WISE MONEY

The highlight overnight was the release of the minutes from the August 10th Federal Reserve Open Market Committee meeting. Some Federal Reserve officials were concerned that a decision to keep securities holdings unchanged would inadvertently signal an intention to resume large scale asset purchases.

Also, a few policy makers said the economic effects of the decision “would be quite small,” but at the same time, some officials saw “increased downside risks to the outlook for both growth and inflation” and voiced concern that further shocks would cause “significant slowing in growth”.

The debate shows the challenge Fed Chairman Ben S. Bernanke may face in achieving consensus for any additional monetary stimulus to reverse a slowdown in growth and reduce joblessness more quickly.

In a speech last week, Bernanke said “Policy makers haven’t agreed on specific criteria or triggers for further action”.

In other important US economic releases, we had the Conference Board’s confidence index yesterday afternoon which showed that confidence among U.S. consumers rose more than forecast in August; a sign the biggest part of the economy may avoid a slowdown that would derail the recovery.

The Conference Board’s confidence index increased to 53.5 from a five-month low of 51 in July, figures from the New York- based private research group showed. More confidence may help ease concern that consumer spending, which accounts for about 70 percent of the economy, will falter.

As we approach the ECB meeting this Thursday, yesterday’s Eurozone annual inflation reading fell from 1.7 in July to 1.6 in August, coming in well under the ECB’s target of 2%. Inflation looks set to remain muted for the rest of 2010 and into 2011 as European governments implement austerity packages to shore up their sovereign balance sheets.

Yesterday we also saw German unemployment continuing to fall, for the 14 month in a row, slightly better than expected sparking a rally in the Eur/Usd which provided strong support going into the release of the Fed’s minutes. Investors had been keenly anticipating the release of these minutes but were somewhat disappointed as it lacked any new information triggering another move higher for Eur/Usd.

In contrast to the UK inflation figures falling yesterday eurozone inflation yesterday hit a 20 month high eu data has shown.
Annual inflation in the 16-nation bloc rose to 1.7% in July, up from 1.4% in June and the highest rate since November 2008, Eurostat said.

The figure was boosted by more expensive fuel costs for transport, and higher alcohol and tobacco prices.

Across all 27 nations in the European Union, prices were up 2.1% in July, compared with a rise of 1.9% in June.

Some countries – Finland, Greece, Spain, Portugal and Romania – raised their rates of VAT in July, which also helped to push prices higher.

On a month-on-month basis, prices in the eurozone fell 0.3% in July, and in the wider EU fell 0.2%.

Today is all about monetary policy meetings with the UK and the Eurozone committees all deciding on levels for interest rates for the next month.
As with previous months it is a fairly common view that both the MPC and the ECB will decide to leave their respective rates on hold, resolving to also leave the levels of QE unchanged as well.

For the MPC, that will be it for a week or so until the minutes of the meeting are released.

I would expect Andrew Sentance to once again prove to be the lone dissenter for leaving rates unchanged although it would be a shock if there was not evidence of protracted discussion amongst the members over the stubbornly high level of inflation and its effect on the UK economic outlook.

This is also the first meeting attended by Martin Weale therefore the minutes will also be awaited to discover his thoughts and voting intentions.

The results of the Eurozone bank stress tests were eventually released on Friday evening showing only 7 of the 91 banks tested were deemed to have failed, and the capital shortfall was estimated at €3.5 bn. Both are very much at the lower end of consensus forecasts, raising questions over the credibility of the tests. Interestingly, a sovereign default or restructuring scenario was not included, as media leaks earlier in the week had suggested.

At the press conference, ECB Governing Council Member Constancio justified this decision by noting that “instruments have been put in place precisely to avoid that scenario”. Nevertheless, as the leaks had suggested, many participating banks voluntarily disclosed their sovereign debt holdings, and this has brought some improved transparency on sovereign debt exposure.

