Judging from the prevailing mood in financial markets, this was a good week. The Dow Industrial stock index continued its flirt with the 13,000 points mark. Economic data in the U.S. continued to look encouraging despite some cautionary words from the Chairman of the Federal Reserve (FED) Ben Bernanke. Overall, U.S. buoyancy and the launch of the second tranche of the European Central Bank’s (ECB) cheap loan program for banks largely offset bad economic data (particularly on unemployment) in Europe. Overall it was the bulls that carried the week.
However, widespread relief about brightening economic skies could be followed by a cold shower, particularly if politicians let their guard down now. Looking at Germany, this week already offered enough worrisome developments to chew on. It all started with the vote on the latest Greek rescue package in the German Bundestag on Monday, which offered both good and bad news. German lawmakers overwhelmingly endorsed the latest Greek bailout package of 130 billion euros. However, it is now clear that German Chancellor Merkel’s government majority is shrinking, and that resistance to the series of deals to rescue the euro is still growing. Seventeen lawmakers within the Chancellor’s coalition opposed the latest Greek package, and others failed to turn up to vote or abstained. Merkel had to rely on the main opposition parties to obtain an absolute majority of the votes necessary to carry the day convincingly. Tellingly, thanks to Germany, the week ends on a low note with a summit in Brussels that will fail to deliver on the only decision everybody is waiting for — strengthening Europe’s firewall. Merkel needs time to regroup and assess the political damage. German media have started painting the picture of a Chancellor suddenly weakened, both at home and abroad.
To be sure, for all those Europeans who insist that a bigger firewall is a crucial mechanism to halt this crisis, the delay was a setback. However, if there was disappointment in the capitals of the old continent, it did not show. Italian Prime minister Mario Monti confidently told Bloomberg News that he still expected an agreement by the end of the month. In a separate interview, the head of the Euro Group, Luxembourg’s Prime Minister Jean Claude Juncker, echoed Monti’s words. The French government chose to keep quiet. Europeans are still behaving as if they have received assurances from Merkel that she will agree to what, in Germany, is still a very controversial step. And crucially, financial markets have already priced in a larger firewall. All leading political actors involved in this delicate kabuki dance know that it would be unwise to disappoint investors now that they are just beginning to regain some level of confidence.
For those anxiously waiting for a German decision, it must have been heartening to read German papers on Thursday March 1st. Quoting unspecified government sources, the daily Sueddeutsche Zeitung reported that Merkel told her government allies that the discussion on a bigger firewall, specifically about folding the financial firepower of the temporary European Financial Stability Facility (EFSF) into the permanent European Stability Mechanism (ESM), can no longer be avoided.