WISE MONEY

Eurozone finance ministers are meeting to discuss the region’s debt crisis in the first of several summits to be held in Brussels over the weekend.On Saturday, ministers from all 27 EU countries will hold talks. EU leaders will then gather on Sunday and at an extra meeting on Wednesday.

They need to agree a second bailout for Greece, how to recapitalise banks, and a stronger bailout fund, before Greece can then be allowed to default- and there still appear to be deep divides between France and Germany.

In particular, the two need to agree on how to increase the firepower of the eurozone’s bailout fund, the European Financial Stability Facility (EFSF), from its current 440billion euros ( £383 billion).

France has proposed turning the EFSF into a bank so that it could borrow from the European Central Bank (ECB), but Germany has refused to sanction such a move, arguing it would compromise the ECB’s impartiality.

The German government has also promised its taxpayers that its contribution will not go above 211bn euros so is looking for a way to increase the size of the fund without increasing the liabilities of German taxpayers.

Despite no apparent movement on the deadlock, markets were trading higher, with the leading indexes in London, Frankfurt and Berlin all up between 1.5% and 2.7%, while US markets also rose at the start.

Jean-Claude Juncker, the chairman of the eurogroup and the prime minister of Luxembourg, said the delay to a deal portrayed a “disastrous” image of the eurozone to the rest of the world, adding that it was not necessarily just France and Germany that had differences of opinion.

This crisis has underlined that the EU, in large part, remains a Franco-German union. The other members of the eurozone appear as bystanders whilst the French and German leaders determine the fate of their currency.

A deal on the euro had been expected to be signed on Sunday, but France and Germany said they would not be able to reach an agreement by then and announced that leaders would meet again on Wednesday.

Sunday’s summit had already been delayed from 17-18 October because more time was needed to finalise a plan.

A second hurdle in the way of any rescue plan is that negotiations have not yet begun properly with private sector lenders to Greece on a further reduction of what the Greek government will repay them.

Banks have already agreed to take a 21% loss, or “haircut”, on their loans to Greece but there is growing pressure for them to accept higher losses.

Previous disagreements between France and Germany about the bailout plans have centred on how much the private sector would have to contribute to any package.

A QE3 could still be launched according to the Federal Reserve minutes released last night, with two on the ten strong FOMC committee suggesting the current US economic outlook could justify stronger policy action. Operation twist is aimed at keeping down long term interest rates by selling shorter term notes to buy longer dated maturities, but how successful this policy will be at keeping the economic recovery going is unclear at this stage.

Which is why the much more potent QE3 is being kept in the wings should we see another deterioration in outlook.

The news has gone some way in tempering the recent Dollar strength we have seen against Sterling and the Euro alongside investors regaining their risk appetite over the past few days.

Bank recapitalisations in Europe are fast becoming the new battle front between the banks and governments, with the head of Deutsche Bank saying the lender will do everything in its power to avoid a forced recapitalisation.

Interestingly Mr Akerman suggested that pressure from governments to hold eurozone bonds had cost the bank close to €400 million this year alone.

The Euro continues its tear higher on the back of higher than expected German CPI this morning, the ECB is heavily influenced by the German inflation hawks and so if inflation continues to climb over Europe the probability of the ECB cutting rates begins to fall.

Disappointing unemployment figures yesterday in the UK had surprisingly little impact against the Dollar and Euro.

The number is extremely worrying, given jobs are the lifeblood of the economy, and lend weight to the Bank of England’s thinking over further QE.

We can expect the jobs situation of get worse before it gets better – especially in light of the looming government cuts ramping up next year.

The money markets were calm in yesterday’s trading day as traders and investors alike attempted to interpret the rumours surrounding a Eurozone bailout package that started over the weekend.Stories have been popping up about a €1.7 trillion fund which would be aimed at saving the Eurozone and allow Greece to default on its £340bn debt pile.

This would involve propping up the banks that have invested in Greek bonds so that a controlled bailout can begin on the ailing country.

Further plans involve recapitalising Europe with tens of billions of Euros to reassure the markets.

UK Chancellor George Osbourne was forced to issue a hastily drafted statement after a British Treasury official outlined behind-the-scenes moves allowing a Greek default.

His comments insisted that Greece does have a recovery plan and must carry it out as he rejected claims that the G20 would allow a default.

The markets reacted with the Euro taking a small hit across the board, but also the US Dollar as some investors hastily moved funds from the so-called “safe haven” other  instruments.

Little volatility has occurred since then as everyone waits for any more news/rumours surrounding the main story of the moment.

