Archives for July 2010

Europe's dog days are here. Not those sultry, cloying, enervating weeks of the Washington summer. Not the oppressive stillness. But the sparseness of Brussels's streets, the absence of traffic, the empty tables where only weeks ago they doled out moules at 25 euros a throw. There is that feeling of somehow being left behind. Most of the Eurocrats have caught the fast train to the coast.

By reputation the dog days bring no joy; they come with a bad rap. These were the times "when the seas boiled, wine turned sour, dogs grew mad, and all creatures became languid".

So far the wine seems to be holding up, but these are certainly weeks of languor, a dreamy, lazy time-out. And Europe's elite are gliding off to their gites, villas and palazzi in surprisingly good spirits.

The worst didn't happen. The euro has not only survived - it is at a perky 11-week high. The European project which wobbled for awhile has settled back again, weakened surely, but out of danger. There are green shoots everywhere.

Business confidence in places like Portugal is at its highest since 2008. In Italy sentiment is at its peak for two years. The German economy is booming. The costs of insuring against countries defaulting (the much-accused credit default swaps) are at a two-month low. The bond spreads are tightening and the cost of borrowing for hard-up governments is falling. Growth forecasts are being rounded up. It may reach 1.5% by the last quarter. The talk of a double-dip recession is fading.

The European good life under a Tuscan sun can be resumed. There is a quiet satisfaction abroad. Earlier in the year the President of the European Commission, Jose Manuel Barroso, had railed against the intellectual glamour of pessimism. The French Prime Minister Francois Fillon said only last week that "we must not underestimate the climate of scepticism surrounding the EU, which could be fateful for it".

Some say that in the past few weeks Europe has started defying its critics. Others are counselling "not so fast".

The New York Times in an editorial this week was among the unconvinced. "In just a few months, " its editorial opined, "Europe's leaders have gone from panic to complacency about the future of the euro". "Today's complacency," it went on, "is so dangerous since none of the euro's basic problems... have been addressed".

Economic growth has reappeared, but it is uneven. Germany is pulling away; its unemployment is the lowest since November 2008. The words "economic miracle" have reappeared. Meanwhile in Greece growth and consumer confidence are flat and the economy only splutters in Spain.

The differences between Germany and some of the other euro countries are widening, not narrowing.

Then there is austerity. Much of it has still to kick in. In Italy MPs have only just approved their austerity package. Elsewhere it has yet to bite. There is wide disagreement as to its impact. Some believe the spending cuts will choke the recovery just as its starting. Others believe that confidence will only return when the deficits are reined in.

The crisis in the eurozone has raised again the question of how countries that are so different can inhabit the same monetary union. International bodies, like the IMF, have insisted that countries like Greece and Spain have to become competitive. This will not only mean wage cuts but "structural reforms" - making it easier to hire and fire for instance. In Greece they are trying to open up road freight to competition. The result is that Athens is running out of fuel as the fuel delivery drivers strike.

We do not know how Europe's workers will take to "structural reforms". Neither do we know how Europe's public sector workers will react to change. In France, which has hardly begun an austerity programme, there is widespread resistance to raising the pension age. The autumn will see public sector workers returning - and in what mood it is hard to predict.

Outsiders still see the heart of Europe's crisis as that it cannot sustain its comfortable way of life.

My eye was drawn to some analysis in the China Daily. "It was not widely known until now," the article read, "that the average wage of workers at the government-owned railway company in Greece was $75,000 a year. Some train drivers were paid as much as $130,000. That's about 10 times the average salary of the highly qualified ...train drivers in Hong Kong."

Now I've no idea whether these figures are true, and it is necessary to point out that China's workers have increasingly been complaining about their own working conditions, but the perception remains that Europe has been living beyond its means. Social programmes will be cut back. Countless painful questions will have to be asked. For instance, can it be sustained that staff in Belgium are paid travelling-to-work expenses?

When Europe's leaders return from their holidays they will immerse themselves in trying to prevent the eurozone crisis occurring again. Budgets and spending plans will be monitored. Those who break the euro's spending rules will be disciplined. Will that be enough to ensure the survival of the single currency, or will there be a push for fiscal union? And if so, what strain will that put on already frosty relationships?

Others see Europe's growth spurt dying away towards the end of the year. Gilles Moec of Deutsche Bank says "there's no big change in terms of the underlying macro picture; we're in for slow growth."

Slow growth will pose a huge challenge. Most observers accept that Europe cannot sustain its way of life with growth under 2%.

