Merkel between Devil and deep blue sea

Top officials in Brussels believe that Italy “cannot be saved”, The Slog has learned. Influential sources there believe that the EU is moving too slowly to keep ahead of the markets….and that the indecisive debate about eurobonds is representative of this.

As Nicolas Sarkozy and Angela Merkel prepare to meet at their Berlin Summit this afternoon, officials back in Brussels are offering the opinion that without a eurobond being introduced into the mix, Italy’s borrowing costs will continue to rise faster than Jean-Claude Trichet’s Italian bond-buying programme can take the junk off bank balance sheets. As The Slog reported yesterday (in contrast to several other news media) Sarkozy and Merkel had already agreed a joint line stating clearly that eurobonds were “not on the agenda”.

The ECB is meant to purchase sovereign bonds until late September, at which point the EFSF euro bailout fund is sheduled to take over the job. But the ECB bought twice as many bonds already – in a day – than it bought all last week. Credit sources have suggested to me that even a medium-term bill could be €300 billion….thus eating up most of the EFSF budget should it happen on its watch. And with French loan infection sliding onto the radar last week, the EFSF is increasingly being seen by the markets as a Toytown fund. So inevitably, the eurobond solution looks like the only one left in the armoury.

The two leaders may now very quickly be forced to unagree their pre-Summit line: but if they do – which seems unlikely – the German leader is going to face serious problems keeping her Coalition in order. As Der Spiegel opines this morning:

‘….the government coalition in Berlin — made up of Merkel’s center-right Christian Democratic Union (CDU), its Bavarian sister party, the Christian Social Union (CSU) and the business-friendly Free Democratic Party (FDP) — is getting increasingly nervous. Senior party officials are worried they might not secure majorities in the upcoming votes on the euro bailout package in the Bundestag, Germany’s federal parliament. What’s more, they’re afraid that Trichet’s controversial bond plan might spark opposition within their own ranks….’

Above all, what most German Parties fear is inflation. If it carries on at this rate, the ECB bond-buying scheme cannot be other than inflationary.

So, to summarise: the EFSF can keep on bond-buying, producing inflationary pressures that will destabilise the Merkel Government; or a eurobond can be created to make all eurozone members severally responsible for debt, except that France can’t afford that, Merkel is firmly opposed to it, and German voters have no intention of picking up the tab for French (and other) banks going under. But as the eurobond has been rejected as an option at this session, officials in Brussels say Italy cannot be saved from spiralling debt costs – and eventual need of a bailout.

When told this kind of stuff, of course (“Italy is dead”) one always has to look for the agenda behind the leak….and at the moment, Brussels Sprouts are leaking Italy’s imminent demise all over the place. So one has to see it as probably designed to ratchet up the pressure for a eurobond. But that doesn’t alter the fact that the markets are close to writing off Italy….and probably Spain. Said one senior London-based manager yesterday:

“It’s the same old same old, really. Lots of German denial and smiley French faces, but always at last three beats behind the music. Merkel is defending her domestic position, and Sarkozy is protecting his banks. Reality doesn’t get a look in”.