What's Next On The EU's Agenda?

The German elections are now behind us and financial markets and politicians should soon begin to focus on what is next on the EU agenda. Prior to the elections, sensitive EU issues were de facto paused in order not to upset the German voters. Most of these issues will probably remain on hold until a new government is formed, which is likely to take weeks or even months. When a new government is formed, we may see renewed progress on many issues. This said, the reform speed has also slowed for another reason. The pressure from financial markets has been an important driver of reforms and, now that markets have calmed, we believe politicians are likely to be less eager to show progress on politically sensitive issues such as the Banking Union.

The German constitutional court in Karlsruhe will rule on the ECB’s OMT programme. The court has no jurisdiction over the ECB but if it rules that the German government should seek to impose limits on the OMT or change the ECB’s mandate to reduce its scope of action, it could bring into question the effectiveness of the OMT instrument and cause the debt crisis to reignite. In our view, bond purchases have become part of the central banks’ standard toolbox and the ECB has not gone very far compared with the Fed, Bank of England and Bank of Japan. As long as it uses the instrument to correct market failures and not to keep insolvent states artificially alive, we do not see this as a problem. It would be wise of Karlsruhe to rule in favour of the OMT programme. We think that the ruling will be a lifted finger at most.

The political eagerness to create a fully fledged Banking Union has declined as the debt crisis has calmed down. The European Commission is still aiming for a fully fledged model and presented in July its proposal for a Single Resolution Mechanism to cover all euro area lenders as a supplement to the Single Supervisory Mechanism. The European Commission hopes that final agreement can be reached this autumn. Germany is resisting a strong centralisation of power that puts fiscal sovereignty into question without changes to EU treaties. Germany is opting for a network of national resolution authorities but might be willing to accept a single resolution authority for the 130 euro area banking groups that will be supervised by the ECB from the second half of 2014. The main hurdle is to agree on a EUR55bn single resolution fund replacing national funds. The intention is that banks gradually pay into this central resolution fund and losses will be shared across the euro area.

Government budgets for 2014 will also be in focus during the autumn. A number of countries need to come up with austerity measures to reach their deficit targets. In Portugal, the government is struggling to find new austerity measures following the constitutional court’s rejection of cost-cutting measures on two occasions. In the Netherlands, the government is struggling to find support for the austerity budget presented on 17 September 2013.

The ECB intends to undertake an asset quality review of European banks in 2014 before taking over the supervisory role. The ECB has strong incentives to run harsh stress tests before taking over supervision. There is a risk that the review will reveal weaknesses in some banks. The ECB’s asset quality review will be followed by the EBA stress test.

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