Two final thoughts. One of the stories of this crisis has been its unpredictability. All of us, officials, observers, politicians have reacted to events. We have been unable to see the twists and turns and the autumn looks no easier to predict.

The debate so far has been about crisis management. Considering the fundamental questions that are being asked, there has been relatively little soul-searching about whether the EU is on the right road, how it prospers in a world where power is moving to the nimble and politically ambitious countries like Turkey, Brazil and India.

On that note I, too, will join the ranks of the languid for a couple of weeks and head to Europe's hills. For those also finding ways to escape, bonnes vacances and thank you for taking part in this conversation.

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In Ankara today David Cameron made an impassioned pitch for Turkey to become part of the European Union. "I'm here," the British Prime Minister said, "to make the case for Turkey's membership of the EU. And to fight for it".

The Prime Minister said he was "angry" that Turkey's progress towards EU membership had been frustrated. He promised to remain Turkey's strongest advocate for EU membership. It was, he said, "something I feel very passionately about".

This fulsome embrace needs to be seen against recent fears that Turkey is increasingly looking east. The Americans say Turkey is being pushed to look for "other alliances" because it feels snubbed by Europe. Washington partly blamed European coolness for the fact that Turkey voted against new sanctions on Iran.

Certainly there is a confidence, even a swagger to Turkey. Its economy is growing by 11% a year. With a powerful economy comes influence. Ankara has been busy building links with Syria and Iran. It wants to become a power in the Muslim world. Its biggest trading partner is now Russia, not the EU.

There are plenty of voices in Turkey who believe they can do without the EU. Faith in eventual membership is ebbing away.

What has brought this about?

The EU accession talks are going nowhere. They are stalled with no breakthrough in sight. In truth neither President Sarkozy of France nor Chancellor Merkel of Germany wants Turkey as a full EU member. They want Turkey to settle for a second-class "privileged partnership". The French are committed to holding a referendum on Turkey's accession.

The Turkish view is that the "old powers" don't want another big player in the club. They suspect that public opinion in much of Europe is lukewarm or even hostile about 75 million Muslims joining the EU. The Turkish Prime Minister, Tayyip Erdogan, said "the EU will only be a Christian club without Turkey". He also, at one point, denounced what he called Angela Merkel's "hatred against Turkey".

There are, however, real issues that affect the road to EU membership.

Cyprus is a major roadblock. Turkey does not recognise Cyprus or allow its ports to be used by Cypriot vessels. It didn't help that a veteran nationalist, Dervis Eroglu, was elected president in the Turkish-backed area of northern Cyprus.

The EU is a secular union and there are fears that the Turkish government is moving away from secularism.

Turkey will also be judged on its stance towards Iran and its nuclear programme. On Monday the EU agreed on tough new sanctions against Tehran. Turkey faces a choice of either supporting the EU or enabling Iran to bypass the new restrictions.

David Cameron said today that "it's Turkey that can help us stop Iran from getting the bomb". He did not flinch from laying out the case against the Iranian regime: "Iran is enriching uranium to 20 per cent with no industrial logic for what they are doing other than producing a bomb."

Iran is rapidly becoming the biggest test as to where Turkey's interests lie.

Then there are the fears that if Turkey joins the EU, Europe will lose its identity. The politicians will have to have that discussion with the people of Europe if Turkey is to join. The people may have to be consulted. David Cameron addressed those concerns directly today "I will argue that the values of real Islam are not incompatible with the values of Europe."

Turkey for its part is watching and deciding whether it can be a bridge between East and West. The Turkish President, Abdullah Gul, said recently that Europeans "are at a point where they need to decide whether the Union is a closed entity, whether the current borders of the EU will define it for eternity, or whether it should plan 50 years ahead and think of its grandchildren, the future".

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As each month passes the moment draws closer. No one knows precisely when it will be, but the day is coming when either Iran abandons its uranium enrichment programme or it develops a nuclear bomb or it is attacked.

There is an urgency to events. The Russian President, Dmitry Medvedev, said recently, "it is obvious Iran is getting close to acquiring nuclear capability that can be used in theory to create nuclear weapons". The French President, Nicolas Sarkozy, said that Iran must be compelled to negotiate. It is the only way "to prevent a catastrophic alternative: the Iranian bomb or bombing Iran".

There is a new determination that the Iranian dance cannot continue. For years the ritual was the same. The West applied a little pressure. An Iranian negotiator hinted at compromise or talks, but nothing came of it and crucially Tehran gained time.

