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The fifth EU make-or-break summit in 19 months proved to be far from the solution some expected to end the bloc's sovereign debt crisis once and for all. Instead of dealing with the underlying problem that threatens to break apart the currency bloc, the main focus has been on a proposal for a financial transactions tax.

In the lead up to the summit, analysts gave short shrift to the tax proposal, thinking that it would be a second-tier conversation.  Instead, EU officials thought their best efforts would be directed toward more heroic efforts like keeping the currency bloc together, stopping Italy from going bankrupt and protecting the triple A credit ratings of Europe's largest states. But that was not to be. Along came U.K. Prime Minister David Cameron and his British bulldog spirit and the focus of the summit shifted.

The United Kingdom wanted to get a waiver for itself on the financial transactions tax proposed by French and German leaders during the EU Leaders' working dinner on Thursday night; however around the time of dessert (chocolate cake and ice cream, I believe), Germany and France gave a decisive no, so Cameron vetoed the plan for closer fiscal union and a change to the 2007 Lisbon Treaty.

This was the headline-grabber. In the United Kingdom, the majority of the press have hailed the PM a hero defending the Kingdom's economic heart -- its financial services sector -- while in Europe, he is a pariah. So now the debate about the future of the EU isn't about a union without profligate Mediterranean states, but rather one without the United Kingdom.

This summit was much more political than the others, and as such, the markets are finding it a tough one to digest. Hence, stocks reversed initial losses on Friday to close higher and the euro traded between 1.3280-1.3440, and it ended up closing the week at 1.3380 -- roughly the same place where it started.

I think that the chief economist at the IMF, Olivier Blanchard, summed it up perfectly when he said that although he was more optimistic about the Euro zone today than a month ago, last week's summit was not the full solution necessary to stabilize the region.

So what did it achieve? First, it got 26 EU members to agree to closer fiscal union (and a financial transaction tax). It also agreed to implement automatic fines for running domestic budget deficits over 3% of GDP and writing a balanced budget agreement into national laws, essentially meaning it will be illegal to overspend or under-collect tax (good luck getting that to work in Athens). It will also allow national central banks to lend some 200bn euros to the IMF, which can then lend to individual member states in financial trouble.

But is this enough? Most would say no. First, the budget deficit rules have always been in place, and have always been broken by
EU countries, including Germany -- the paragon of economic virtue at the moment. Once people or nations are used to breaking a rule, even by writing it into law, it is incredibly hard to get them to stop doing it. Thus, a future of financially responsible euro zone members seems no closer to reality after this Summit.

The IMF loan is slightly more positive, in that the EU now has some skin in the game, which may be enough to entice some more cash from Brazil, China, and other nations, and thus create a big enough firewall to prevent Italy from going bust in the next three years. However, if the EU rules weren't so complicated, we wouldn't be in this bizarre situation where the Bundesbank and other institutions have to make loans to the IMF, rather than let the ECB (European Central Bank) -- which is the only institution with the necessary firepower -- finance these troubled states that are at risk of default.

So why aren't investors rushing for the exits? They should be: European banks have a capital shortfall of 115 billion euros that they need to plug, the sooner the better, and added to that is the fact that euro zone states have 1 trillion euros that need to be re-financed next year, a third of which is just for Italy. This is no insignificant sum, and with Italian bond yields back above 6.5%, the chances of a failed auction or more serious tensions in the financial markets are rising by the day. If this happens, then expect another summit, especially after the ECB essentially ruled out anything but support for the banks. So the can has been kicked down the road yet again.

Right now, the markets hope that this will be enough to at least temporarily halt this crisis: The ECB has thrown liquidity at the European banking sector, which it could use to purchase more government debt, thus reducing the chance of a failed bond auction. But banks have disposed of more than 60 billion euros of sovereign debt this year, so they may not be so keen on loading up on it again.

The markets are likely to be jittery this week, but will the Santa rally be enough to see us through to the year's end? With all but the Dow Jones in the black for the year, long-only stock investors will hope so. However, for those willing to go short, there are too many loose ends in Europe to make a rally sustainable, in my opinion.

The euro is a different matter. The single currency could be jittery as we await European December PMI data this week. We have been prepared for bad news; the EU Commission and the ECB expect weak growth next year of 0.5% and 0.3%, respectively; however, the PMI data will confirm whether the currency bloc fell into recession this quarter, which is now highly likely. But throw a Fed meeting into the mix, and the outlook for the euro and the dollar is even cloudier. A fall in the November unemployment rate largely due to a reduction in the number of people not working in the United States is unlikely to placate the dovish elements of the Fed. Although the outlook for growth has picked up, will it be enough to balance employment concerns? We shall have to wait and see.

Ratings agencies can't be forgotten. It's highly unlikely that this summit has done enough to save France from a two-notch downgrade from the S&P ratings agency. This could disrupt any hint of a rally as we get to the end of the year. This reminds me, this is the last full week at work before Christmas and New Year holidays (yippee!), so expect things to be volatile and volumes to be thin.  

Kathleen Brooks| Research Director UK EMEA |

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