Europe's Leaders Prepare for Summit

Market Gloom Prevails as Europe's Leaders Prepare for Summit

By STEPHEN CASTLE
Published: June 25, 2012
LONDON — Market gloom prevailed early Monday at the start of a crucial week for the euro, as Spain was expected to make a formal application for billions in aid for its sickly banks and European leaders prepare for talks over the creation of a European banking union to shore up the currency.
Stock markets and the euro dropped on Monday amid pessimism about the prospect that European
Union leaders, who are due to meet Thursday and Friday in Brussels, will achieve the far-reaching breakthrough needed to relieve pressure on Spain and Italy, both of which face elevated borrowing
costs.

The Euro Stoxx 50, a measure of European blue-chips, was down 1.46 percent. National benchmarks were also down, led by the MIB in Milan, which was down 2.32 percent, and the Ibex 35 in Madrid, down 1.83 percent. The DAX in Germany was off 1.45 percent, and the CAC 40 in France was down 1.31 percent.

The euro was at $1.2499 in midmorning trading in Europe, down from $1.2560 late Friday in New York.

Asian stocks were also lower Monday, with the Nikkei 225-stock index in Japan down 0.72 percent and the Hang Seng index in Hong Kong down 0.51 percent.

Audit reports released last week indicated that Spain will need as much as 62 billion euros, or $79 billion, to shore up a banking system brought low by a real estate crash. But its formal application is likely to leave open the question of whether aid should go directly to financial institutions, as the Spanish government would like, or through the government in Madrid, as European Union rules currently say it must.

Leaders may discuss whether to change those rules at their meeting in Brussels at the end of the week. They will also debate a series of far-reaching changes to the regulation of banks, including a plan to wind up insolvent banks, a central deposit guarantee fund and a bigger supervisory role for the European Central Bank.

The issue of bank regulation highlights the threat posed by the so-called doom loop at the heart of the euro zone, in which the weak finances of banks and governments on Europe’s periphery drag each other down.

An outline agreement to bail out Spanish banks, struck earlier this month, failed to impress financial markets because the loans from the euro zone rescue fund will, under the current rules, only add to the debt of Spain’s government.

An audit of Spanish banks was commissioned by Spain’s Economy Ministry in May after the government took control of Bankia, a giant mortgage and prime casualty of the real estate collapse that left many of Spain’s banks with mounting levels of loans in or near default. Spain’s deep recession and high unemployment are compounding those problems.

Spain expects finance ministers from the 17 euro zone countries to set the terms of the loan, such as the interest rate, at their meeting on July 9. It then expects the results of more audits of its banks by the end of July and may not specify a final figure until September.

In effect, Spain is happy to drag out its bank rescue in order to let the idea of a European banking union ripen and in the hope that, by the time the funding is provided, it can be paid directly into the banks — whatever the current rules say now.

Spanish officials know that, at the center of discussion at the two-day summit of E.U. leaders on Thursday and Friday, will be a proposal for a banking union at the European level, which could break the cycle that threatens the future of the single currency.

That and other ideas for centralized bank supervision will be outlined in a paper from the president of the European Commission, José Manuel Barroso; the president of the European Council, Herman Van Rompuy; the president of the European Central Bank, Mario Draghi, and the heads of the Eurogroup of euro zone finance ministers, Jean-Claude Juncker.

The document will also outline proposals for deeper economic integration in the euro zone.

But even if the details can be agreed upon this week, such a plan will take months if not years to implement.

In the meantime, Spanish borrowing costs have hovered near record highs of around 7 percent for long-term debt, a figure which the government in Madrid would not be able to sustain in the medium term without seeking a full bailout. Italian borrowing costs also rose last week on fears that Italy would be the next country to seek aid.

On Monday the benchmark Spanish 10-year bond traded to yield 6.413 percent, up 15.9 basis points, while the comparable Italian bond was at a yield of 5.838 percent, up 6.3 basis points. A basis point is one-hundredth of a percentage point.

Italy’s prime minister, Mario Monti, has proposed a plan to limit the difference between the lending costs of the euro zone nations, deploying the resources of the euro zone bailout fund and the European Central Bank. Germany’s chancellor, Angela Merkel, refuses to do that without first constructing a fiscal union that would give Brussels more say in how the Italians and others spend their money.

The summit at the end of this week is also expected to debate a relaxation of the bailout terms already negotiated by Greece. But the country’s newly installed prime minister, Antonis Samaras, and his nominee for the crucial post of finance minister, Vassilis Rapanos, were hospitalized Friday and will miss the summit.

Mr. Samaras, who is recovering from eye surgery, and Mr. Rapanos, who was struck by intense abdominal pain, nausea, sweating and dizziness on Friday, will be replaced at the meeting by a ministerial delegation.

With the two men in the hospital, representatives of Greece’s so-called troika of foreign creditors have postponed a trip to Athens that was scheduled for Monday, state television reported Sunday.