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April 16, 2018

Italy's and Germany's pained response to the Syria attacks

Donald Tusk welcomed the missile strikes by the US, the UK and France. Federica Mogherini did not, while emphasising the need for a political solution in Syria.  

It is in Italy where the issue is politically at its most sensitive. We assume that Mogherini's reticence is related to a need to salvage her own political career, as the next Italian government will almost surely not nominate her for a second term at the Commission. Silvio Berlusconi produced a luke-warm endorsement of the military action, and recommending Italy as a potential interlocutor between the US and Russia - an idea we find preposterous. Matteo Salvini condemned the attacks, leaving no doubt that he is on the Russian side on this conflict. There are no points to be scored in Italian politics by supporting of Donald Trump, Emmanuel Macron, or Theresa May. We are at the point where Italian politics is becoming a serious issue for the cohesion of the EU. 

In Germany, politicians tried to combine two positions within themselves. Angela Merkel formally supported the action, but rejected German participation. President Frank-Walter Steinmeier also defended the action, but said it was wrong to demonise the Russians. At least the German coalition managed to avoid an overt split as its most senior members have issued very similar sounding statements. 

In substance, however, the German reaction is the same as it always was: a pretence of solidarity but with no willingness to participate in military action. This is the same attitude as in the discussion on Nato defence spending targets. As the German media have been reporting, the country's Tornadoes and Euro Fighters are now such a decrepit state that they are no longer deemed fit to participate in Nato missions.

In view of Germany's hardening position on eurozone reform, we are wondering how Syria will affect the Franco-German relationship. Macron must surely be realising that Germany is not the partner he had hoped for.

FAZ also notes that (unlike in the UK) Germany cannot participate in such action without an explicit vote by the Bundestag. The paper notes that Germany is now very likely to come under increasing pressure from its partners, as it did when it refrained from participating in the campaign against Libya. It was only the subsequent perception that this campaign had worsened the political chaos in the country that criticism of Germany became more muted, but it is not clear this will so again.

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April 16, 2018

On the end of the eurozone's economic honeymoon

We noted last week a string of disappointing economic statistics coming from Germany. We are not sure that this is the beginning of an economic downturn - German figures are notoriously volatile. But there is some interesting corroborating evidence from Gavyn Davies. His hedge fund has produce a so-call nowcast - an estimate of economic indicators as they would be right now - showing a decline in the eurozone's economic activity to about 1.2%. This is a sharp drop from the levels recorded as recently as January, when the rates exceeded 3.5%. This decline in activity is not mirrored in other parts of the world. It is specific to the eurozone. 

Davies makes the point that the combination of survey data and hard statistics moving in the same direction is a sign that something is afoot, a view we tend to agree with. He offers two explanations. The first is the waning effect of QE. The second is supply constraints now starting to bite. The two are not mutually exclusive. We also thought it was implausible that the eurozone would singularly emerge from the crisis with a permanently higher growth rate. The end of austerity in combination with monetary easing provided a stimulus, the effect of which has now disappeared as both fiscal and monetary positions are no longer loosening relative to previous years. Davies notes that the economic uncertainty will persuade the ECB to remain dovish for a while, a view we also agree with.

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April 16, 2018

Why Bulgaria should stay out of the euro

When Bulgaria assumed the rotating EU presidency this semester, it signalled its intention to apply to join the exchange rate mechanism ERM 2 by mid-year - the last remaining prerequisite for euro membership. But is that a good idea? There are misgivings about high levels of corruption hindering Bulgaria's participation in the banking union, and the country already had its application to join Schengen rejected in the past on similar concerns. Now Henrik Enderlein, Max Emanuel Mannweiler, and Lucas Guttenberg argue that Bulgaria would be better served by staying with its currency board arrangement than joining the eurozone, because of the additional flexibility this allows.

The authors note that the Maastricht convergence criteria are not sufficient to ensure sustainability in the eurozone. After the eurozone debt crisis the European Commission adopted a macroeconomic imbalance scoreboard. Of these the indicator that is most out of range is the net international investment position, which shows a net liability of 60% of GDP according to the Commission's latest country report on Bulgaria, when the threshold is 35%. Another issue for Bulgaria is the high proportion of non-performing loans in its banking system, 12.5% which is about twice the eurozone average. 

As to institutional flexibility, having a currency board already imposes strong constraints on Bulgarian economic policy. The flexibility the authors refer to is the ease of access to EU support in case of a balance of payments crisis. They point out that eurozone member states only have recourse to ESM programmes with stiff conditionality, while non-euro countries can access the Commission's balance of payments facility which was tapped by Latvia, Romania and Hungary at the height of the financial crisis with little controversy.

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April 16, 2018

Where shall we meet after Brexit?

How will Ireland and the UK work together after Brexit? Leo Varadkar proposes to hold annual joint meetings of their cabinets to bolster the relationship between both countries post-Brexit, according to the Irish Times. Varadkar suggested this to Theresa May already back in February when they met in Belfast but he only made it public last Friday. The idea is to hold meetings similarly to those involving the French and German cabinets once a year. Currently the EU council meetings allow the two prime ministers to have one-to-one meetings five or six times a year. This will change with Brexit. There are other institutions in place that deal with the bilateral relationship such as the British-Irish Council, but they have specific roles, many arising from the Belfast Agreement. A cabinet meeting allows talking about things that are fundamental to the politics and trade between the two countries but are not covered by other arrangements.

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