Eurozone crisis averted, but for how long?

Have eurozone leaders finally come to a solution that stave off worries about a euro collapse? David Cameron certainly thought last night’s emergency summit of the EU’s 17 leaders, which went on for 11 hours, was in safe hands – half way through, he swanned off to Australia.

When French leader Nicholas Sarkozy announced, at 4am, that ‘the eurozone has adopted a credible and ambitious response to the debt crisis,’ he looked relieved – if a little exhausted (although admittedly less exhausted than wife Carla, back home with a new baby). Not only should the ‘three-pronged’ agreement help to ease Greece’s debt burden and strengthen banks (and the European bailout fund), but it should put paid to rather sinister comments made by the likes of German chancellor Angela Merkel.

The nitty gritty of the tripartite agreement is as follows:

1) The much-maligned ‘haircut’: Private investors will have to accept a loss of 50% on Greek bonds, which will cut Greece’s debt burden to 120% of GDP by 2020. Obviously, investors (mainly banks) aren’t happy about the idea, but the pressure on them from eurozone leaders to accept a writedown has been described as ‘immense’.

2) Higher core tier one capital ratios: banks will be forced to raise (even) more capital to protect them against losses resulting from any future writedowns. That was agreed earlier, though. So far, so straightforward.

3) The science bit: the group also approved a crucial mechanism to boost the eurozone’s main bailout fund, the European Financial Stability Facility, to an estimated €1tn (£880bn). The EFSF will start to provide ‘risk insurance’ to new bonds issued by struggling eurozone countries, like Greece and Italy. Crucially, though, no one can be sure about the exact amount that’ll increase its firepower by, because no one knows quite how much money is left in the fund. Analysts estimate the magic number to be around €250bn after the second Greek bailout, putting the fund’s new firepower at more than €1,000bn. For its part, French/German head of state hybrid Angolas Merkozy says it’ll increase the size of the EFSF ‘four or five times’.

There’s a catch: this is all premised on cash-rich emerging economies like China and Brazil getting involved. Klaus Regling, the EFSF’s CEO, will explain a scheme by which the facility acts as an insurer for bonds issued by weaker eurozone economies like Italy or Spain, so China (for example) can buy up bonds without having to worry too much about them defaulting. Sarkozy is planning to discuss the idea with Chinese president Hu Jinatao today, but it’s a risky strategy: it was hard enough to come to an agreement about increasing the size of the EFSF this time. The Chinese drive hard bargains and may run out of cash/patience (or both)

What’s crucial in all this is the reaction of the markets – and they seem to have given eurozone leaders the benefit of the doubt – for now, at least: France’s Cac 40 was up almost 3%, while Germany’s Dax rose 3% and the FTSE 100 was up 2%. The euro, too, was up against the dollar.

But the markets are a fickle bunch, and they won’t be this positive forever. As Pierre Gave, head of research at Hong Kong research group Gavekal, told the FT, the deal is ‘big on words but short on detail’. ‘What is this, the 14th meeting in the last 20 months? I think it’s just more of the same,’ he said – the implication being that this may be a solution, but it’s far from permanent. As Gave put it, this may simply mean that ‘Europe is going to continue to muddle through – but we won’t know the end-game until a year or two from now.’