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A team of Citi analysts led by Chief Economist Willem Buiter predict that the European Central Bank will ultimately step in to save the eurozone, but not just yet.According to an investor note released yesterday, four conditions must be met in order to warrant stronger ECB action:
- “Market conditions need to be very tight and disorderly.”
- “Policymakers of countries in need of ECB support, such as Italy or Spain, would need to make credible commitments to undertake further fiscal and structural reform.”
- “Policymakers of creditor/donor nations, notably Germany, would need to commit to increasing their own fiscal support activities.”
- “Euro area governance rules have to be tightened immediately, including the commitment to introduce automatic penalties for countries that do not comply with the fiscal rules of the enhanced Stability and Growth Pact.”
The team thinks these conditions will be met, “potentially in a matter of weeks and certainly in the coming months.”
Until it can participate in primary bond markets, the bank will step up sovereign debt purchases in secondary markets. But the long-run picture still looks murky.
Here’s what’s going to happen:
In our central projection, two or more insolvent sovereigns (Greece, Portugal and possibly Ireland) undergo orderly debt restructuring in 2012-13. We also expect a ring-fencing of the illiquid but most likely solvent sovereigns (Italy, Spain, Belgium, France and Austria) through greater ECB involvement, directly or indirectly, as lender of last resort for sovereigns, through enhanced EA-wide fiscal facilities and through extra-EU assistance, most likely organised through the IMF. This suggests that after increasing market stress and further widening of sovereign bond spreads in 1H 2012 spreads are likely to narrow in the course of the year, but to remain at high levels. Finally we expect fiscal support, through national governments or through common EA or EU institutions or facilities (such as the EFSF or the EIB), for bank recapitalisation and for term bank funding. In addition to the limited further fiscal integration in the EA implied by our central projection for 2012, we also expect the euro area countries to commit to and take the first steps towards deeper fiscal integration to prevent and mitigate future fiscal debacles. Joint and several guaranteed E-bonds can be part of this medium-term scenario, but are unlikely to figure prominently in the solution of the present crisis.
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