Wednesday’s Great Expectations

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The future of the EU is dominating the general mood on the financial markets this week. It is expected that any deal regarding the main issues of the European debt crisis will now be unveiled until at least Wednesday.

The Top issues are mainly three:

THE BAILOUT OF EUROPEAN BANKS - This has been one of the main disagreements between France and Germany. France wants the European Financial Stability Fund (EFSF) to operate as a bank that would lend to member nations on demand. Germany believes that this breaks treaties preventing the ECB from funding state spending.

THE PLAN ON BANK RECAPITALISATION - There is also disagreement about the pace of bank recapitalisation and the percentage loss bondholders should suffer if Greece defaults. It is thought that a new round of stress tests will result in banks having to raise around €110bn (£95.6bn) but no definitive position or confirmation has yet emerged from the EU leaders.

GREEK DEBT - There are talks about the size of the haircut holders of Greek debt will face should they default with a view to reducing Greece’s national debt but a final decision would be tough to reach. Germany wants private investors to agree to a 50 per cent haircut which will reduce the national debt to 120 per cent of the Greek GDP. However those holding the debt, mainly European banks, do not want to go so far way and propose a haircut of around 40 per cent. In any case, the amounts are far larger than the initial 21 per cent agreed in July and increases fears of Greece’s insolvency.

Markets have been in limbo whilst waiting for a solution that should initially have come today. Wednesday’s summit has been seen as “made or break” for the Eurozone and for the global economy. The Euro-Dollar rate lost some ground over the weekend whilst there has been hardly any change on the Sterling-Euro rate.

Sarkozy has added fuel to the fire after a bitter exchange with Cameron during a meeting of all 27 EU leaders this weekend. The French leader snapped at Cameron: “We are sick of your criticising and telling us what to do. You say you hate the euro, you didn’t want to join and now you want to interfere in our meetings”.

The British Prime Minister has expressed his fears that the solution to the European problems will end up creating is Franco-German domination that would impose regulations benefiting Paris or Frankfurt over the City of London.

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