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The European Commission’s Bazooka is a route to recovery, but will struggle for backing

28 May 2020
Following last week’s high-profile joint Paris-Berlin proposal for a €500bn European Recovery Fund, the European Commission outlined their plan today, which called for the power to borrow €750bn to help the region through the coronavirus crisis.

Markets initially reacted very positively to the news with the single currency jumping nearly one big figure versus the dollar. This blueprint is definitely another step on the way to potentially transforming the EU’s central finances, but as always, strong obstacles lay ahead.

As we detailed, the half-trillion euro recovery package from Germany and France was impressive on the face of it, but may have lacked size with the timing delayed as well. However crucially, all of the fund was to be handed out in grants which the southern states demanded.

‘Next generation EU’

The commission’s proposal matches this ambition and then some, with the total package worth €750bn made up of €500bn in grants and €250bn in loans. This will be financed by bonds issued by the EU, backed by the EU budget and guarantees from EU member states, with the repayment period lasting until 2058. The grants will be targeted towards the hardest hit parts of the EU with Greece, for example, receiving aid worth more than 13% of its 2019 GDP, Spain close to 6% and Italy around 5%.

Interestingly, one of the major changes to recent policies concerns the pitch of new EU taxes and levies to pay back the debt over the coming decades, raising funds from areas including carbon emissions and a new digital tax hitting the tech giants. This part of the repayment plan is a potential solution to the everlasting discussion about own resources for the EU.

Game changer part 2?

The Commission’s plan is the next part of the ongoing discussions (and no doubt drama) that the EU always undergoes to get approval from all EU members, as we continually point out when discussing eurozone economic policies. Certainly, it signals a potential to boost confidence that member countries are committed to supporting the union in times of crisis and having the backing of the two major European powers is key. Boosting the recovery of those economies worst hit by the pandemic is of course also a massive possible boon for the bloc.

‘Frugal 4’ to dampen down plans

However, unanimity among all the states is required to pass any new fund and there are diverging views, especially from the Netherlands, Austria, Sweden and Denmark who have been anti-grants and highly sceptical of the German-French proposal, raising their own plan of conditional loans.

Details are all important and there are still many questions - how quickly will the funds be in use and if there is any conditionality to promoting real economic reforms. The latter is perhaps a more long-term concern, especially to some net contributor countries, as condition-free fiscal transfers risk a form of moral hazard going forward. New funding sources for the EU budget have also tended to be highly controversial among national governments.

Burden-sharing is strongly opposed by the ‘frugal ‘four’ and other member states so expect there to be much horse-trading in the next few weeks, with the next EU summit on June 18/19 in sharp focus. Interestingly, the rotating EU presidency moves to Germany from the start of July - does German Chancellor Merkel sign off her leadership with a grand show of deeper integration?

EURUSD at the top of the trading channel

The EUR broke the 200d MA at 1.1012 for the first time since late-March after the new proposal news broke but has pulled back slightly below 1.10. Gains need to extend beyond the 1.10s in the coming sessions to break the narrow 1.08-1.10 range we’ve been in over the last couple of months.

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