The likelihood of Greece being able to follow its current plan and rebuild its economy seems unlikely and some sort of default or write down of their debt seems inevitable.

Greece will once again be the key driver in the markets for the week ahead as inspectors assess whether the Greek economy is on schedule to meet its debt obligations due next month and so avoid a default.European Union and IMF inspectors are set to hold a conference call today with the Greek finance minister.

Doubts are growing that Greece are still not doing enough to align with the financial assistance provided.

Politically the pressures are growing with Angela Merkel the German chancellor losing another regional election in Berlin, in addition nine out of ten Greeks are dissatisfied with the governments handling of the crisis.

Last week the euro regained some lost ground and Greek two year notes improved for the first time in two months, this followed rhetoric from Germany and France to keep Greece in the euro area.

However this week we once again hit a crunch point and we will see what the divergence is between political will and confidence in the financial markets- Asian currencies have fallen on renewed fear on Euro debt as we kick start the week.

Elsewhere, we have seen a small gain in UK house prices for September in a survey by Rightmove- the Pound has marginally improved against the US Dollar and the euro on the back of this data.

Economic data will also be very important this week following the IMF and OECD pointing to a lower global growth outlook. The highlights will be Bank Of England minutes and Public sector net borrowing from the UK.

The minutes will highlight the thought process of the MPC and the potential for more QE in the future.

It was a turbulent day for markets yesterday, as they ponder over the escalating European debt crisis and the evident failure to reach agreement on raising the US debt ceiling. As it stands Europe’s crisis looks to be going from bad to worse, as suggested in the record breaking higher costs of French, Italian and Greek debt yesterday.

The situation reached breaking point as Italy suspended trading on government and corporate bonds following last weeks release of EU stress tests.

The panic led to billions wiped off the value of European banks with the UK alone losing £6.3bln with Lloyds falling 7.5%, with RBS and Barclays losing 6% and 3.7% respectively.

Despite Italy grabbing the headlines attention is still very much focussed on Greece and reaching agreement on a second bailout for the country, with further discussions at the special EU summit on Thursday.

The hot issue remains the extent of private sector participation in any debt restructuring.

The assessment to improve the flexibility of the EFSF bailout fund to embark on debt buybacks has not helped.

As a result contagion risks to other countries in the Eurozone periphery are at a heightened state.

In spite of this the EUR has shown a degree of resilience, having failed to sustain its recent drop below 1.40 versus USD and currently trades at 1.4156.

A possible reason for the EUR’s bounce is that the situation on the other side of the pond does not look much better.

Murmurs of QE3 in the US and the stalemate between Republicans and Democrats on budget deficit cutting measures tied to any increase in the debt ceiling are limiting the Greenback’s ability to profit from Europe’s distress.

Furthermore, more weak data including a drop in the Empire manufacturing survey and a drop in the Michigan consumer sentiment index to a two-year low, have added to the worries about US recovery prospects.

The head of a leading economic body- the Organization for Economic Co-operation and Development (OECD) has insisted he does support the UK government’s deficit reduction strategy after his colleague appeared to suggest the pace of cuts might be too fast.
The OECD’s chief economist Pier Carlo Padoan had said earlier that the UK might have to change it’s plans if growth stayed weak. But secretary general Angel Gurria said that would only be needed if there was “a very dramatic drop” in growth.

Asked later whether Mr Padoan’s words signalled a watering down of the OECD’s support for the government, Mr Gurria said: “Oh no, I was there.

“He was being questioned about a hypothetical example about a very dramatic drop in the rate of growth, and whether one would then have to change course.  He said that if there are some terrible results or whatever we’ll have to take a look at it. But no way was there any signal of a change in course.”

Asked again if the OECD backed the coalition’s deficit reduction plans, Mr Gurria said: “Absolutely. We think it’s the way to go. We have said that you should stay the course and continue to support this route.”

The Treasury said the OECD had never swayed in its support for the government’s strategy.

Conservative MP Matthew Hancock said: “Ed Balls’ credibility has today sunk to a new low. His typically misleading attempt to claim the OECD’s support has spectacularly backfired.

“The OECD, the IMF and every major business organisation in the UK support the Government’s plan.”

Speaking on Wednesday, Prime Minister David Cameron said the government had been right to prioritise deficit-reduction since coming to office and cited the fact market interest rates had fallen in the UK – while rising elsewhere in the EU – as “proof” of international support for its deficit plans.

Will the euro survive in its present form come 2012? Greece appears to be scuppering the chances of this and all the news since Friday related to its financial situation has been negative.

This has run alongside negative ratings action from Fitch and S&P plus the large scale protest vote at the Spanish elections.

