ECB Stress Relief: Fresh Liquidity Buys Time for EU Leaders

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The European Union summit was free of drama on Thursday for what feels like the first time in years. That calm is misleading, though. It is the result of the massive injection of liquidity into European banks by the ECB. The move buys time -- and it is up to EU leaders to use it wisely.

Finally, a drama-free EU summit. Chancellor Merkel in Brussels on Thursday evening. Zoom
AFP

Finally, a drama-free EU summit. Chancellor Merkel in Brussels on Thursday evening.

A bit of skirmishing over the correct formulation, some back-and-forth with Great Britain and an agreement over making Serbia an official candidate for European Union accession. At first glance, the EU summit on Thursday night seemed just as harmless as such summits were before the crisis. There was little of the drama that has infused meetings of European leaders in the last two years, a time when the 27-member club seemed to be constantly teetering on the edge of the abyss.

No wonder. The acute symptoms of the euro crisis have recently receded. The interest rates that countries like Italy and Spain must pay on their sovereign bonds have dropped below 5 percent. And EU leaders seem to have found a bit more confidence in Greece than they had just a few weeks ago. Even Jean-Claude Juncker, the head of the Euro Group and prime minister of Luxembourg, said that "things are progressing well" in Greece.

"I have to say that it was a totally normal European Council meeting," said European Parliament President Martin Schulz after the first summit talks on Thursday evening. He saw the lack of drama as a "breakthrough."

Indeed, about the only ripples to be found were the result of Juncker's comments on the summit sidelines that he would not seek an additional tenure as Euro Group head once his current term expires in the middle of the year. "Definitely not me!" he told German newswire DPA when asked who would be the chair of the group in the future.

The appearance of calm, though, is somewhat deceiving. In reality, the crisis is only taking a bit of time off. The reason has little to do with austerity programs and aid packages pushed through by EU heads of government; rather the respite comes thanks to the European Central Bank (ECB). Under the leadership of Mario Draghi, the ECB pumped a further half trillion euros into the financial markets on Wednesday, the second such liquidity injection in just two months.

Helping All Involved

European banks are able to borrow that money for up to three years at the minimal interest rate of just 1 percent. The move not only drastically improves the prospects of several struggling European banks, but also helps heavily indebted member states in the euro-zone. Banks have invested much of the cheap credit in relatively profitable sovereign bonds, a deal which helps everyone involved.

As such, the ECB turning on the liquidity faucet grants crisis-stricken euro-zone countries a bit of time -- perhaps a few months, at most three years. At that point, the banks will have to pay the ECB back, and the hope is that the situation will have improved to the point that Europe's financial institutions will then be able to satisfy their liquidity needs elsewhere.

German Chancellor Angela Merkel is well aware of the gift the ECB has given to Europe. "We now have the time to improve competitiveness, growth and the employment situation in Europe," she said on the sidelines of the summit. "We absolutely have to use this time. Otherwise, we will find that the world does not trust us."

Merkel isn't the only European politician who seems to have found a new favorite word. "This meeting is all about growth," said European Commission President José Manuel Barroso, adding that structural reforms must now move forward. "We have to change our focus from crisis to growth," he added.

It's easier said than done, though. In seven of the 17 countries belonging to the common currency union, the economy will shrink this year according to forecasts by the European Commission. The others will experience only minimal growth, too little to pull the Continent out of crisis.

A New Guardian Angel

Furthermore, it is difficult to see where the impulses for growth might come given the myriad austerity packages that have been imposed across the euro zone, particularly on its weakest members. Plus, stimulus measures require money, and it is difficult to see where that money will come from. After all, 25 of the 27 EU member states have just recently agreed to a German-designed fiscal pact which is to impose penalties on those that overspend. On Friday, EU leaders plan to officially sign the pact.

Given such stringent budgetary rules, governments are showing a preference for measures with a lower price tag. There is plenty of talk about structural reforms -- the further liberalization of European markets, for example, or increases to the retirement age in some countries. EU countries have also signalled their intention to increase funding for research and innovation as well as reducing non-wage labor costs.

Whether such measures will be enough to lead the currency union out of crisis in the next three years remains to be seen, and some EU leaders have their doubts. Indeed, many would like to see an immediate enlargement of the yet-to-be-implemented permanent euro bailout fund, the European Stability Mechanism.

It is a measure that the European Commission, in concert with several EU countries, the International Monetary Fund and several powerful countries around the world including the US, India and China, have been insisting on for weeks. The idea is to increase the volume of the ESM from its current size of €500 billion to at least €700 billion. Germany has been the sole opponent of the plan. On the eve of the summit, however, Merkel sent signals that she was reconsidering her strict opposition, but the topic will not be addressed until later this month. First, Berlin would like to wait and see just how the private-sector debt-relief plan for Greece will work.

There was one point related to the ESM that all could agree upon, however. The €80 billion in capital that provides the foundation for the bailout fund is to be collected more rapidly than originally planned -- by the end of 2013. Just in time, perhaps, to replace the ECB as the euro zone's guardian angel.

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