EU surprises mkts; banking body needs teeth: StanChart

In an analysis of the European markets, Sarah Hewin, senior economist, Standard Chartered explains to CNBC-TV18 that the EU summit surprised the markets by announcing solutions to address the short-term problems instead of discussing measures which would take effect only in the medium term.

Hewin also adds that the banking regulator will have to be granted with powers to control the smaller banks which have been one of the sources of the economic crisis. Below is an edited transcript of the analysis on CNBC-TV18. Also watch the accompanying videos. Q: What do you make of the banking compact announced by the European Union? Does this compact put a floor to bond prices as well as banking shares or do you think there will be enough hiccups to take Spain's yields back to the 7%-mark?
A: We have certainly seen a good rally on Spanish bonds and equally significant moves in Italy and Ireland. I think the initial response of the market to the EU Summit has been positive. What remains to be seen is how the market deals with the details.
In terms of a banking union, the commitment will start with a banks supervisory body led by the European Central Bank. This is not going to come into being until later this year or early next year with some detail yet to be ironed out. But it does mean that Spain's banks can be recapitalised without the Spanish government taking on board the debt. It certainly is a positive step. Q: So you mean Spanish banks can be recapitalised before the regulator is in place?
A: The Spanish banks will be recapitalised ahead of the new supervisory body. And what will happen initially is that they will probably tap the funding from the temporary bailout the EFSF that will transfer to the European Stability Mechanism which is the permanent bailout fund once that is operational.
Ultimately, when the new supervisory body comes into being, the debt will no longer be on the Spanish government’s books. So the debt will not be Spanish government debt. Q: Do you think the changes announced at the EU summit were cosmetic? Do you think the summit has restored market confidence enough to a level where yields may not skyrocket again?
A: The summit certainly addressed some of the immediate problems. The concerns of the markets last week had been that the summit was really only going to be discussing longer-term issues such as the move towards a banking and fiscal union which are all steps in the right direction, but will only take effect over the medium-term.
In reality, the summit announced steps to address the immediate problem of high borrowing costs, particularly for Spain and Italy, which took effect by Germany conceding that the governments could use the bailout mechanism to buy bonds in the primary and secondary markets.
That was the reason for the rally in bonds and the yields falling quite sharply in Spain and Italy. Ireland also turned a beneficiary because the increase in the Irish government debt, and the high level of debt is largely a result of the bank bailout.
So if banks can be recapitalised through a bailout mechanism rather than the government stepping in, it is a positive for Ireland. Q: Perhaps the next event to watch would be the ECB effect a 25-bps rate-cut. What do you expect? Do you think there could be discussion on further LTROs or further easing by the ECB?
A: The market sort of increasingly anticipates a 25 bps rate-cut. A rate-cut is expected either in the second or third quarter and some of the recent announcements from the European Central Bank have raised market expectations of the rate-cut that likely to occur sooner rather than later.
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Another LTRO again may not possible. Some strain on bank funding is beginning to emerge in the region. The ECB would probably want to keep its powder dry to a certain extent just in case there is an escalation in the crisis.
So a rate cut is more likely than a LTRO. If we do see another LTRO, it will possibly be for a year rather than three years at this point. Q: Is the banking union going to be glitch-free? Will the regulator, while providing funds for recapitalisation, establish a few caveats?
A: Germany wants to keep its own banks under control and will use the banking union as largely relating to the large cross-border banks. But the banking union will need to have some supervisory powers over the small banks because largely that is where the problems have arisen.
So it is feasible that in time some aspects of the banking union might will run up against national concerns and if the process is not smooth, then that carries its own risk.
The other issue is the bailout funds. There was always a concern that bailouts sums were not large enough to bailout Italy, and that situation has not changed. All that has changed is that there is more flexibility being conceded by Germany.
Finally for Greece, the troika (the European Union, the European Central Bank and the International Monetary Fund) are back in Athens this week and there is potential for confrontation between the Greek government and the creditor countries. Q: I know you are an European specialist at StanChart. Nevertheless, do you think this increase in risk in asset classes might have further steam, especially in crude? There's been a big jump in crude prices. Will Brent cross USD 100 or will it stay much below that?
A: Standard Chartered's view is that Brent will move higher in the second half of this year partly as a result of sort of very gradual pick up in demand from China and emerging economies getting mildly stronger in the second half of the year which should underpin demand.
At the same time there are supply constraints that need to be borne in mind. So I guess a lot of movement recently has been on a sort of risk aversion and real worries about the outlook for China which were probably overdone. Certainly, a pick-up in demand from the emerging economies is expected in the second half of the year.