 July, provided it is complemented by swift coordination with the national governments, is a convincing plan to support the adjustment of the two systemic peripherals.
We review the political and legal conditions surrounding the various practical options. The news-flow must be interpreted with prudence, but our baseline – after both the French and the German finance ministers publicly saluted Draghi’s statement – is of a joint intervention by the ECB and the EFSF/ESM on the peripheral bond markets, possibly complemented by additional efforts on collateral and liquidity by the central bank.
The next two months in France could be dominated by, first, the possibility that the Supreme Court forces a constitutional revision for the endorsement of the European Fiscal Compact and, second, the unveiling in September of the 2013 budget. Next year the government faces a dilemma. Boosting potential GDP by raising the employment rate means reducing the tax wedge. This means either a significant rise in VAT – hence, further impairing consumer spending – or an earlier and decisive shift towards spending cuts
to maintain the fiscal consolidation on track.
In the UK, a sharp contraction in GDP prompted extensive discussion on a number of issues which we explore this week: the deficit reduction programme, the country’s AAA status, the divergence between growth and employment, and how much of the fall might be due to one-off events versus underlying weakness. Also in this week’s Focus Europe we assess the Troika negotiations with Greece, delve into the Slovenia’s funding risks and look at Hungary’s progress with its EU-IMF talks.
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