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Thursday, 10 March 2011

Significant Two Weeks for the Eurozone Begins Tomorrow

Angela Merkel the German Chancellor has laid down some key concessions Greece and Ireland must adopt in order for Germany to consider easing the bailout terms i.e. interest payments on loans lent to them.

Today it has emerged that two concessions Merkel favours are that Ireland must increase its corporate tax rate, which is the lowest in Eurozone (see chart below). Also Greece is not exempt, Merkel has said that it must begin to seriously consider selling state owned assets in order to begin raising its own capital. Report from France 24 indicated that the Greek government was seeking an advisor in order to pen a list of assets that the government should consider selling.

The pressure on Ireland to increase its corporate tax rate is all part of grander plan for a standardisation of corporation tax, retirement age and caps on government spending. This is part of the Franco-German Pact for Competitiveness . However due to Ireland's high dependence on corporation tax for government revenue, it is  unlikely to move on the issue.

Even these concession are no guarantee that the bailout terms will be loosened. Even closely allied Austria and the Netherlands, not to mention Merkel's fellow party member are against it. There is very little optimism surrounding this summit due to mounting divisions and political point scoring.

However this summit will take place on the backdrop of Moody's downgrade of Spain today (hopefully this will spur the EU into action).  This was on concerns that the government has not set aside enough money to bail out its financial sector. Furthermore the Spanish Central Bank released figures today, for how under-capitalised the Spanish financial sector is. The Bank of Spain said that its banks were under-capitalised to tune of 15bn euro's, but this was well inside of estimates of 20bn euro's. This has led analyst and investors to speculate about the validity of these figures.

Strategist are already sceptical about what the EU summit, set to begin tomorrow can achieve, saying that it is likely to tip Portugal over the edge this would leave them in situation where they would require a bailout. This would put further downward pressure on the Euro which has been rising steadily over the last couple of months against its major counterparts (see chart below).

If these 13 days result in little more than a minor agreement on a small expansion of the region's bailout fund and a few "pact for competitiveness" style reforms, bond markets will react negatively and the pressure on Europe will again be very real.

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