EUROPE FINANCIAL AND ECONOMIC REPORT: July

UNCLAS SECTION 01 OF 05 BRUSSELS 000931 SENSITIVE SIPDIS NOT FOR INTERNET DISTRIBUTION E.O. 12958: N/A TAGS: EFIN ECON ETRD EIND EINV EUN SUBJECT: EUROPE FINANCIAL AND ECONOMIC REPORT: July 4th, 2009 SUMMARY: Following is the biweekly financial report from the U.S. Mission to the European Union. The report is divided into three sections: Economic Conditions and Policy, Financial/Monetary Conditions and Policy and Financial Supervision/Regulation. ECONOMIC CONDITIONS/POLICY -------------- ECOFIN MINISTERS MEET ON JULY 7: -------------- ¶1. (SBU) At the July ECOFIN Council - the first one under the Swedish presidency ministers will exchange views on the preparation of the forthcoming G-20 meetings, i.e., the G-20 finance ministers meeting preceding the G-20 summit in Pittsburgh in September. There Council will also discuss: 1) pro-cyclicality (and is expected to adopt conclusions); 2) the Commission's proposal to open excessive deficit procedures concerning Lithuania, Malta, Hungary, Poland and Romania under the stability and growth pact; and 3) the Commission's assessments of the stability and convergence programs for Belgium, Austria, Slovakia and Slovenia. Ministers are also expected to examine member states' medium-term budgetary objectives, as well. SECOND QUARTERLY REPORT ON EURO AREA SHOWS EARLY SIGNS OF IMPROVEMENT: -------------- -------------- ¶2. (SBU) On June 29, the European Commission published the second Quarterly Report on the Euro area for 2009. The analysis done by the services of DG ECFIN shows that the euro-area economy is still in recession, but the EU's "strong and coordinated" policy response is providing support to economy activity. Most financial markets are showing signs of stabilization although conditions remain fragile. Spreads on money and bond markets have narrowed on the back of improved economic sentiment and lower risk aversion. Financing conditions in the euro area have also improved as the cost of bank loans, equity capital and market debt have all declined. However, the report shows that money and credit growth have slowed further in recent months. Euro-area GDP dropped by 2.5% q-o-q in the first quarter of 2009, according to Eurostat's release of 3 June, driven mostly by an inventory adjustment and a continued sharp fall in investment. On the positive side, the fall in private consumption was contained by the deceleration of consumer price inflation. While hard data have so far remained depressed, survey data have begun to show a pick-up in confidence in most euro-area countries. The report also shows that the banking support measures implemented by Member States since autumn 2008 have helped to avert financial meltdown and have had a positive impact on banks' capital and access to wholesale funding. However the situation of the banking sector remains fragile, and further significant asset write-downs are still to be expected, as confirmed by a recent ECB study. OECD REPORT REVISES EUROZONE GROWTH DOWNWARDS: -------------- - ¶3. (SBU) In its June 23 revised economic forecast, the OECD sees few "green shoots" in the 16-nation euro-area, as the 2009 forecast was cut to show a contraction of 4.8%, compared with a 4.1% decline foreseen in March. The Organization predicts stagnation for the Eurozone in 2010, compared with a previous 0.3% decline. OECD general Secretary Angel Gurria recommended that the Eurozone cuts interest rates further and continue the unconventional monetary policy as well as the stimulus policies, arguing that countries with room to maneuver should even increase their efforts. He warned in particular Germany not to end stimulus measures prematurely. ¶4. (SBU) The OECD forecast conflicts with that of the World Bank, which on Monday said that the global economy will contract 2.9% this year, compared with a previous forecast of a 1.7% decline, but echoes the view of the IMF which now forecasts worldwide growth next year of 2.4%, up from April's 1.9% estimate. EC 2009 REPORT ON EMU PUBLIC FINANCES SAYS EXIT STRATEGY NEEDED: -------------- -------------- ¶5. (SBU) On June 23, the European Commission released its 2009 Report on Public Finances in the EMU, which forecasts that the total cost of national rescue of banks is likely to lie anywhere between 2.75 - 16.5% of EU GDP, depending on the veracity of underlying assumptions and the ability of governments to recover capital BRUSSELS 00000931 002 OF 005 SUBJECT: EUROPE FINANCIAL AND ECONOMIC REPORT: July 4th, 2009 SUMMARY: Following is the biweekly financial report from the U.S. Mission to the European Union. The report is divided into three