Merkel retreats - "Victories" for Spain and Italy

The EU Summit seems to have ended in a... German retreat which resulted, after 14 hours of discussions, in an agreement to establish a mechanism by the end of 2012 to allow the recapitalization of banks directly through the European support mechanisms (EFSF and ESM), without adding extra weight to the debt of the country which will resort to this mechanism.

Following this decision, Italy and Spain withdrew their reservations about the 120-billion-euro growth package, which was agreed upon earlier by the EU leaders.

European Council President Herman Van Rompuy said that EU leaders decided to change the terms of the imminent bail-out of Spanish banks and allow Italy to raise money from the Eurozone support funds to reduce the costs of its borrowing.

According to the Bloomberg financial agency, Berlin was forced to back down after Spain and Italy’s pressure for increased support.

Rome and Madrid had connected their consent for the adoption of the 120-billion growth package in Europe by implementing immediate solutions for countries facing pressure from the markets.

"We agreed to short-term measures for Spain and Italy," said Eurogroup President Jean-Claude Juncker, stressing that they will make all the necessary moves and consider every possible scenario to normalize the situation.

The conclusions

"We confirm that it is of utmost importance to stop the vicious cycle between banks and States. The Commission will shortly present proposals based on Article 127 (paragraph 6) for a monitoring mechanism. We ask the Council to address these proposals as urgent by the end of 2012.

Once such a mechanism is established, valid for the ECB as well, Eurozone banks will be able to go through it directly to recapitalization. This will be based on conditions, one of which will be the compliance/agreement with state aid rules, which will have to be cleared by the specific institution or sector or the economy generally, and will be formalized by the Memorandum of Understanding. The Eurogroup will examine the situation of the Irish financial sector to further improve the functioning of the adjustment program.

Similar cases will be dealt with in the same way.

"We press for a quick completion of the Memorandum of Understanding, which is directly connected with the financial support of Spain to recapitalize its banking sector. We confirm that we will provide the financial support from the EFSF until the ESM is able to provide such assistance, and that later the help of the EFSF will be the sole responsibility of the ESM, which will not gain seniority status.

We confirm our clear commitment to do whatever necessary to ensure the financial stability of the Eurozone, using the existing bodies of EFSF/ESM in a flexible and effective way to stabilize the markets of member-states, and respect specific state recommendations in conjunction with other commitments, including time limits specified by the European Semester, the Stability and Growth Pact and the Process of Macroeconomic Instabilities.

These terms should be provided by the Memorandum of Understanding as well. We welcome the agreement of the ECB to take on the role of EFSF/ESM representative, carrying out audits into the functioning of markets in an efficient manner.

We ask the Eurogroup to implement these decisions by July 9, 2012."

The short-term measures to support Italy and Spain will be decided today

The immediate measures totaling 120 billion euros which EU leaders agreed on for growth are a fact, said EU president Herman Van Rompuy during a press conference in Brussels.

Eurogroup chairman Jean-Claude Juncker, insisting that European leaders did not "close the door" to short term measures to calm the markets, said that "we will not exclude any intervention option in order to make the corrections needed to calm the situation. It is certain that the final decisions will be made on Friday. We have made great progress."

During the Summit proceedings on Thursday, they decided on a capital strengthening euros of the European Investment Bank (EIB) by 10 billion and the immediate pilot implementation of the so-called "project bonds", which will increase the bank’s overall lending capacity to 60 billion euros.

French President Francois Hollande said the 27 EU leaders agreed on a growth pact, although Italy and Spain will sign it later. According to the French President, Spain wants immediate recapitalization of banks, while Italy wants measures to reduce yields on bonds.

In essence, the "quartet" leading the European institutions (Rompuy, Barroso, Juncker and Draghi) should prepare a map for the new architecture of the Eurozone by the end of the year. Meanwhile the rescue funds will be ready to buy Spanish and Italian bonds, if they cannot sell them on the market at reasonable prices.

The details of the short-term measures to support Spain and Italy in order to keep markets in check until the presentation of the final draft, will be discussed at noon on Friday at the meeting of the 17 Eurozone leaders. The basis for discussion is the Finnish suggestion that the rescue funds buy government bonds which are covered by state guarantees (state property, etc.).