This seems to have averted any euro selling pressures as the single currency continues to trades close to Friday’s 1.29 range against the dollar.

From a data perspective, the euro had already managed to move higher on Friday morning after stronger than expected German business sentiment data. The German IFO business confidence index recorded its strongest rise for 20 years in July.

The closely watched index rose to 106.2 points from 101.8 in June. Germany’s economy shrank by almost 5% last year, but has been recovering due to strong exports. The result was much better than expected, with most economists having expected a slight fall.

Sterling has just received a welcome boost after the release of positive retail sales figures.Data showed a 0.7% increase month-on-month & 1.3% yoy, the highest monthly figure since April 2008.

The ONS suggested the World Cup boosted consumption of electrical goods, which after England’s performance should see a double whammy when people look to replace the TV’s thrown out of the window after the Germany game.

Bank of England minutes released showed a 7-1 vote in favour on keeping interest rates on hold, with Andrew Sentence, the only dissenter, voting for a rate rise. More interestingly, the minutes showed discussion of an extension to the asset purchase scheme if, as expected, the economic outlook continued to deteriorate.

Sterling continues its recent volatility in light of the comments & also rumour circulating yesterday that the bank has reopened dollar swap lines and low liquidity in the market exaggerates moves.

The Euro continues to tread water ahead of the Stress test results. There is increasing uncertainty around the release of the results, the planned announcement is today at 4.30pm.

Strange that an exercise in reducing uncertainty and restoring credibility is actually having the opposite effect, and that is feeding though to the Euro which now trades lower against both Sterling and the Dollar.

The perceived safe haven of the Swiss Franc has also hit the headlines as the SNB announced a huge FX loss following large bouts of currency intervention earlier in the year. The continuing strength of the Swissy will be a real headache for the central bank as it fights to remain out of a potential deflationary spiral brewing in the Eurozone.

This week is all about the euro and the approaching stress test results which will offer much needed feedback on the health of European banks.
The euro has experienced a significant turn of fortune from its June 4 and half low against the USD gaining over 10 cents to test the 1.30 level.

One reason that the euro has gained is simply that the market was significantly over short in the euro and naturally a lot of these short investors paired their positions leading to a short squeeze higher.

In addition some comfort has come back into the euro approaching Fridays stress test results as comments in the run up from members of the IMF and the ECB have been bullish – we will see!

Recent gains have led to EUR/USD testing the 1.30 level and GBP/EUR falling back into 1.17 territory. The results are due out from 5pm GMT on Friday- good feedback should push EUR/USD over 1.30.

The Bank of England has kept UK interest rates on hold at a record low of 0.5% for the 16th consecutive month and the European Central Bank (ECB) has held eurozone interest rates at a record low of 1% for the 14th month running.
The banks have kept rates low to try and stimulate the economies following the global economic downturn.

Many analysts argue rates need to stay low as governments are cutting back on spending- which undermines growth.

The Bank of England’s Monetary Policy Committee (MPC) also decided not to inject any more money into the economy under its policy of quantitative easing (QE).

The decision had been expected but calls have been growing for an increase in rates to curb inflation.

The National Institute of Economic and Social Research (Niesr) estimated that the economy grew by 0.7% in the three months to the end of June, marking a slowdown from the 0.9% expansion seen in the three months to May.

The minutes of July’s meeting, which will reveal how MPC members voted, will be released in two weeks’ time.

Explaining the ECB’s decision to keep rates on hold, president Jean-Claude Trichet said the eurozone’s economic recovery continued in the first half of the year, adding “we expect the area’s economy to grow at a moderate and still uneven pace, in an environment of high uncertainty”.

The eurozone economy has been in the international spotlight in recent months, with concerns about high government debt levels hitting global stock markets and threatening to derail the economic recovery.

In recent weeks, attention has turned to bank debt, with investors eagerly awaiting the results of stress tests designed to see how well equipped banks are to cope with future financial crises.

