EU Recovery Deal and Its Implications for European Financial Markets

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on Jul 22, 2020

Updated: Dec 19, 2022

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The EU Summit came to an end in the early hours of Tuesday. Unsurprisingly, the leaders reached a deal on the size and composition of the Next Generation EU. Much of a debate centered on the so-called Recovery Fund (RRF) and the loans vs. grants ratio, but the entire deal extends far beyond the RFF.

More precisely, the Next Generation EU funds total EUR750 billion, and only EUR560 billion belong to the RRF. This was the scope of the negotiations – grants from the RRF vs. loans.

Milestone for the European Union

Big words were used yesterday by most financial analysts and politicians, as the European Union (EU) responded in a single voice to the health crisis. The deal reached both Northern and Southern countries, albeit at a closer look the initial grants proposed by the European Commission a month ago were lowered, while loans increased.

More precisely, the original proposal involved €500 billion in grants, and the deal reached only €390 billion. Also, the original €250 billion in loans increased to €360 billion. Why did the Euro and financial markets celebrate it as a success if the so-called “frugal states” got what they wanted – more loans, fewer grants?

One reason is that these are small but important steps to European integration. They overcome taboos like common debt issuance (in size) and fiscal transfers for the first time.

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Financial markets welcomed the deal. The EURUSD reached 1.1530 yesterday, more than seven big figures compared with where it was in March. Moreover, optimism surrounds the EU deal boosted the Dow Jones and brought the S&P500 closer to turning positive for the year.

However, not all is bright and positive out of this deal. The Northern states got an increase in rebates that even Germany accepted. Moreover, the cuts in grants came from mostly public EU projects, something that would have helped integration further. It may not sound important now, as everyone focused on the money, but in the long term it may have a detrimental effect.

The currency market, as always, is the first one to send the real message. While the EURUSD moved above 1.15, other USD pairs rose too – AUDUSD or GBPUSD. In other words, it was not all about the Euro. Moreover, the EURGBP and EURAUD crosses had a worse day, declining for the entire European session.

All in all, a consensus is what the EU needed. It remains for the European Parliament to pass the deal and the funds to start pouring.

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