This statement provides information that has become available since the issuance of the staff report. The information does not alter the thrust of the staff appraisal.
The situation in Greece has been evolving rapidly. Since the issuance of the staff report, the Greek parliament passed a package of reforms as the basis for starting negotiations on a new ESM program. National parliaments in several euro area countries have endorsed these reforms. With the approval of bridge financing by the European Council, Greece met a July repayment to the ECB and cleared its arrears to the Fund. And the ECB last week increased its cap on emergency liquidity assistance (ELA) to Greek banks.
Market developments have been broadly positive, returning asset prices to the levels prior to the recent turbulence. Spreads on 10-year European sovereign bonds relative to the German Bund have declined, while European equities—led by bank stocks—have gained. The 10-year German Bund yield has also fallen to under 0.8 percent, reflecting expectations of continued sovereign asset purchases by the ECB. The euro is trading more than 3 percent lower relative to the U.S. dollar, partly reflecting expectations of earlier U.S. policy rate normalization.
The market reaction to both the initial deterioration and the subsequent improvement suggests that new policy instruments such as QE, as well as a stronger banking union have helped limit contagion. Nonetheless, further episodes of significant uncertainty and volatility arising from the situation in Greece cannot be ruled out. As noted in the staff report, policymakers should stand ready to deploy, and if necessary adapt, the full arsenal of available instruments to manage spillovers. Beyond the near term, steps should be taken to strengthen the monetary union and European firewalls. Fully severing bank-sovereign links would require a common deposit insurance scheme with a fiscal backstop, a larger and fully funded Single Resolution Fund, and easier access to direct bank recapitalization from the ESM. Such additional risk-sharing should be supported by a stronger fiscal and structural governance framework.