By: Dr. Mike Campbell

Markets in Europe are up strongly the morning after an EU leaders meeting was held which aimed to put a bottom under the sovereign debt crisis in Europe and shore-up bank finances. Time will tell if the measures can have the desired effect, but market sentiment so far has been positive. By mid-morning, the CAC and the Dax had put on 3.88 and 3.66% respectively; the FTSE was up a more modest 2.24% - the UK does not use the Euro and UK banks are not so heavily exposed to Greek sovereign debt as some of their continental counterparts. The news was also greeted positively in Asian and Australian markets.

The “deal” that emerged from the meeting in Brussels last night involved providing banks with a guarantee of support against their agreement to accept a closer “haircut” on Greek debt than previously agreed. If Greek defaults on her obligations – and it is still far from certain that this will happen – the banks have accepted to agree to write-down losses of 50%. The EU leaders have agreed that the EU bailout fund will be increased to €1 trillion (before we get carried away, this is slightly less than the Italian sovereign debt). The idea is that the fund will be large enough to cover any eventuality and therefore should restore confidence to the markets.

The banks will also be expected to raise further capital to strengthen themselves against potential losses, thereby providing increased confidence that the banks will not fail in the event of a future crisis.

It will be instructive to see how the ratings agencies respond to this development; the banks have implicitly indicated how they would behave in the event of a Greek sovereign default.