sections: Economic Conditions and Policy, Financial/Monetary Conditions and Policy and Financial Supervision/Regulation. injections and loans. The report also shows that an exit strategy strengthening fiscal policy frameworks, reforming age-related spending and spelling out the broad consolidation measures envisaged when the recovery will have taken hold is required to address the concerns over public finance sustainability and underpin consumer, business and financial market confidence. SWEDISH PRESIDENCY URGES EU MEMBER STATES NOT TO ADOPT FURTHER STIMULI -------------- -------------- ¶6. (SBU) Fredrik Reinfeldt, the Swedish PM taking over the six-month rotating EU presidency, said that he will guide the EU based on the assumption that Europe's financial sector is still in crisis, and urged the member states not to "push on with more stimulus packages, because you might face additional problems with the financial sector." He emphasized the need to reverse the rise in EU budget deficits and public debt, referring to the estimates released last month by the ECB estimating that Eurozone banks face potential write-downs of $283bn between now and the end of 2010, due mainly to bad loans. COMMISSION ASSESSES SCPS FOR AUSTRIA, BELGIUM, SLOVENIA, SLOVAKIA AND ROMANIA: -------------- -------------- ¶7. (SBU) On June 24, the European Commission examined the last five Stability and Convergence Programs (SCPs) on fiscal measures submitted by Austria, Belgium, Slovenia, Slovakia, and Romania. As in other EU countries, budgetary positions are expected to deteriorate markedly, reflecting the global recession and the economic stimulus packages adopted in line with the European Economic Recovery Plan (EERP). In all five countries, budgetary targets are subject to downside risks. The Commission also concluded that Malta, Lithuania, Poland, and Romania are running excessive deficits and opened Excessive Deficit Procedures (EDPs) recommending deadlines for their correction. On Hungary, already the subject of an EDP, the Commission recommends postponing the deadline for deficit reduction by two years, to 2011. The Commission is requesting that Malta end its excessive deficit situation by 2010, Lithuania by 2011, Poland by 2012, and Romania by ¶2011. ECB LEAVES RATES UNCHANGED AT 1%, AS EXPECTED: -------------- - ¶8. (SBU) On July 2, the Governing Council of the ECB decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unch and 0.25% respectively.IndicQarea improved slightly May. However, the levows, suggesting that yQar-on-year industrial production growth was sQill negative in May and will remain subdued in June, the report said. Managers' production expectations and opinion of stocks of finished goods continued to improve. By contrast, orders continued to deteriorate. The Economic Sentiment Indicator (ESI) rose to 73.3 points, from 70.2 points in May. "The BRUSSELS 00000931 003 OF 005 SUBJECT: EUROPE FINANCIAL AND ECONOMIC REPORT: July 4th, 2009 SUMMARY: Following is the biweekly financial report from the U.S. Mission to the European Union. The report is divided into three sections: Economic Conditions and Policy, Financial/Monetary Conditions and Policy and Financial Supervision/Regulation. increase observed at sector and country level is mainly driven by improving expectations, as the main economic actors seem to be gaining confidence that the crisis is easing," the commission said in the report. The improvement was driven by higher consumer and service sector confidence in particular, and to a lesser degree by the industry. Most EU countries saw improvements, with Germany, France and Britain showing strong gains. ¶11. (SBU) The Eurozone purchasing managers' index, covering manufacturing and services, rose from 44.0 in May to 44.4 in June, a nine-month high, indicating that the recession is easing, though it remains below the 50 mark which indicates a contraction in activity. The rate of improvement was less than expected, however, because of weaker performance in the service sector. According to the Commission, the indices still point to a substantial contraction in second quarter economic activity. FINANCIAL / MONETARY POLICY AND CONDITIONS -------------- COUNCIL BACKS SUPERVISION AND REGULATION REFORM PROPOSALS, WITH SOME CHANGES: -------------- --- ¶12. (SBU) The June 18-19 European Council endorsed the Commission's May 27 proposed financial supervision and regulation reforms, with some changes. The Council specifically supported: --The creation of a European Systemic Risk Board (ESRB),whose chair will be elected by the members of the ECB General Council (the Commission had proposed that the