Sarkozy and Merkel Reach New Agreement

Joel Anderson  |

News that German Chancellor Angela Merkel and French President Nicolas Sarkozy have reached an agreement on amending the European Union treaty as part of a more comprehensive plan for settling the debt crisis was well-received by the markets this morning.

The deal has long been anticipated as markets responded tepidly to the series of smaller moves and half measures throughout the last year intended to avoid a collapse. However, the new plan, which will still have to be approved at the upcoming EU summit on Thursday and Friday, is much more comprehensive, creating a plan for the future that should prevent countries from falling into budget crises to begin with. The new agreement calls for all members to keep their annual budget deficits under 3 percent of GDP while total debt cannot exceed 60 percent of GDP. This may sound familiar as it was part of the original EU treaty, but weak implementation and a lack of enforcement led to a number of members breaking the rule without consequence. Merkel and Sarkozy, though, have agreed to a series of automatic sanctions to keep EU nations in line. The sanctions could be blocked by a super majority, but it reverses the old system where sanctions could only be implemented through a majority vote.

The new agreement also features a new "Golden Rule" for balanced budgets, makes it easier for member nations to go after budget practices in other member nations, and gives the European Court of Justice the power to determine when sanctions are to be applied. Merkel and Sarkozy intend to submit the new plan to the European Union during a meeting of leaders on Thursday and Friday and hope to get the unanimous support of all 27 members. However, even without full support, Merkel and Sarkozy are confident that they can pass the agreement with the support of those 17 countries in the Euro Zone. "We will see whether it will be 17 or 27," Sarkozy said during a joint news conference with Merkel. "But we're going full steam ahead to re-establish confidence in the euro and the euro zone."

“At first glance, today’s plans should give the euro zone a clear head start in maybe the final week of truth. Now, the big challenge will be to put everything on paper and to convince the European partners,” said Carsten Brzeski, an economist at ING Bank in Brussels. However the plan is viewed, the existence of a structured agreement on how to move forward could mean an end to the spiraling debt crisis sooner rather than later and investors reacted to the positive news. The plan's intent was to reassure bond traders that European sovereign debt is safe, with Sarkozy and Merkel promising investors that the 50 percent haircut on Greek bonds earlier this year was a one-time deal, and yields at Spanish and Italian auctions plunged as a result, with the return on Italian ten-year bonds retreating over 50 basis points to get under 6 percent.

Markets in the United States also responded positively, with all three major indices gapping up and holding gains of about 1-1.5 percent until an afternoon sell-off. As one might expect, financial stocks were up across the sector in response to the news. Among the biggest gainers were foreign banks, with Lloyds Banking Group PLC (LYG) gaining nearly 10 percent, Royal Bank of Scotland Group plc (RBS) up over 6 percent, and ING Groep N.V. (ING) jumped almost 5 percent. Major financial institutions at home, though, were also on the move. Morgan Stanley (MS) and Citigroup (C) both gained over 6.15 percent.

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