Now the European Union is expected to tighten the screw with a new sanctions package. European officials have described it as "by some way the most far-reaching sanctions adopted by the EU against any country". Considering the strong economic links that countries like Germany have with Iran it was thought agreeing to a tough package would be difficult. Officials have been pleasantly surprised as to how straightforward the talks were. "Now was the moment to send a very strong signal," said one.

The main target is the oil and gas sector, the backbone to the Iranian economy. The new sanctions will bar the "sale, supply or transfer of key equipment and technology for refining, liquefied natural gas, exploration and production".

New European investment in major sectors of the Iranian economy will be banned. More than 40 individuals and more than 50 companies will be blacklisted.

The ban on the sale of nuclear technology will be extended to dual-use goods that are also used in conventional weapons.

Any financial transfer from Europe to Iran above 10,000 euros will require notification with national authorities. Iranian banks will be prevented from setting up new branches in Europe.

There is the possibility that ships suspected of being involved in illegal activities will be stopped at sea.

Now the EU has chosen unilaterally to go further than the UN resolution of 9 June. It follows action taken by Washington against the Iranian energy sector.

So will it work? There is not much optimism out there, but there is agreement that serious sanctions have to be tried. The CIA director Leon Panetta says it could be a mere two years before Iran could develop a nuclear warhead. But on the key question of whether they can be dissuaded he is doubtful. "Will it deter them from their ambitions with regards to nuclear capability? Probably not," he concludes. Sanctions rarely bend the will of authoritarian regimes.

Many regimes might choose to compromise. The Iranian regime is still steeped in the mindset of revolution. It thrives on perceived plots. When under pressure they play the victim, arguing that outsiders are set on destroying the Islamic Revolution.

There are signs, however, that the squeeze may be hurting.

Tehran's ability to ship goods has been significantly reduced because Western insurance companies, under pressure from the US, won't insure Iranian shippers. Without insurance Iranian-flagged ships face problems using foreign ports. Lloyds has stopped underwriting gasoline exports to Iran.

Iran lacks refining capacity and is dependent on imports for 40% of its fuel needs. The United States has passed a law that authorises sanctions on "any entity that provides or helps Iran obtain refined petroleum, including supplies, shippers, banks, insurance and reinsurance companies..." The regime would fear the fall-out of petrol shortages.

There are reports that work on prestigious projects like the South Pars gas field is slowing without the relevant technology.

The International Atomic Energy Authority says that "longer term the development of (Iran's) oil and gas industry will clearly be adversely affected".

However, Iran still has access to Chinese technology. It may not be of the same quality as the Europeans provide but it can fill many of the gaps.

Already, and on the eve of the EU moves, there are hints that the Iranian negotiator Saeed Jalili might offer to talk as early as September. That is what the Europeans want, but they will be wary of being drawn into another inconclusive round of meetings. The bottom line for the international community is that Iran stops uranium enrichment.

As always it is difficult to read the Iranian leadership. At the same time as there are signals of new talks, the Iranian President, Mahmoud Ahmadinejad, has warned the EU against imposing unilateral sanctions. He said Tehran would react swiftly and cause remorse if its ships or planes were intercepted. He also appeared to be mocking his critics by saying "are you helpless, do you fear one Iranian atomic bomb?"

For the international community sanctions that target Iran's key energy sector are one of their best cards to play. Neither China nor Russia has joined them in this. If these sanctions fail then the Europeans might ratchet them up in six months' time. In the United States there are those who are talking of developing an "economic warfare strategy".

Others like the Saudis and the United Arab Emirates are quietly letting it be known "we cannot live with a nuclear Iran". Reports from Washington suggest that the policy of accepting and then containing a nuclear Iran is losing its appeal.

Much now rides on the slow choke of sanctions.

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So how stressful was it?

Seven banks failing the stress test was fewer than many had expected. Some thought the figure would be closer to 10 or 12.

As expected, the heart of the problem lies with Spain's regional savings banks, which were so badly damaged by the collapse in the property market. The five that failed in Spain are deemed too weak to survive another financial shock. They are all in the process of being consolidated.

The cost of shoring up these failed banks is put at 3.5bn euros (£2.9bn; $4.5bn). Analysts had predicted at least 40bn euros would be needed.

So the relief at the outcome is combined with scepticism. "I see nothing stressful about this test," said Stephen Pope of Cantor Fitzgerald. Others felt the tests did not factor in sufficiently the risk from a sovereign debt crisis.

