European leaders may struggle to maintain the euphoria that drove the euro to its biggest one-day gain in more than a year as scrutiny deepens on their latest attempt to stem the region’s turmoil.
The weaknesses of Europe’s common currency area, ranging from its design to a persisting dearth of bank funding and anemic economic growth, weren’t properly addressed in the measures revealed yesterday to stem investor panic, said Harvard University economist Kenneth Rogoff and Jonathan Loynes at Capital Economics Ltd. in London.
“My read of this is that the markets are cheered that they’re still alive,” Rogoff, a former International Monetary Fund chief economist, said as a compensated speaker at the Bloomberg FX11 Summit in New York yesterday. “Even in a fairly short period, doubts will start to grow again.”
Ten hours of bargaining by European leaders at the 14th crisis summit in 21 months culminated in an agreement to bolster the region’s crisis-combat toolbox by boosting their rescue fund to 1 trillion euros ($1.4 trillion) and persuading bondholders to take 50 percent losses on Greek debt. Measures also included a recapitalization of European banks and a potentially bigger role for the International Monetary Fund.
The euro jumped against the dollar after the accord yesterday and the Standard & Poor’s 500 Index advanced 3.4 percent, erasing its loss for 2011. Europe’s common currency was little changed today at $1.4152 as of 11:29 a.m. in London.
German Chancellor Angela Merkel described the agreement as “a good joint package to take the next steps,” while French President Nicolas Sarkozy said the accord will allow Greece to “save itself.” The summit outcome also drew international praise, as U.S. President Barack Obama labeled the deal a “critical foundation” for averting a global economic slump.
Europe’s leaders have claimed victory before. They described their plan in March as a “comprehensive” strategy, while Luxembourg Prime Minister Jean-Claude Juncker said the July 21 accord on a second bailout for Greece and more powers for the rescue fund was the “final package, of course.”
“The very best you can hope for is it buys you time,” said Loynes, Capital Economics’s chief European economist. “It avoids an imminent catastrophe and means Greece should be able to meet its obligations in the near future, and it may restore a bit of confidence. But it won’t prevent the debt crisis overall from rambling on and indeed escalating.”
The focus has now shifted from Brussels back to Europe’s capitals. Italy faced an increase in borrowing costs at a sale of 8.5 billion euros in debt today, the first auction of conventional bonds since the summit. While EU allies demanded action to speed debt reduction by spurring growth, Prime Minister Silvio Berlusconi stopped short of new measures with a 14-page blueprint for reforms pledging asset sales, easing labor laws and raising the retirement age.
In Greece, Prime Minister George Papandreou faces the challenge of maintaining consensus on budget austerity and job cuts amid protests and languishing growth. He urged Greeks to back his efforts to revamp the economy after returning to Athens having bargained for an easing of Greece’s debt burden.
“The crisis gives us the opportunity and this agreement gives us time,” Papandreou said in a televised address yesterday. “We negotiated and managed to erase a very important part of our debt. Tens of billions of euros have been lifted from the backs of the Greek people.”
European leaders also promised to look “urgently” at ways to guarantee bank debt and thaw funding markets, though lenders needing to refinance more than $1 trillion of debt next year may struggle until policy makers follow through on a guarantee of their bond sales. Many banks remain dependent on the European Central Bank for its unlimited short-term financing.
“The biggest problem at the moment is that banks haven’t been able to fund themselves,” said David Moss, who helps manage about 8.5 billion euros at F&C Asset Management Plc in London. “If banks can’t fund themselves, they’ll struggle to exist.”
While much of the agreement still needs to be hammered out and enacted, the summit may still mark a turning point in Europe’s crisis management effort, said Erik Nielsen, global chief economist at UniCredit Bank AG in London.
“Although lots of details still have to be elaborated on and some issues have to be clarified, yesterday’s deal underpins my view that the summit would likely be the place where the odds start to change in the right direction,” he said in a note to investors today.
Rogoff remained skeptical and said that the sustainability of the whole euro project is in doubt because of “too many inconsistencies” about a bloc of countries seeking to stay independent while unifying their currency.
“It’s pretty darn clear the euro does not work,” he said. “It’s not a stable equilibrium.”
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