By Paula Dwyer
The market for European government bonds seems happier today than it's been in months.
The risk premium between Italian and German 10-year notes narrowed 79 basis points, or 0.79 percentage point, to 3.73 percentage points.
The reason investors perceive less risk, of course, is that German Chancellor Angela Merkel and French President Nicolas Sarkozy emerged from lunch at the Elysee Palace today with a plan to fix the euro debt crisis.
The leaders of Europe’s two biggest economies said the plan involves automatic penalties for deficit violators. In addition, euro states would have to enshrine debt limits into their constitutions, presumably making them inviolable. Sarkozy said they hope to reach consensus by March with the 15 other euro area nations, which will have to adopt treaty changes.
But what bondholders really focused on was the leaders' promise not to force existing creditors to take a haircut -- except in the case of Greece.
The Greek exception stems from that country's already-agreed bailout -- which European officials don't want to renegotiate -- requiring private-sector creditors to take haircuts. "Greece is and will remain an exception," Merkel said.
Merkel and Sarkozy will detail their proposal Wednesday, and European heads of state will discuss it at their Brussels summit Thursday and Friday.
Germany and France appear to have resolved their differences over how to impose fiscal discipline within the euro area. Germany had preferred that each country's budget plans be reviewed by an apolitical panel of technocrats, subject to European court appeal, while France had wanted each country to retain more sovereignty through some form of political escape valve. They appear to have compromised in the sense that a majority of European countries could override the technocrats, opening the door to heads of state lobbying one another to reverse the fiscal panel.
The two again rejected the creation of euro bonds jointly backed by all 17 countries in the currency bloc. No surprise there. They also affirmed the independence of the European Central Bank when asked about the ECB's role in stemming the crisis. But markets expect the ECB will aggressively purchase Italian, Spanish and French sovereign debt once the Franco-German fiscal compact provides the central bank with the necessary cover.
(Paula Dwyer is a member of the Bloomberg View editorial board.)-0- Dec/05/2011 21:19 GMT