However, French Finance Minister Christine Lagarde said "in my view the test was tough, it was inclusive and it was very competitive".

Over the weekend and before the markets re-open, there will be further analysis of these results. There may still be uncertainty in early trading next week.

It is still too early to declare Europe's banking system sound enough to survive further shocks to the European economy, but a significant hurdle was passed today.

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For a long time Europe's banks and officials have been haunted by the fear that something is out there. They have not been able to identify the monster alien but, like in the science fiction TV series, they are convinced it's lurking out there.

For months now they've been troubled by the spectre that there is something rotten in some of Europe's banks. It has troubled them to the point that they've been reluctant to lend. Inter-bank lending is still closed to some lenders.

So, rather belatedly, the Europeans edged towards stress-testing their banks. The Americans had done it last year and it managed to squeeze some of the suspicion out of the system. Of the 19 banks analysed, 10 failed and were told to go off and raise $75bn. But the worst was known and the banks loosened up.

Now the Europeans are looking at 91 banks. The markets have been concerned with three sectors. Firstly, the Spanish Cajas or regional banks. They were badly burnt by the collapsed real-estate market and have been scrambling to merge with each other.

Secondly, there are German Landesbanks, which were set up to promote regional development. Many of them were exposed to heavy losses in the American mortgage markets. Thirdly, suspicion has fallen on Greek banks and the debts they are holding.

So on Friday afternoon the Committee of European Banking Supervisors will deliver its verdict after the markets have closed. The prize is that a positive outcome will soothe market nerves and one more step will be taken towards managing Europe's debt crisis.

But this is a psychology test. The results have to be convincing to work.

Now already various ministers and officials are predicting happy outcomes. Twenty-seven Spanish banks are up for review. The Spanish Finance Minister, Elena Salgado, has said "when all the figures are known, we will see that the truth is that our financial system is solid and ready to face the future". She is not saying no Spanish bank will fail, but she is optimistic. The Greeks too are chirpy - the finance minister says Greece's banks will pass. Banking officials in Germany say there is no indication that any of the Landesbanks will fail. The French Finance Minister, Christine Lagarde, is not worried about French banks either.

So all looks good? Well, not exactly. Some, like Neil Mackinnon, strategist at VTB Capital, is warning of a "whitewash". Far from being stressful, he thinks it could be a stroll for the banks.

Others are asserting that some banks must fail in order for the exercise to carry conviction. "If its outcome is to be credible," says Nicolas Veron from the economic think-tank Bruegel, "it will necessarily reveal significant capital shortfalls in a number of banks". Analysts at Credit Suisse say $40bn of extra funding will be needed when the tests are done. Others put the figure closer to $100bn.

The grey area is the criteria used to assess a healthy balance sheet. "Stress-testing is a gamble," says Ken Wattret of BNP Paribas. The assessors are assuming that the EU economy will underperform. But the big dilemma is: what losses to factor in for sovereign debt? Do you reckon banks will take a 20% or even 50% hit on say Greek bonds?

So the stress test has to pass a credibility test itself.

Now if a bank fails then a plan to raise capital has to be in place by the time markets open on Monday morning. That, of course, could be difficult for governments in the midst of an austerity drive.

There have been and still are real concerns about the future of the eurozone. They may have retreated in recent weeks, but they have not gone away. But there is also perception. Those of us who have been following the eurozone crisis have watched fear morph. There was a fear that countries could default, a fear of debt, a fear of low growth and fear that the European banking system was unsound.

As the song says, "But I know there's something out there, something somewhere, I feel it all around". The test of the stress test will be whether the fear factor subsides.

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It is another day in Greece. There is by now a ritual quality to it. Flights are grounded, hospital workers are striking, tax collectors and customs officials are sitting on their hands. Hundreds of thousands of civil servants are staging a four-hour walk-out.

Yesterday it was police, firefighters and harbour police who were doing the protesting. There have been six general strikes this year.

Today the anger is directed at pension reform which was a condition of the 110bn euro bail-out from the EU and the IMF. For six long months the Greeks have been resisting the austerity being imposed on them.

For some time there have been two versions of how the Greek story would end.

Senior EU officials insist that Greece is on track. It is sticking to the terms of the bail-out. The crisis is subsiding. Growth will eventually return and Greece will manage its debts.

The only problem with this narrative is that I find almost no-one who believes it. There is a widely-held expectation that sooner or later Greece will either default or will have to restructure its debt.

