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Europe awaits eagerly a comprehensive solution for the debt crisis

Europe awaits eagerly a comprehensive solution for the debt crisis

Wednesday’s meeting of Euro Zone leaders was given added impetus yesterday – as if it needed it – with the release of the flash estimate of Euro zone PMI, which showed a deeper than predicted contraction to 47.2, against expectations of 48.8. The Euro Zone service sector was the main drag on the survey, with France in particular experiencing a sharp contraction. Manufacturing also moved further in to contraction and the data showed German manufacturing shrinking for the first time in two years. It now appears that the weakness affecting the European periphery has now spread to the core. The stalling of new business across both the manufacturing and service sector indicates that future readings are likely to deteriorate further.

Confidence that the all-encompassing solution to Euro Zone crisis will be announced tomorrow has subsided slightly over night. Italian Prime Minister, Silvio Berlusconi, yesterday warned other European leaders that no one is in a position to teach lessons to their partners. This will raise concerns in Berlin and Paris that Italy is unlikely to have progressed plans to reform the labour markets and trim the countries generous pension system. Also, Charles Dallara, managing director for the Institute of International Finance and the lead negotiator for the private sector, warned that European and IMF demands for a 60% hair cut on Greek debt crossed the line on what could be considered voluntary. He argued that if this was the case, then it would be a default which would isolate Greece from the international capital markets for many years.

Meanwhile, Angela Merkel yesterday faced the difficult task of persuading the Bundestag to approve plans to increase the firepower of EFSF. She had to ensure them that the German public would not have to stump up further funds, as these would be supplied by financial engineering.

It now appears that there are two options which are being looked at for increasing the EFSF. The first option is the insurance model in which the EFSF would guarantee the first fraction of losses to buyers of sovereign debt. The second involves generating capital from European and non-European public and private investors through a special purpose vehicle attached to the IMF.

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