x Abu Dhabi, UAEFriday 28 July 2017

Markets lower as Germany warns debt agreement may fail

A German official suggested yesterday that European leaders could fail to agree on a plan to tighten the continent's economic ties by the end of the week, dampening investors' optimism about a broad resolution of Europe's debt crisis.

BERLIN // A German official suggested yesterday that European leaders could fail to agree on a plan to tighten the continent's economic ties by the end of the week, dampening investors' optimism about a broad resolution of Europe's debt crisis.

Instead, a senior German official said it could take until Christmas for changes to the European Union treaty to be agreed upon, a critical first step in saving the euro.

It is unclear whether the leaders have that long, as ratings agencies have warned of a possible credit downgrade of 15 European countries unless they quickly build a firm plan to solve the continent's two-year debt crisis.

Markets turned lower after the German official's comments, dampening the optimism that had seen stocks and bonds rally over the past week. Investors had been hoping that a promise of more enforceable rules on budgets would permit the European Central Bank to take bolder action to reducing borrowing costs for Italy and other struggling countries.

The senior German official, speaking on condition of anonymity because talks were still ongoing, said his government would not consider an alternative to the proposal the German chancellor, Angela Merkel, and the French president, Nicolas Sarkozy, outlined on Monday and published yesterday.

That proposal calls for tightening budget controls, either through a change to the 27-nation EU treaty or by writing a new treaty for the 17 countries that use the euro.

But Herman Van Rompuy, the president of the European Council, says there is an easier way to get agreement on future fiscal discipline. He favours simply amending existing rules that apply to the 17 countries that use the euro. That would allow leaders to avoid the trickier step of requiring every country to approve the new treaty through parliamentary votes.

This split and others - including on whether to make automatic penalties for countries that overspend - has the potential to delay any agreement by European leaders, who had hoped to clinch one at the end of a summit in Brussels tomorrow.

It could be Christmas before everyone agrees to a new treaty, the German official said. "If several rounds of negotiations are necessary for that then we are also prepared for that."

Earlier yesterday, the US treasury secretary, Timothy Geithner, struck a more optimistic tone on the prospects for a deal.

"We are very encouraged with the progress that is being made," Mr Geithner said to reporters following a meeting with the French finance minister, Francois Baroin, on the second day of his whirlwind trip through Europe.

There are divisions between the 17 EU nations that use the euro and the 10 others that do not over how to handle treaty changes.

The 10 EU countries that do not use the euro are concerned that they will be left out of future economic discussions that would affect all of Europe, although Germany has insisted that any interested countries would be welcome to adopt the changes of the eurozone 17.

The British prime minister, David Cameron, is wary of losing power with the 27-nation bloc if France and Germany create a tighter club of eurozone nations with tough rules for national budgets. And his government does not want to transfer any of its decision-making powers to Brussels.

Markets have nevertheless rallied over the past few days on the hope that at least a tentative deal will be secured this weekend. Stocks and bonds have risen, while the borrowing rates for key countries such as Italy and Spain fell to monthly lows.

Experts say those gains are based largely on hopes that the European Central Bank will eventually step up its support for weak eurozone countries.

The ECB president, Mario Draghi, hinted in a speech last week that a commitment by euro countries to crack down on overspending could set the stage for further financial assistance from the bank.

Markets have interpreted Mr Draghi's comments to mean that the ECB could get more aggressive in purchasing European government bonds.

Those bond purchases would probably drive down interest rates, allowing debt-laden countries to cut their borrowing costs.

The proposals agreed on by the German and French leaders are based on three key issues to be debated in Brussels: having all 17 countries that use the euro amend their constitutions to require balanced budgets; instituting enforceable penalties for countries that run excessive budget deficits using EU institutions such as the European Commission and European Court of Justice, and the use of those institutions might require that all 27 EU countries agree to it; and trying - again - to greatly increase the EU's financial capacity to bail out countries in trouble.

The hope is that markets will not worry so much about what will happen if one of the euro-using countries goes bust.