ECB chair, but this was opposed by the UK); and --The establishment of a European System of Financial Supervisors (ESFS),comprising three new European Supervisory Authorities (ESAs),aimed at strengthening oversight of cross border groups through colleges of supervisors and creating a single set of rules for all financial institutions across the single market. ESAs should have binding decision-making powers to ensure that national supervisors follow the agreed-upon rules and to settle matters in case of disagreement among supervisors. However, ESA decisions should not impinge on fiscal responsibilities of Member States (this differs from the Commission proposal, in spelling out that the ESAs will not be able to force national authorities to pay for bank bailouts). ESAs should also have supervisory powers for CRAs. ¶13. (SBU) The Council took stock of progress achieved in improving the EU financial market regulatory framework and called for further progress, noted the first signs of a sustainable economic recovery and reiterated its determination to restore jobs and growth, stressing that consolidation should keep pace with economic recovery. In addition, the Council: 1) warned of continued weakness in the banking system; 2) called on Member States to "stay alert" for possible needs of further support; 3) welcomed the ongoing EU-wide bank stress-testing exercise; 4) supported the adoption by Latvia of new budgetary measures, 5) welcomed the intention of the Commission to swiftly disburse the next installment of its balance of payments support for Latvia; 6) called for a coordinated EU position for the next G20 financial crisis meeting September 24-25; and 7) reaffirmed that Member States have stated their readiness to provide 75bn in fast temporary additional support to the IMF. The Council's conclusions pave the way for the Commission to introduce specific legislative proposals in September to implement the reforms. Final adoption is expected in 2010. ECB's latest Financial Stability review warns of additional losses for banks in 2009: -------------- --- ¶14. (SBU) On June 15, the European Central Bank published its latest Financial Stability Review, which forecasts $283bn of additional losses for banks by end-2009, and considers that the risk to the financial sector remain high. The main risk components have been identified as: 1) renewed loss of confidence in the banks; 2) balance sheet trouble for insurers; 3) a larger-than-expected fall in US house prices; and 4) an even stronger recession. The review forecasts $283bn of additional bank losses for banks by end-2009. BRUSSELS 00000931 004 OF 005 SUBJECT: EUROPE FINANCIAL AND ECONOMIC REPORT: July 4h, 2009 SUMMARY: Following is the biweekly financial report from the U.S. Mission to the European Union. The report is divided into three sections: Economic Conditions and Policy, Financial/Monetary Conditions and Policy and Financial Supervision/Regulation. "Hard-to-value assets have remained on bank balance sheets, and the marked deterioration in the economic outlook has created concerns about the potential for sizeable loan losses," the ECB said. ECB INCREASES LIQUIDITY BY 442BN: -------------- ¶15. (SBU) The ECB organized a 442bn 12-month repo auction on June 24, the largest and longest-dating ever, through which 1100 European banks have obtained new liquidity. Bundesbank president Axel Weber said that while there is no systemic credit crunch, there are credit constraints, particularly for small companies. Weber also stated that the German government's forecast of a 0.5% growth next year was too optimistic, and that he expects zero growth. DG COMP WARNS UK BANKS MAY NEED TO SELL ASSETS TO COMPLY WITH COMPETITION RULES: -------------- -------------- ¶16. (SBU) On June 30, EC Commissioner for Competition, Neelie Kroes, told a British Bankers Association conference that RBS and Lloyds may be forced to sell assets in order to comply with EU rules on aid. "The likelihood of significant divestments by RBS and Lloyds is strong," she said. Under EU rules, beneficiaries of government-sponsored rescue plans are required to restructure their operations to compensate for the competitive advantage they enjoyed. Lloyds and RBS have together received more than #40bn in direct UK government assistance, bringing the public stake in them to 43.5% and 70% respectively. "Having co-operatively agreed changes to several German banks, our attention must turn to UK banks," she said. Negotiations between the UK Treasury and the Commission are reportedly already underway, and decisions may be reached before August. FINANCIAL SUPERVISION/REGULATION: CRD AMENDMENTS