Some in Brussels fear euro zone crisis moment approaching

EUROPEAN DIARY:While EU leaders breathed a sigh of relief at the Irish vote there is still huge uncertainty and the next few weeks will be turbulent

AT A time of acute stress in the euro zone, Ireland’s acceptance of the fiscal treaty was received as “limited” good news. Whether the Government can strike a new deal to ease the burden of the State’s colossal banking debt now depends on events beyond its immediate control.

For the moment, however, the overwhelming sentiment in Brussels is one of relief at the Irish vote.

“It’s one less sword of Damocles hanging over us,” said an adviser to a top European figure. Another, reflecting the views of many in Brussels, said Taoiseach Enda Kenny was widely held to have pulled off a considerable political achievement in hostile territory.

Yet the real impact is minimal. While a No vote would have made a bad situation worse for Ireland and the euro zone, the Yes vote may be a less weighty thing. It shields the State from the risk of a second bailout, but it cannot guarantee that such an intervention won’t be necessary. This is the way we live now.

Although the referendum result can be read as a clear demonstration that the Irish people are serious about the recovery effort, the fact remains that many voted through fear of disaster if they renounced the treaty. They didn’t, but there are mountains still to be climbed. The long slog continues.

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Then there are the dreaded banks. Kenny may have won kudos in the summit chamber but kudos is not sufficient to deliver a debt-relief deal. It doesn’t harm his case but neither does it win the argument. If only.

Germany’s blunt rejection of the notion that Ireland deserves a special garland for backing the treaty cannot have come as any great surprise to Dublin. It is in keeping with Berlin’s established position.

At the same time, the vote comes amid huge uncertainty over the fate of Greece, Spain and the euro zone at large.

The sense remains that any big new initiative to protect Europe’s banking system generally would provide an opening for the Government to strike for home.

But this is still an exceedingly tricky task. All along Berlin has made the case that any restructuring of the Anglo Irish Bank promissory note would necessitate a big extension of Ireland’s EU-IMF programme, something which would require a new vote in the Bundestag.

Germany also argues that renegotiation now would send an undue signal of distress to markets at a time when the bailout is proceeding well.

The problem with both arguments is that the worsening situation in the euro zone still threatens to sweep Ireland’s recovery drastically off course.

The return to private debt markets is still not assured. Thanks to troubles in Athens, notional Irish borrowing costs have risen again. Any move to cut Greece loose from the single currency – reluctant though EU leaders are to do that deed – would only intensify the pressure.

In the backdrop is the Spanish-led clamour for the ESM bailout to be given the power to directly recapitalise banks. This has powerful advocates, among them new French president François Hollande, Italian technocrat leader Mario Monti and economics commissioner Olli Rehn.

But the stance of German chancellor Angela Merkel mirrors her rejection of eurobonds. Simply put, the idea is anathema. Indeed, some German critics of direct ESM banking aid see the idea as opening the door to a crazed, amoral free-for-all in which national banking debts are yoked onto the backs of all Europeans and German backs particularly. Not for this did they enter the single currency.

Against that is the argument that the single currency and the EU now face peril. The Greek election on Sunday week threatens chaos, and Spain is too big for a full-blown bailout. The objective remains to keep Madrid in regular bond markets for day-to-day expenditure while using rescue aid to recapitalise its banks. The snag is that the increasing debt Spain accrued from regular bailout loans would still curtail its capacity to borrow on the open market.

This explains support for the idea of the ESM recapitalising the banks directly, with Spain free of the debt. Notwithstanding Merkel’s public position, German reports suggest discreet talks are already under way on this front.

This remains something of a gigantic leap to take but it may be the only way of preventing Spain from overwhelming the fragile edifice set up when Europe first rescued Greece. It is obvious that any move in this direction could create an opening for the Taoiseach – and that he can point to the referendum as evidence of Ireland’s goodwill and commitment to fiscal discipline.

For Europe the alternative may well be catastrophe, with explosions in Spain or Greece setting off a vicious chain reaction. How big is the risk? Suffice to say that some around Brussels speak of a possible Cuban Missile crisis moment in which the entire European construct comes under threat.

The coming weeks will be crucial. Hold on tight.