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Can EUR break out on recovery fund agreement?

Jul 9, 2020
EU heads of state and government will meet a week Friday to discuss the €750 billion recovery fund initiative aimed at alleviating the economic damage of the coronavirus crisis. The face-to-face negotiations will bring together the northern and southern states, including the infamous ‘frugal four’, for intense negotiations around a proposed €1.85 trillion package that includes the region’s seven-year budget. Who will come out smiling and can this push the single currency higher?

The planned €750 billion ‘recovery and resilience facility’ proposed and inspired by Franco-German plans has already been supportive for European assets. By reducing the significant tail risks of a Eurozone breakup during the pandemic crisis and causing a compression of core and non-core bond spreads, sentiment towards the single currency has been boosted.

Let the backroom horse-trading commence…

We now get to the hard part where EU leaders will have to bridge the deep divisions that exist between member countries if they are to achieve a historic breakthrough next week when they hold their first physical summit in five months. On the table will be Brussels proposals for the €560 billion fund, €190bn of further debt issuance to finance other policies, and draft plans for the next budget.

It is the latter which has traditionally involved tough late-night negotiations to accommodate all the members wishes. But it also lends a degree of heightened urgency as the new seven-year budget must start on January 1 and agreement needs to be reached quickly in order to allow for the inter-institutional discussions to start as well.

Frugal Four sticking point

If the budget isn’t hard enough to reach agreement upon, nations are at loggerheads over the extent to which the recovery fund should be given out either in the form of grants or loans, plus the allocation criteria that will determine who receives what. How all these funds will be financed is yet another issue, perhaps the key long-term one, with the European Parliament keen on creating new revenue streams for the EU budget. Known as ‘own resources’, ideas already facing resistance include a digital tax on the tech giants and a carbon border tax.

This joint debt is the critical issue for the ‘frugal four’ countries – the Netherlands, Sweden, Denmark and Austria - who want the fund to be smaller and more of the cash handed out as loans, with strings attached. Effectively, these countries and others like Finland are demanding a greater role in approving national plans so that the countries receiving the funds, mainly the southern member states hit hardest by the pandemic, implement the necessary agreed reforms. On the flip side, Spain, Greece and others would like a less political process where they can choose their own priorities for reform with the Commission having more say.

Middle ground to be found…eventually

EU negotiations are a classic case study in how heated debates eventually lead to some sort of compromised agreement. German Chancellor Merkel has ramped up the pressure by saying the EU “is facing its biggest challenge ever” and the fact that any EU country can veto the budget-and-recovery package is also in the back of many continental minds. As we mentioned in our initial assessment of the recovery fund a few weeks ago, particularly instructive may be the fact that Germany now holds the rotating EU presidency, so Chancellor Merkel may be keen to sign off with a historic integration message.

EUR/USD cycle highs ahead

Technical trend signals are lining up quite positively for the euro with the recovery from the April-May lows appearing to consolidate ahead of another move higher. The June high at 1.1422 is the near-term target to crack before a push higher to 1.1660. This major resistance is at the 4-year trendline and a break here would indicate that a longer-term bottom is in place at the March low of 1.0635. Of course, any major upset in EU plans will see a sell-off with strong support at the bottom of the recent consolidation around 1.1168.

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