EUROPE FINANCIAL AND ECONOMIC REPORT: October 9,

UNCLAS SECTION 01 OF 03 BRUSSELS 001392 SENSITIVE SIPDIS NOT FOR INTERNET DISTRIBUTION E.O. 12958: N/A TAGS: EFIN ECON ETRD EIND EINV EUN SUBJECT: EUROPE FINANCIAL AND ECONOMIC REPORT: October 9, 2009 BRUSSELS 00001392 001.8 OF 003 Upcoming Issues/Events: -------------- ECOFIN Meeting: -------------- ¶1. (SBU) On October 20, EU27 Finance Ministers will meet in Luxembourg. They are scheduled to discuss: --preparations for the November 6-7 G-20 Finance Ministers meeting; --exit strategies from measures put in place in response to the economic and financial crisis; --climate finance; --reform of financial supervision; --strengthening of EU financial stability arrangements; and, --taxation issues. The ECOFIN will be preceded by a meeting of the Eurogroup. ¶2. (SBU) Commission to present proposals on derivatives and financial stability: On October 21, the Commission is expected to issue two Communications (non-legislative proposals) setting out principles for regulation of derivatives and improving crisis resolution arrangements. Recent Events: -------------- Informal ECOFIN hails stress tests and moves towards reforming supervisory architecture: -------------- -------------- ¶3. (SBU) At the October 1-2 informal ECOFIN meeting in Goteborg, EU finance ministers and central bank governors: (1) agreed that current signals point to a bottoming out of the crisis and that a tentative recovery is underway, albeit fragile and uncertain; (2) described as positive the results of the stress tests conducted on 22 unnamed large EU banks; and (3) failed to reach agreement on exit strategies. ECB President Trichet called for an exit from stimulative policies as soon as the recovery starts, while French Finance Minister Lagarde noted that an exit would first require a fall in unemployment. ¶4. (SBU) Broad consensus is emerging regarding the need to promote financial stability and enhance European financial regulation and supervision. The Swedish Presidency announced its commitment to reach agreement on the creation of the European Systemic Risk Board (ESRB) by October on the European System of Financial Supervisors (ESFS) by December. Stress tests of EU banks produce reassuring results: -------------- -------------- ¶5. (SBU) Stress tests of the top 22 banks in the EU (representing 60% of EU bank assets) found that they could survive "a severe macroeconomic deterioration", resulting in 400 billion in credit losses in 2009-10 under the tests' adverse scenario. ECB President Trichet noted that, "even with this tough stress testing, we see that our system is resisting in a way that's reassuring." Many details of the tests were not made public, however, including country-by-country breakdowns or the names of the 22 banks that were tested. EU stock indices showed little investor reaction to the tests. ¶6. (SBU) A statement issued by EU finance ministers and Central Bank governors reported that under current EU forecasts for 2009 and 2010, the largest banks in the region would maintain an average Tier 1 capital ratio "well above" 9%. A "more adverse" scenario would increase losses and cut the average ratio to about 8%. Bank Tier 1 capital ratio would not fall below 6% for any of the tested banks. European Parliament establishes special committee on financial and economic crisis: -------------- -------------- ¶7. (SBU) On October 7, the European Parliament voted to create a special committee on the financial and economic crisis. The Committee has been given the tasks of: (1) analyzing the extent of the financial crisis and its impact on the EU and its Member States; (2) evaluating the state of global economic governance, and (3) evaluating the current implementation of Community legislation BRUSSELS 00001392 002.6 OF 003 in all the areas impacted by the crisis. The 45-member Committee has been established for a period of one year, with the possibility of extension, and is expected to produce proposals for the long-term reconstruction of sound, stable financial markets. German Liberal Democrat Wolf Klinz is expected to be elected as chairman. European Parliament resolution supports single financial supervisor: -------------- - ¶8. (SBU) On October 6, the European Parliament adopted by a large majority a joint resolution in response to the conclusions of the G20 summit meeting in Pittsburgh. MEPs welcomed the G-20 agreement and the focus on global imbalances and expressed the view that "the European Union needs to work towards a stronger financial supervisory architecture with a single financial supervisory authority as an objective." Germany