The argument is a simple one. Greece has debts of more than 350bn euros. It is also borrowing from the EU/IMF bail-out fund. But its economy is shrinking, so how will Greece be able to pay off its debts once the bail-out period is over? Most economists say it is impossible and the day of reckoning lies ahead.

So the question remains - can the Greeks defy the pessimists?

Firstly the Greek government has been resolute in implementing its austerity measures aimed at reducing its deficit. Its determination has surprised outsiders.

EU/IMF officials say Athens is sticking to the bail-out conditions.

For the first six months of this year the deficit on a year-by-year basis declined 46%. The government exceeded its own target of 35%. (Revenues, however, missed their target).

This week the Greek government concluded a successful sale of treasury bills.

It was expected that austerity would persuade Greeks to keep their wallets shut. Private consumption is actually up by 1.5%.

Strikes are continuing but some say protest fatigue is setting in. The numbers on the streets are declining.

That, in itself, is surprising considering the austerity plan. Public sector pay is frozen until 2014. Pensions have been frozen for three years. The retirement age has been raised to 65. Public sector allowances have been slashed. Higher paid-civil servants are losing their holiday bonuses. VAT is at 23%. Taxes on fuel, cigarettes and alcohol have been hiked by 10%.

Today a striker was quoted as saying over pension reform: "This is the worst that has ever been passed by a socialist government... the pension reform will bury the weak, the workers."

Many public sector workers are furious but there are many others who seem to accept there is no alternative.

All of these can be interpreted as positives but they don't answer the question of whether Greece can escape its debt mountain.

And here is the difficult part. The pace of economic activity is still slowing. The economy is expected to shrink 4% this year and 2.6% next year. The government doesn't expect the economy to start growing again until 2012. The economy won't be back to pre-crisis levels until 2014 at the earliest.

As Ben May, European economist at Capital economics, points out "the fiscal tightening is going to have to go on for some time". It will get brutal. Public investment has been slashed by 40%. The fiscal adjustment Greece has agreed to amounts to 10% of GDP.

Unemployment rose to 11.9% in April and may well go higher.

Now the hope is that as costs and prices fall, Greece will regain its competitiveness and its economy will start growing again. Under the bail-out deal wages are being held down, even in the private sector, helping to boost exports and attract inward-investment. But can Greece find the economic growth to pay off debts that are predicted to reach 150% of GDP before falling.

Some like economist Nouriel Roubini are convinced it is impossible.

"The 110bn euro bail-out agreed by the EU and IMF in May only delays the inevitable default and risks making it disorderly when it happens," he said.

And that is the dilemma. Will Greece - against all the odds - somehow manage its debts three years down the road or is the inevitable just being postponed?

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So the French lower house has voted to ban the burka or niqab in a public place. It was by a massive majority: 335 to 1. The Greens and some of the Socialists abstained.

There are still hurdles to be crossed, but France is heading to a moment when a woman wearing a full-face veil in public could be stopped by a police patrol and fined 150 euros (£125). If the police gather evidence that a woman is being forced to dress in a niqab, then the man faces a very heavy fine.

The mood among MPs today heading into parliament was strongly in favour of a new law. No doubt some would have been influenced by polls that suggest that up to 70% of French voters support such a ban. One French MP described veils as "muzzles", and "walking coffins".

But the main motive behind this vote was to reinforce French identity. MPs believe that those who live in, or visit, France should embrace French values. Time and again in parliament MPs argued that hiding a woman's face violates the ideal of equality and encourages segregation. The fear behind this is of separate, parallel communities.

There are only about 2,000 women in France who wear the burka or niqab. Many are recent converts to Islam. I spoke today to 26-year-old Anissa. She has been wearing the niqab for two years. She says the new law is Islamaphobic and she will not remove her veil.

"I think it is against international law," she told me. "Personally speaking, removing my veil is against my conscience. And I won't take it off."

That will be one of the difficulties: enforcing such legislation. Initially there will be a six-month period where women who wear the full-face veil are stopped and told about French laws and the reasons behind them. But after that period a police officer could tell her to remove the veil or risk a fine.

Clearly, in some suburbs of Paris with strong Muslim communities it would be very sensitive to order a woman to remove her veil. It will also be hard to prove that a woman is wearing a veil against her wishes.

Another risk is that the ban will create martyrs. Frederic Lagache of the police union said to me today: "Our concern is that some people will be manipulated by extremists and cause trouble on the streets when we stop them."

Already a businessman has offered to set up a fund to pay any fines incurred by women.