Friday afternoon’s markets became fearful over the repercussions of a heavy defeat for the ruling Socialist party in Spanish elections on Sunday.

The fear is that the newly elected representatives will reveal a much worse set of budget situations than had been originally thought, putting the Governments austerity plans into jeopardy.

This morning, Fitch has downgraded the Greek sovereign rating by 3-notches from BB+ to B+ and retained its negative watch.

Fitch cited a greater risk that the EU/IMF funding will be delayed and added that they would regard any debt rescheduling as been a default event.

This news emerges with 2 negative news articles this morning.

The first, according to the Greek press, being that the IMF had suspended its quarterly review of the country’s fiscal consolidation programme until a time when further austerity measures have been drawn up.

The second article, which comes from Switzerland claims that without the next lot of funding from the IMF/EU by the end of June, Greece would be insolvent by 18th July.

Adding to the Eurozone financial uncertainty is Standard & Poor’s decision to downgrade Italy’s long-term rating outlook to negative from stable pointing to weak growth prospects.

With little Eurozone data released for today, the Euro has slipped back below 1.40 against the Dollar.

This morning saw the release of the Independent Commission on Banking (ICB) preliminary report on competition and stability in the financial sector. Rumours of a recommendation to break up Britain’s largest banks did not materialise, and shares in Barclays and Lloyds Banking group were up in early trading on the news.

The report did call for core tier one capital ratios of at least 10 per cent, higher than the current 7 per cent level and it also recommended the ring fencing of savers deposits from risky investment banking operations.

Full details of the report will come out over the course of today, but there will the main criticism will be that  the recommendations maintain the status quo, and do not go far enough in the reforms attempting to prevent the next banking crisis.

The Euro shrugged off an interest rate rise and Portuguese bail-out last week and continues to trade very strongly against the Pound and Dollar.

Sterling conceded further ground over the weekend as Germany announced an upgrade of GDP, even as details of Greek debt restructuring emerged and talk of Irish negotiations on their debt continued.

Over on the other side of the pond with a temporary US budget deal finally agreed – and governmental shut down avoided – all eyes are now on Thursday when this stop gap measure runs out. US data this week include advance retail sales, CPI and University of Michigan confidence survey.

The pound strengthened to 1.22 against the Euro yesterday for the first time since November 2008.

Sterling continues to benefit from the UK budget announced earlier this week and the news that one MPC member voted for a rate hike this month. A strong response from the credit agencies took away fears that the UK’s AAA rating could be downgraded.

Concerns over the European debt crisis were on the rise again yesterday with Greek credit default swaps hitting a record high.

ECB president Trichet said he is “pleased” with Germany’s decision to concentrate on fiscal discipline, he also commented that the idea that austerity measures could trigger economic stagnation is “incorrect” and he does not think the risks around deflation will materialise.

Another cause for concern in the Eurozone is the requirement for European banks to repay the $540bn of ‘special’ 1-year loans that they borrowed from the ECB.

The added problem here is that a number of the banks used the loans to buy up bonds in Greece, Spain and Portugal – fixing in a healthy interest margin in the process. Now they have to repay their ECB loans, the banks may decide to offload some of these bonds, which could reignite tensions in European financial markets.

Chancellor George Osborne’s produced the toughest Budget in a generation yesterday with Britain facing drastic cuts of 25% to government departments.
The exception will be those departments with “protected budgets,” such as the National Health Service and foreign aid.

Other key take outs include an increase in the VAT from 17.5% to 20% from January next year and a new £2 billion levy on the banks.

The budget reveals a more rapid fiscal response than that planned by the previous Labour government. The Chancellor said, “This emergency budget deals decisively with our country’s record debt.”

The budget also found support from Fitch, the rating agency, who stated the budget “…sets out an ambitious deficit reduction path that, if delivered upon, will materially strengthen confidence in UK public finances and its ‘AAA’ status.” The Office for Budget Responsibility cut it’s economic growth forecast to 1.2% this year and GDP growth next year has been cut to 2.3%.

The news provided further support for Sterling yesterday as it rallied against the Euro and the Dollar. Pre-budget we were trading GBP/EUR 1.1960 and GBP/USD 1.4730, the markets view this as a credible plan and we currently sit at 1.2139 and 1.4924 respectively.

Over in the US and existing house sales numbers were below par despite the continuing tax incentives for the housing market. Although we saw little reaction in the currency markets, (EUR/USD currently sits at 1.2279 from a high of 1.2320 yesterday) equities did sell off at the close leaving a weaker outlook for stocks across Europe and Asia.