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Latest European Union Treaty Focuses on Fiscal Compact

Latest European Union Treaty Focuses on Fiscal Compact

Christopher Vecchio, CFA, Tzu-Wen Chen,

Will the Euro-zone and the Euro survive the sovereign debt crisis? While the answer is unknown, what is known is that European leaders are exploring every avenue to find a solution that would keep the common market together. After the developments this past week, there is the possibility of another interim solution for those that choose to agree to the new treaty’s standards.

A draft of the European Union’s latest treaty, titled “Treaty on Stability, Coordination and Governance in the Economic and Monetary Union”, was released on January 27, 2012. The proposal focused on the obligations of each of the member nations of the European Union to work towards common objectives for sustainable growth, employment, competitiveness and social solidarity. These goals would be reached by each of the members following a set of rules to ensure budgetary discipline through a fiscal compact and to improve the coordination of economic policies.

The key points discussed in the treaty are highlighted below:

  • Government budget must be balanced or in surplus. The health of the budget is assessed against the medium-term objective for the annual structural, or non-cyclical, balance. This objective is country-specific as set out in the Stability and Growth Pact. What it means: countries can’t run deficits except in economic downturns, specific levels set by the Stability and Growth Pact.
  • If a member nation is not achieving its medium-term objective, corrective measures must be taken in line with the nature, size and time frame proposed by the European Commission. The Commission will evaluate its progress based on an overall assessment of the structural balance. What it means: the European Commission will step in if a country breaks the rules.
  • Deficits and government debts should not exceed 3 percent and 60 percent, respectively, of GDP. If government debt is more than 60 percent of GDP, the nation will need to reduce its debt at an average rate of one twentieth per year as a benchmark. If the deficit is excessive, it must also submit a plan to the Commission and Council with a detailed description of the structural reforms that must be implemented to correct the excessive deficit. The Commission and Council will monitor the implementation and progress of the program and yearly budgetary plans. What it means: the European Commission will step in if a country breaks the rules.
  • If the Commission finds that a nation has failed to comply with its corrective measures obligations, the matter will be brought to the Court of Justice of the European Union. If the Court finds that the nation has not complied with its judgment, it may impose on it a penalty payment. What it means: a country that then violates the Commission’s judgment would be fined.
  • Member nations must inform the Commission and Council of upcoming public debt issuance plans (ex-ante), to enable better coordination between member nations. What it means: Treasuries need to tell the Commission when they’re selling debt.
  • Member nations must discuss all major economic policy reforms that they plan to undertake ex-ante, and coordinate among themselves in an effort to work towards a more closely coordinated economic policy. What it means: countries lose some sovereignty and have to discuss all major economic policy reforms in the planning stages.
  • Euro Summit meetings will be held at least twice a year.

This latest Treaty will be come into effect from the earlier of January 1, 2013 or the first day of the month following ratification by twelve member nations. This, however, isn’t guaranteed. Today, Irish Prime Minister Enda Kelly warned that a referendum on the treaty would be held, if necessary. If this were to occur, an event as cataclysmic as Ireland leaving the Euro-zone could happen, though, this remains purely speculation at this stage of the Euro-debt drama.

Additionally, there are significant obstacles in the form of the Greek, Italian, Portuguese, and Spanish economies. Currently, no agreement has been reached on the Greek debt swap deal. In the bond markets, Italian and Spanish 10-year bonds continue to hover in the 5.500 to 7.000 percent yield range, while Portuguese 10-year bond yields have recently jumped over the 15 percent threshold. Structurally, problems exist too: Euro-zone unemployment is at its highest rate since the inception of the Euro, with Spanish unemployment just a hair below 23 percent.

EUR/USD Daily Chart: September 2011 to January 2012

Latest_European_Union_Treaty_Focuses_on_Fiscal_Compact_body_Picture_2.png, Latest European Union Treaty Focuses on Fiscal Compact

Charts created using Marketscope– Prepared by Christopher Vecchio

In summation, while the treaty provides (another) starting point for reforms to take hold and progress to be made, market participants will need to see results before pressure on the EUR/USD eases. Should these pressures pick back up in the coming days and weeks, we would expect the EUR/USD to head back towards its year low of 1.2626 with relative ease. At the time this report was written, the EUR/USD was already well-off its January high of 1.3236, trading at 1.3088.

--- Written by Christopher Vecchio, Currency Analyst, and Tzu-Wen Chen, DailyFX Research

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com.

Follow him on Twitter at @CVecchioFX

To be added to Christopher’s e-mail distribution list, send an e-mail with subject line "Distribution List" to cvecchio@dailyfx.com.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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