There are also likely to be a series of legal challenges.

But today marked an important moment in the debate over multiculturalism. Increasingly the French want new arrivals and members of ethnic minorities to integrate more. There will be those in the banlieues - the suburbs where many minorities live - who will argue that they are the ones who are prevented from integrating into mainstream French society.

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In the aftermath, the verdict. Spain, masters of possession. Germany squeezed out of the game. They had hoped to hurt the Spanish with fast counter-attacks but they couldn't. It was predicted Spain would play that way in the World Cup semi-final. They did and Germany could not counter it. It was a match that underlined the different tactics of two European sides.

Whatever the differences on the field of play, they are as nothing to the differences on the great plains of the European economy.

Recently, a German newspaper trumpeted a new economic miracle. Industrial orders were 30% higher than a year before. For Mercedes Benz, June was the best month in its history, with orders up 13% on the previous year. Unemployment has fallen for 12 straight months. Growth this year could be 2.3%. Even its budget deficit looks as if it will be lower than expected, prompting its finance minister, Wolfgang Schaeuble, to call the news "delightful".

Germany is "big surplus" country, currently running at 5.5%. Even if the shine comes off some of these trends in the coming months the German motor is purring.

In Spain unemployment continues to edge up. It is close to 20% and is more than 40% for those aged between 16 and 24. The International Monetary Fund forecasts that Spain's economy will shrink this year by 0.4%. It is struggling to emerge from recession. Spain has a budget deficit of 10%.

In the private sector there is still huge debt, some of which may have to be written off. The Spanish good years were built on a housing boom. It was, for a time, the biggest creator of jobs in the EU. The burst bubble has left behind an injured coastline, 800,000 unsold homes, and companies burdened with debt.

These two countries share a single currency and inhabit the same monetary union. Spain would benefit from a looser monetary and fiscal policy. Germany would not.

For Spain there are two big questions: How will it grow again, and how will it become competitive again?

Firstly, there is the not insignificant fact that Spain is committed to reducing its deficit by 2013. Public sector wages have been reduced, some benefits are being scaled back and some investment programmes postponed. All of this, of course, may weaken growth.

Spain would like to generate growth from exports. The falling value of the euro helps a little but not nearly as much as for Germany, which has a far wider range of world-class products to export.

Spain would like to export to a booming Germany but growth there is driven more by exports than expanding domestic demand.

As was apparent from conversations earlier this week in Berlin, Germany will not reduce its current account surplus to help its neighbours. Politically it's a non-starter.

How will Spain become competitive again? In order to become competitive with Germany it will have to embrace wage cuts beyond the 5% already announced for the public sector. It will have to endure a squeeze on income for years.

One of its problems has been its restrictive labour market. Many older people have jobs for life with extensive rights that makes it almost impossible to lay them off.

Many younger people are on temporary contracts with little job training, which prevents them learning the skills for high-quality jobs. There is a generational divide at the workplace.

The question remains unanswered as to who will provide quality jobs for the future.

The Spanish government has started making changes to its labour laws making it easier to hire and fire. Many employers say it does not go far enough. There is already resistance from unions, which will intensify in the autumn. The IMF has said Spain needs "far-reaching and comprehensive reforms".

So Spain is facing cuts and austerity at a time when it needs to re-engineer its society. Gradually people in Spain - like elsewhere - are realising that Europe won't be able to maintain its welfare state unless its economies grow faster than predicted.

The reality is that the differences between Germany and Spain are growing not narrowing.

Spain may have reason to celebrate on Sunday. It may taste success on the football pitch.

But its future is far less certain. Without far-reaching and unsettling reforms it faces a future of stagnation, marked by low growth and high unemployment.

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It may be that the scandal swirling around French President Nicolas Sarkozy is unmasked and shown to be little more than smear and innuendo. Even so, damage will have been done. There seems to be a slow weakening to President Sarkozy's authority. The maestro of bold action has, of late, seemed indecisive. The polls indicate a public tiring of his administration.

The most serious part of the scandal is the allegation that 150,000 euros (£124,000) in cash was secretly given to the Sarkozy campaign in 2007. This would flout laws on campaign financing. The money is said to have come from Liliane Bettencourt, France's wealthiest woman and heiress to the L'Oreal cosmetics empire. The information comes from her book-keeper, who never saw the money handed over but says she was told about it. The cash, allegedly, was passed to Eric Woerth who is current labour minister and in charge of pension reform.

