Divided Europe: The battle between loans and grants

Macro

Christopher Dembik

Head of Macro Analysis

Summary:  The EC is due to present today its proposal of EU budget for the period 2021-27 and the details of the recovery plan. It will open a long and intense period of negotiations between member states regarding the financial instrument that could be used (loans or grants) to help countries in need. A final agreement is expected by at the next EU Council meeting in June. In the interim, Europe is once again wasting precious time needed to fight the crisis.


Today’s agenda :

  • The European Commission will present its revised long-term EU budget proposal and its recovery plan. It is unclear whether the latter will be directly inspired by the Franco-German initiative unveiled last week (see here) that was initially endorsed by the Commission.
  • A final agreement is expected to be reached at the EU Council meeting on 18-20 June.
  • The recovery plan might include billions of euros to promote circular economy and the green transition. According to working papers, the funds allocated to hydrogen energy could double to €1.3bn and €10bn could also be invested in the development of this technology over the next ten years. For the automotive industry, the EC is expected to propose an EU-wide clean vehicle purchase scheme, for about €20bn over the next two years, that could top national initiatives (like the one that was decided yesterday in France).

Over the weekend, the Frugal Four have published a non-paper that was intellectually lazy and basically proposed a one-off, two year emergency loans. The only real point of agreement between the Franco-German initiative and the Frugal Four’s non-paper was that the recovery plan is linked to the MFF. However, it seems that the position of countries most resistant to further European solidarity has changed over the past hours. Both Denmark and Austria appear to be willing to compromise on the future EU budget and recovery plan. Danish foreign minister indicated that his country will participate “constructively” in negotiations and work for a “sensible” and “fair” compromise. For his part, Austrian finance minister opened further the door to a mix between grants and loans, stating that “some EU virus aid can be handouts”. Adding to the ongoing optimism, in a surprising move, the conservative German newspaper FAZ endorsed de facto small fiscal transfers on Monday: “Now it is not the time to make countries pay for past failures. It is the time to help each other. The futures of the EU relies on everyone pulling in the same direction” (see here the article, in German). It is a very strong signal that Chancellor Merkel’s persuasion job appears to be working quite well among German conservative elite.

However, it is still too early to declare victory, it is likely that the diplomatic battle between France and Germany on one side, and the Frugal Four on the other side is not yet over. The proposal that the EC will unveil in a few hours will open a new phase of intense political bargaining between member states that could lead to a final agreement at the earliest at the next EU Council in June. There is not only resistance to the Franco-German proposal in Northern Europe, but also in Eastern Europe where countries have been so far among the main beneficiaries of EU funds and are unhappy that money will be redirected South rather than East.

Even if there are encouraging signs that support for more European solidarity and fiscal union is gaining traction, it is too early to predict the outcome of the negotiations between member states. What is certain is that Europe is once again wasting precious time needed to fight the economic crisis. While Singapore presented its fourth recovery plan since the outbreak yesterday, Europe has not even agreed on the final terms of its first recovery package.

Helped by a decade of research into systemic risks and financial/macro spillovers, the ECB has successfully managed to avoid a liquidity and financial crisis. We expect the central bank will remain in preventive mode and announce further easing at the June meeting consisting in the expansion of the PEPP by €500bn in order to absorb coronavirus debt, and the extension of the programme at least until September 2021. If needed, the ECB can even do more, by increasing the share of supranational debt in the PSPP, cutting further TLTRO rate or even purchasing bank loans as the Fed is doing with the Main Street Facility. In our view, the Eurozone is six to twelve months away from the United States in terms of accommodative measures, but it is bright clear that the current monetary policy cycle will de facto lead to a renationalization of the sovereign bond market on both sides of the Atlantic. But to the fully efficient, the ECB needs fiscal backup, not tomorrow, not the day after tomorrow, but today, right now. Europe has already wasted too much time in political bickering.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract) and Type 3 Regulated Activity (Leveraged foreign exchange trading) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong

By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.