Markets see fiscal union as the solution

EUROZONE negotiations showed no sign of a breakthrough yesterday in the run-up to Thursday’s crunch talks on a new Greek bailout, with markets increasingly convinced that only a full fiscal union with region-wide euro-bonds will stop the crisis spreading.

Politicians, led by Germany, have been in deadlock with the European Central Bank (ECB) for weeks over the issue of private-sector burden-sharing. Berlin insists that banks take a symbolic part in any deal but ECB president Jean-Claude Trichet says that such a proposal would be disastrous.

But investors’ views are hardening, with a growing belief that only a deal to see the region’s sound nations underwrite the debt of its bankrupt governments will be enough.

UBS analysts wrote yesterday that convincing markets “is easy to do if the political will is there: making any one country’s obligations the responsibility of all would do it.”

They added: “This would necessarily involve a permanent reduction in the sovereignty of each nation involved but this would likely prove an attractive outcome compared with the alternatives.”

But it is not clear that politicians will align themselves with financial markets. Barclays Capital analysts said in a note yesterday that the stress test data released on Friday “graphically illustrate the level of interconnectedness among the major banks in Europe... [which] lies behind much of the current sovereign crisis.”

The note adds that the European banking system “is now constructed on the assumption of permanent monetary union through massive cross border-exposures”.