POSTPONED: -------------- ¶17. (SBU) The European Commission postponed the publication of an expected revision to the Capital Requirements Directive (CRD) until mid-July at the earliest. The amendment would impose a binding obligation on credit institutions and investment firms to have sound risk management and remuneration policies, and give regulators the power to impose financial or non-financial penalties against firms that fail to comply. The amendment would also aim to increase the amount of capital banks have to set aside to cover re-securitization positions and risky assets held on their trading books. Due diligence requirements for complex re-securitization and the supervisory process to enforce them would be increased. Supervisors could potentially bar non-compliant institutions from investing in such instruments. The latest draft of the proposed amendment obtained by USEU is attached. UK, SWEDEN TO ADVOCATE VALUE OF HEDGE FUNDS, PRIVATE EQUITY: -------------- -------------- ¶18. (SBU) Britain and Sweden, which takes over the EU's rotating presidency on July 1, agreed to work together to explain to other uropean nations the valu%ovenment and Financial Market Mats Odel. On JulQ 1, Mr. Odel warned that the EU's focus on hedgQ funds and private equity is misguided and exaggerated, as neither is responsible for this crisis, and would lead to overregulation. CMMISSION GIVES CEIOPS A TIMETABLE FOR LEVEL 2 AQD THIRD COUNTRY EQUIVALENCE WORK: -------------- -------------- ¶19. (SBU) The European Commission has publisheda letter dated 12 BRUSSELS 00000931 005 OF 005 SUBJECT: EUROPE FINANCIAL AND ECONOMIC REPORT: July 4th, 2009 SUMMARY: Following is the biweekly financial report from the U.S. Mission to the European Union. The report is divided into three sections: Economic Conditions and Policy, Financial/Monetary Conditions and Policy and Financial Supervision/Regulation. June 2009 to the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) providing an update on the Solvency II project and the CEIOPS' work on developing Level 2 implementing measures (Level 2 measures) and on third-country equivalence. The Commission intends to have Level 2 measures in place at least twelve months before the Solvency II regime comes into effect, to CEIOPS is invited to provide its final advice on Level 2 measures by the end of January 2010. On third country equivalence, the assessment process will be split into two phases, the first for the development of the general criteria to be used for the assessment (and which will be subject to the scrutiny of the European Parliament),and a second one to carry out the actual assessment of individual third-country supervisory regimes (which will take the form of a Commission's decision). CEIOPS is requested to provide its final advice on the general criteria by March 2010, and on the actual assessment of the regimes of the first wave of third countries by July 2011. COMMISSION MOVES TO FORCE MEMBER STATES TO IMPLEMENT RULES ON ACCOUNTING AND AUDITING: -------------- -------------- ¶20. (SBU) The European Commission decided to refer Austria, Ireland Italy and Spain to the European Court of Justice over non-implementation into national law of the Statutory Audit Directive, whose deadline expired June 29, 2008. The Commission also decided to make formal requests to Belgium, Ireland, Greece, Luxembourg, Poland and Portugal as they have failed to fully implement into their national laws the latest Directive in the field of accounting within the prescribed deadline of September 5, 2008. Commission publishes expert group report on credit histories: -------------- -------------- ¶21. (SBU) On June 15, the European Commission published the report of the expert group on credit histories, which had been mandated to identify solutions that would improve the access to and exchange of consumers' credit data within the EU. The report calls for action in a number of areas to improve the access to and quality of credit data, and identifies the sharing of credit data between creditors to assess borrowers' creditworthiness as key in order to enhance the quality of creditors' loans portfolio and assist compliance with responsible lending obligations. The expert group points out that cross-border lending is hindered by numerous differences in national credit reporting systems, but acknowledges the high costs of radically changing national credit register systems. Thus, the report rejected global and complex solutions such as setting up a pan-European credit register or aligning all Member States to a single credit data model. The consultation is open until August ¶31. MURRAY