The government fiercely denies this story. The police are now investigating. The president describes it as a "libel that aims only to smear, without the slightest basis in reality". That in itself will not call off the Parisian press pack. Yesterday one reporter said it sounded like the classic "non-denial denial".

It is a golden rule of government scandals that leaders have to get ahead of the story by answering the allegations in detail and providing as much documentary evidence as possible. That has not happened so far.

There are reports that the president and his advisers have considered an appearance on national TV. It may just be he will wait until 13 July and the traditional pre-Bastille address to the nation. If so, it gives the impression of a leader being driven by events. In the vacuum there is the drip-drip of revelation.

It feeds into a growing sense of indecision at the heart of the Elysee. There was the by-now famous case of one of his ministers who treated cigars worth 12,000 euros as a perk of office. In an era of austerity such extravagance no longer flies. In the end the minister and another resigned, but Sarkozy missed the opportunity to move boldly and decisively.

Now it could be that the campaign contributions can be denied and dismissed convincingly. Then there is the case of Mr Woerth. He may have done nothing wrong but there is a sense of a conflict of interest. While he was in charge of tax, his wife was acting as financial adviser to Liliane Bettencourt. He was also treasurer and party fundraiser for the UMP, Mr Sarkozy's party.

Even without substance there is a problem here of appearance. Mr Woerth also happens to be the minister pushing through controversial pension reforms that have already brought thousands onto the streets in protest. The scandal reveals networks of power and influence and that could stiffen opposition to reform. Some within the UMP want a reshuffle, which presumably means that Mr Woerth, who vehemently denies any wrong-doing, would be moved from his post.

President Sarkozy's party was defeated in regional elections in March and has not recovered. He faces re-election in 2012. Yet this is a time when he is committed to pushing through pension reform and France this autumn will have to announce its own austerity plan. The finance minister has said it is a dangerous balancing act between avoiding social unrest while ensuring that France too reduces its deficit. It will be a time for leadership, but the prospect of re-election rarely encourages boldness.

Angela Merkel, Europe's other big leader, is also weakened. She, too, has suffered electoral setbacks and has been damaged by squabbling within her coalition. Fortunately for her Germany is enjoying a strong economic recovery, with an indication in some manufacturing sectors that orders are back to pre-recession levels.

The European summer will bring only light relief. The crisis in the eurozone has not been solved. Differences between some euro economies are growing, not diminishing. Growth in many countries is anaemic at best. In the autumn protestors will challenge the austerity programmes on the streets across Europe. Someone will have to make the case to Europe's voters that their cherished way of life with its strong social programmes cannot be sustained.

It will test Europe's leaders at a time when they are already weakened.

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France moves closer to banning the full-face veil today when its parliament begins debating a law that would outlaw the wearing of the burqa or the niqab anywhere in public.

It is a measure that seems popular with the public. Polls suggest 70% back a ban.

The numbers that wear the full-face veil in France are tiny. Perhaps 2,000 and then the tourists from the Gulf, who like to shop in the luxury stores on the Champs Elysees.

The French government says this is not an argument about religion but about values. By adopting this legislation the French are insisting that those who live in France abide by their values. As the writers of the legislation say, hiding your face in public is "an offence to the nation's values". It violates the republican ideals of secularism and gender equality.

The French President, Nicolas Sarkozy, said it was "a sign of debasement". The Immigration Minister, Eric Besson, described the burqa as a "walking coffin".

The French Prime Minister, Francois Fillon, said Muslims who wear face coverings are "hijacking Islam" and provoking a "dark and sectarian image". That seems to go to the core of the complaint - that some new arrivals live in France but do not embrace French identity.

The moves to ban the burqa also reflect a changing attitude towards multiculturalism in much of Europe. For a period it was accepted that new groups would arrive and continue living much as they had done in their countries of origin. There was increasing concern, however, that this was leading towards separate, parallel communities.

Now the legislation will be voted on next week and then goes to the Senate. It is likely to be law by the beginning of next year.

Enforcing the new laws will be difficult. Men who force their wives to wear the full-face veil will face substantial fines. A woman risks a much lower fine of 150 euros (£130) because they are "often victims given no choice". Persistent offenders risk further fines and prison. All of these penalties will be difficult to enforce and there is every chance that a woman may choose to go to prison and become a martyr for her cause. It is also difficult to see police officers intercepting women from the Gulf on their shopping trips.

A woman driving in a niqab was recently stopped in Nantes and fined because the garment "blocked her lateral vision".

Some Muslims in France support a ban. Many argue that the burqa or niqab is not principally a statement about religion, but about culture and identity.