Mr Trichet said the tests should “build confidence” in markets as investors learnt how exposed banks were to bad debt. Transparency, he said, would be beneficial.

The results of these tests are due to be published on 23 July.

We get our first view today at the methodology behind the stress tests currently being applied to European banks to assess their health.The markets reaction will not be instant due to the expected weighty tome of equations and statistics to wade through. However, there is a key point worth noting in advance.

Analysts will be looking for the models to incorporate large haircuts on holdings of Greek bonds, maybe 30 pence in the pound and similar (but not as severe) on other periphery Eurozone countries bonds.

If, as the Financial Times suggests, the haircut in the models is significantly less than 30 per cent, the credibility of the tests and as such the banks they are testing will be completely undermined.

The whole point of these tests is to restore confidence into the banking system so it is vital that the methodology is perceived as credible. We can then wait with baited breath rather than indifference, for the results of the tests on 23rd of July.

The Dollar gave up further ground to Sterling and Euro on the back of the disappointing employment data from the US on Friday.

However, the Forex market is either ignoring or completely in the dark about when Mr Obama will begin to tackle the US budget deficit (I think it may be a combination of both). Currently running at over 9% of GDP, it seems some in the US are unwilling to implement similar austerity measures to those in the UK to tackle the deficit.

And since the US makes up such a large slice of world demand, any budget cuts and the time scale over which they are implemented will have wide reaching implications for its main trading partners, China, The UK and the Eurozone and also for the Dollar over the coming months.

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The Euro reached a two month high versus the US Dollar late on Friday as investors remain content for the time being with better than feared results from the European Central Bank’s tender facility.The Euros surge continued into Friday afternoon’s session on the back of weaker than expected US Non Farm Payrolls data. The risk and commodity currencies took a bit of a hammering late on Friday with both the Euro and Sterling making headway going into the Independence Day Holiday affected weekend and have retained the move so far today.

This week is a busy one in terms of key central bank meetings.

First up is the Reserve Bank of Australia announcing its latest policy decision on Tuesday with the market consensus expecting no change to the base rate.

Next up on Thursday is the Bank of England’s turn. After several months of uneventful policy decisions by the BoE, Thursday’s announcement will be the most eagerly awaited for quite some time. Whilst no change in the bank rate is expected, it’s the first meeting since the emergency budget on June 22nd.

The minutes, due for release on July 21st will be scrutinised for any sign that fiscal consolidation could deter early rate hikes. Furthermore, signs of division on the committee have also recently emerged, culminating in MPC Member Andrew Sentence’s decision to vote for a rate hike at the June.

EU banks have borrowed less than expected from the European Central Bank, easing concerns about liquidity among european financial institutions.
After Tuesday’s sharp falls, stock markets and the euro stabilised on news that the ECB had agreed three month loans worth 131.9bn euros (£108bn). This compared with the 150bn to 200bn euros many had expected.

The euro rose almost a cent against the pound, while European stock markets also made gains. However, eurozone banks are still on welfare support

Banking shares had been under pressure after the European Central Bank confirmed it would be stopping a special 12-month loan facility for euro-zone lenders from yesterday.

Investors were concerned that European banks could face funding problems as a result.

Also this week, the EU has said it is to treble the number of banks that will be subject to public stress tests, as it tries to allay a growing global anxiety over Europe’s finance sector.

The tests are designed to examine how certain banks would perform if there were a repeat of the financial crisis.

The plight of Greece, combined with worries about nations such as Spain and Portugal, means that for the first time the tests would also examine whether institutions could cope in the event of a sovereign-debt default in the eurozone.

The number of those forced to take part in the exercise would expand from the 22 big banks examined last year to include a further 60 to 120 banks, meaning that many not included in last year’s stress-tests will now feature.

They include, for the first time, banks such as German Landesbanken, which are not among the biggest institutions but whose potential weaknesses have contributed to uncertainty in financial markets.

The tests are due to be completed by mid July, with results to be issued on a bank by bank basis.