Weekly Update - A Busy Week in Europe

Last week’s European Council brought together the 27 EU leaders for a two-day summit. One of the key items on the agenda was the approval of the next multi-year EU budget of €1.1tn and the €750bn recovery package – also known as the Next Generation EU fund. The fund was launched at the July summit, but its formal approval had been held up by pushback from Poland and Hungary regarding provisions making disbursements from NGEU conditional on the respect of the rule of law.

Thanks to the compromise struck last week, the European Commission will be able to push ahead with the issuance of € 390bn in EU debt which will be jointly guaranteed by members, a first for the Union. The proceeds from the bonds will be distributed in the form of grants to member states, with the remainder of the package coming as loans. The €750bn total represents around 5.4% of EU GDP and its disbursements will be skewed towards those members most in need – Italy for example is set to receive around 10% of its GDP in total and Spain some 14% (their domestic support measures this year represented 3.6% and 2.9% of respective GDPs).

The ECB’s last meeting of the year brought no surprises – the Pandemic Emergency Purchase Programme was boosted by €500bn to €1.85tn and will now continue until March 2022 while the support measures for bank lending were increased by €300bn and extended until June 2022. With headline euro zone inflation falling to -0.3% year-on-year in November and the economy back in lockdown-induced recession in Q4, easy monetary policy is likely to remain in place for years to come. Brexit negotiators are running out of time. The UK exited the EU on January 31 this year and the transition period – during which it remains part of the single market and customs union – will end on December 31. Yesterday, the European Parliament’s Conference of Presidents stated that an agreement on trade would have to be finalised by Sunday to enable the Parliament to organise an extraordinary session before year-end to approve the deal.

It does appear from press reports that negotiators have made progress on the remaining stumbling blocks – fishing rights, state aid provisions and governance – but as yet no final agreement is in sight. Of course, the EU has accustomed us over the years to last-minute deals just when one was least expected. Looking at sterling, which reached its high for the year yesterday against the dollar at 1.3585, it appears that traders are convinced that another eleventh-hour agreement will be struck.

Bottom line. The NGEU deal eases market concerns about euro zone breakup and reinforces our conviction that the euro will continue to gain ground next year. The ECB’s asset purchases will serve to keep bond yields low for both core and periphery euro zone borrowers, a positive for financial markets in 2021 and beyond. The resumption of dividend payments by euro zone banks is good news but should not hide the fact that flat yield curves and rising bad loan risks are lasting negatives for bank profitability. And finally, a Brexit trade deal may see sterling spike a bit higher, but the move should prove short-lived – whatever the terms of the agreement, trade with the EU (the UK’s main export market) will be handicapped next year.

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