Others oppose wearing the full-face veil personally but believe legislation is unnecessary. "It's going to increase feelings of being ostracised in part of the Muslim community, even parts where women don't wear the niqab," said Jean Bauberot, a sociologist from Sorbonne University.

Amnesty International has said that a "total ban on covering the face would violate the right to freedom of expression". Almost certainly the legislation will be challenged in the French Constitutional Court.

Similar moves are taking place in other European countries.

In Belgium a bill banning the wearing of full veils is awaiting Senate approval.

Spain is examining similar legislation. In Barcelona, the mayor says he will ban the garment in the city. There is support for a ban in the Netherlands too.

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"Say No to" is always an easy form of campaigning. "Say No to the euro" and everyone knows instantly what you're about. "Say No to bull-fighting" and you don't need to explain. You've made your point. Quite a few voters in the UK hoped a Conservative government would say "Say No to Brussels". Once in power, or so it was imagined, the Tories would block, stonewall, and fight to take back powers from Brussels.

It was always a caricature and, in any event, the reality of coalition life has tempered instincts. What is emerging is a much more subtle approach to European policy by the new government in Westminster. Instead of shouting "no" from the sidelines the government promises to engage - and engage actively.

Where once the temptation would have been to enjoy the troubles of the euro, now in power the government wishes the single currency well as long as the British are not part of it (and as long as UK funds don't go towards bailing it out).

Some in the Tory ranks favour life outside the EU. The new government won't give that idea the time of day; Britain's economic future is tied closely to the EU. As for retrieving power from the sticky fingers of the bureaucrats in Brussels, that idea has been quietly shelved.

Today the UK Foreign Secretary, William Hague, disclosed more of his strategy in a major speech. Britain would not just be an active player in Europe - he wants more Brits inside the Berlaymont building, influencing the European Commission.

The Foreign Office's researchers have discovered that UK representation in Brussels is declining. Since 2007 UK officials at director level within the EU have fallen by one third. The UK has 12% of the EU's population but only 1.8% of staff in what they call "entry-level " positions within the Commission.

(Incidentally, those figures are described as "plain wrong" by Richard Howitt, Labour's foreign affairs spokesman in the European Parliament. He insists that there are 1,300 Brits in service and that if you take all grades across the EU we are in sixth place when it comes to representation.)

No doubt the figures can be argued over, but William Hague accuses the Labour government of failing to promote the national interest. "It is mystifying to us," he said, "that the previous government failed to give due weight to the expansion of British influence in the EU". He goes on: "so the idea that the last government was serious about advancing Britain's influence in Europe turns out to be an unsustainable fiction".

Regardless of the past, William Hague's plan will be controversial. Bureaucrats in Brussels are encouraged to shed their national clothes. Not all do of course. But the foreign secretary clearly envisages a cadre of UK officials who will work from the inside, confronting unnecessary red tape and working for a British agenda.

On many levels the institutions work against that, but the Conservatives see an opportunity in the current crisis. There are plenty of European officials - and some have gone on record - who see trouble in the eurozone as an opening to pursue their political goals and integrate further. But some of the old certainty and swagger has gone. As the Nobel Prize-winning economist Paul Krugman wrote, "no, the real story behind the euro-mess lies not in the profligacy of politicians but in the arrogance of elites specifically, the policy elites who pushed Europe into adopting a single currency well before the continent was ready for such an experiment". Now there are plenty of EU officials who lack a rear-view mirror, but there are real debates taking place about the future direction of the EU.

The era of austerity will inevitably challenge Europe's social model. As countries agonise over cutting national budgets attention will turn to the EU's budget. Some will insist EU institutions cannot be immune. It will be an opportunity for London to have a view and to find allies.

The key to Europe's future lies in finding economic growth. Everything depends on it. With expanding economies the debt mountains subside. The unemployment lines that snake across Europe get shorter. Social programmes are maintained. And again this is where the Conservative - Liberal Democrat coalition sees opportunity. They believe the key to growth lies in less regulation, expanding the single market and reducing trade barriers.

So the Tories believe that in uncertain times they will find allies out there for their visions, particularly from some of the smaller countries, who William Hague believes were neglected by Labour. As I have said before, the new British government will be pragmatic in its approach to Europe, being co-operative when it can be and choosing carefully the moments it fights for what it sees as the national interest. But they don't want to be outsiders; they have chosen to pursue their vision by playing the Brussels system. That was the message from today.

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