to shift banking supervision from Bafin to Bundesbank: -------------- -------------- ¶9. (SBU) The incoming German coalition has agreed abolish the country's two-pronged system for banking oversight by stripping Bafin of its mandate and making the Bundesbank the sector's sole regulator. At present, the responsibilities are shared by the Bundesbank, which is in charge of macro-prudential supervision, and Bafin, which is in charge of micro-prudential supervision. The Bundesbank has also proposed that it receive responsibility for insurance regulation. However, no decision has yet been made and the insurance sector is reportedly strongly resisting the Bundesbank proposal. ECONOMICS / FINANCE -------------- Recent Events: -------------- EC calls for deeper macroeconomic coordination and surveillance and argues for stronger international representation: -------------- -------------- ¶10. (SBU) In its annual report on the Euro area, the Commission finds that the euro acted as a valuable shield in the financial crisis, increasing the Euro area's attractiveness for non-Euro area Member States. However, the crisis has had a strong negative impact on the sustainability of public finances and potential growth - which has fallen from 2.5% to 1.0% for 2010-2020 - and may increase divergences in Member States competitiveness. The annual report also highlights the risks of intra-Euro area and domestic imbalances. The Commission calls for stronger and broader macroeconomic surveillance - to ensure sustainable public finances and the implementation of policies to improve potential growth - and argues for EU external representation to be strengthened, particularly within the IMF. Commission initiates EDP for nine additional Member States: -------------- -------------- ¶11. (SBU) On October 7, the Commission initiated excessive deficit procedures (EDP) for Austria, Belgium, the Czech Republic, Germany, Italy, Slovakia, Slovenia, the Netherlands and Portugal on the basis of projected budget deficits above 3% in 2009. The Commission noted that although the deficit levels are exceptional in nature, they are neither close to the reference value of 3% of GDP, nor temporary. The procedures are based on fiscal projections submitted to the Commission by the countries themselves (April EDP notifications) and on the Commission's spring forecasts. The December ECOFIN will decide whether to approve the Commission's recommendation. ECB and BoE stay the course: -------------- ¶12. (SBU)As expected, on October 8, the European Central bank and the Bank of England kept their interest rates unchanged and did not announce any modifications to their quantitative easing programs. Commission proposes 200 million in macro-financial assistance to Serbia: -------------- -------------- ¶13. (SBU) On October 8, the Commission proposed to the Council 200 million in macro-financial assistance (MFA) to Serbia in support of BRUSSELS 00001392 003.14 OF 003 its IMF program. The loan would be provided in two installments, tentatively in the second and fourth quarter of 2010, conditional upon meeting the conditions of the IMF program. Earlier this year, the Commission agreed to provide 100 million in pre-accession budget support grants. September Euro area inflation down, industrial producer prices up: -------------- - ¶14. (SBU) On September 30, Eurostat said that Euro area inflation is expected to be -0.3% in September 2009, down from -0.2% in August and 3.6% in September 2008. August industrial producer prices rose by 0.4% in the Euro area, and by 0.2% in the EU27. Unemployment up, retail trade suffers: -------------- ¶15. (SBU) The Euro area unemployment rate was 9.6% in August 2009, up 0.1% m-o-m and 2.0% y-o-y. In the EU27, August unemployment was 9.1%, up 0.1% m-o-m and 2.1% y-o-y. ¶16. (SBU)Over the same period, retail trade fell by 0.2% m-o-m in the Euro area and by 0.3% m-o-m in the EU27. Year-on-year figures showed a 2.6% decrease in the Euro area and a 1.8% fall in the EU27. Total retail trade rose in four Member States and fell in thirteen. The highest increases were observed in Poland (+1.5%) and Spain (+1.4%),while the largest decreases were in Latvia (-3.3%),Sweden (-2.7%),Lithuania (-2.3%) and Austria (-2.0%). Second quarter GDP estimates revised downward: -------------- - ¶17. (SBU) On October 7, Eurostat released revised estimates for Q2 GDP growth in the Euro area and the EU27. For the Euro area, growth is estimated at -0.2% (versus the previous estimate of -0.1%) and for the EU 27 at -0.3% (versus -0.2%). Year-on-year growth is estimated at -4.8% in the Euro area and -4.9% in the EU27. MURRAY