One step back from the abyss

Greek Prime Minister George Papandreou (l), European Council President Herman Van Rompuy (c) and European Commission President Jose Manuel Barroso Image copyright AP
Image caption All smiles now. But will Greece's rescue deal be enough to calm the markets?

How did they do? Slightly better than expected. Will it be enough? Of course not.

With so many "known unknowns" haunting the markets in these flighty months of summer, Europe's leaders just have to pray that it is enough, for now.

As I discussed on the Today programme this morning, the biggest positives are that Greece, Portugal and Ireland will get a significant cut in the cost of servicing their debts, and the powers of the European Financial Stability Facility (EFSF) have been extended.

As I suggested yesterday, the leaders also appear to have reached an accommodation with the European Central Bank, though they have been suspiciously vague about what that agreement is.

The decision to stop charging a hefty premium on their emergency loans is overdue. These were neither good economics nor good politics. But they were another reflection of Germany's long night of the soul on the question of bailouts. There had to be a big premium to "punish" Greece when the first bailout happened, or there wouldn't have been a bailout at all.

On the question of private sector involvement, attention has understandably focussed on the default issue, and whether it is credible to simply assert that this will apply to "Greece and Greece alone".

But when we stand back from the deal, I suspect the larger questions will be around the actual amount of debt relief that has been offered to Greece.

If the private sector is accepting a 21% reduction in the net present value of their Greek holdings, in exchange for longer term bonds from a country that is now able to service to its debt, that would be a pretty good deal for the banks. Right now the market discount on those bonds is more like 40%.

But that assumes that the deal has taken further Greek defaults off the agenda. I don't think it has.

We need to see more details, but on the face of it, the deal has simply taken the Greek programme back into the realms of "just about plausible if everything goes right".

President Sarkozy said yesterday that the deal would lower the Greek debt stock by about 24% of GDP. By extending maturities, it will also make that debt easier to service.

Big 'if'

That sounds impressive. Until you hear that the IMF has revised up its forecast for Greek debt in 2012 by 23 percentage points in the past 12 months alone. In July 2010, it forecast that Greek debt would be 149% of GDP in 2012. In its latest report, a few weeks ago, that number had gone up to 172%.

Clearly this limited degree of debt relief is designed to stop questions about Ireland and Portugal - because their debt stocks are already significantly lower than the Greeks' will be, even after this deal goes through.

But even if the leaders have silenced questions about debt restructuring in other countries (and that is a big if), they may have done so only at the cost of keeping the question wide open for Greece.

It is an important step that the EFSF is to have to power to intervene in secondary markets. Yesterday, I wasn't sure they would get this far.

But there is no word, yet, on whether the EFSF is going to get any bigger. That is a major disappointment for many in the markets.

President Sarkozy probably thinks it's better to win the battle over the principle. They can haggle about the size at the next (emergency) summit.

But it's a bit feeble to announce a major new tool for confronting market contagion, without saying explicitly that you are giving it more money as well. Most analysts already thought the fund was insufficient, even for its previous, narrower role.

Italian and Spanish bond yields have fallen today. They have been falling most of the week.

But as of now, the Italian ten year yield is around half a percentage point higher than it was a month ago. The Spanish yield is is about a third of a percentage point higher. In that sense, the past few weeks have been a net negative for them. We are not talking a major change in their fortunes - a matter of a a third of a percentage point. But when you've barely grown at all in the past few years, every little helps.

The moment of no return, in any currency crisis, doesn't come when governments run out of options. It comes when governments run out of options that are politically possible - or credible.

In the days leading up to this Summit, it was starting to look as though the eurozone was reaching this point. They have now stepped back from the brink.

Federal union

But it remains an open question whether countries - Germany especially - will one day get to a point where they cannot credibly do what it takes to save the euro.

Think of the UK's own ERM crisis: the game was up when Norman Lamont raised interest rates to 15%to defend the currency peg, in the middle of the recession. Everyone knew that wouldn't wash.

As the German economist, Christian Schultze, told me for my television bulletin on Thursday, Gemany is not ready for collective European bonds - or any big leap towards a full fledged Federal union. If that is really what saving the Euro requires, as George Osborne and Ed Balls have both suggested, then "the euro has a big problem".

It might seem obvious to these UK politicians - both of whom are opponents of UK entry into the single currency. But you can know what needs to be done, and still completely lack the political capacity to do it.

You would think that Mr Osborne might have more sympathy for the Germans' reluctance to sanction a massive transfer of power from sovereign governments to the centre; a transfer which, by all accounts, would be expressly against the wishes of most of their citizens.