WISE MONEY

The British economy is expected to stagnate in the first half of the year according to the British Chamber of Commerce (BCC), with at least one quarter of negative growth expected. A technical recession, two consecutive quarters of negative growth is still a distinct possibility and the BCC warn the UK economy is still in a precarious position.

The government needs to make important decisions and actually act on them to maintain confidence and investment levels, which as promised in the Chancellor’s autumn statement included improving the flow of credit to businesses and infrastructure projects.

Although we are about to see another high speed rail line announced today, the BCC warning is timely, and will hopefully persuade the government that expansionary austerity is not delivering the results that the OBR and Chancellor were hoping for.

The Bank of England has long been suggesting monetary policy cannot be the only tool to lift the economy back towards levels of activity seen before the financial crisis, and will be firmly behind the BCC’s suggestions.

In the MPC meeting on Wednesday and Thursday the main discussion will be whether to expand the QE program.

Further stimulus is probably on the cards, the only question will be when the Bank acts.

For the Pound this means it will come under further pressure against its major trading partners especially the Dollar, which is being boosted from a decent data flow in recent weeks.

With the ECB unlikely to drop interest rates again, the main focus on a busy Thursday will be the exact phrases new ECB chief Mario Draghi uses in his press conference.

The strange relationship between the markets and the head of a central bank means every word uttered is scrutinised in microscopic detail to try to second guess the central banks next move.

Special attention will be given to Mr Draghi when he talks about the ECB plans for bond buying in the secondary market and/or any plans for large scale money creation which it is under pressure to commence but has not yet done so because of intense German opposition.

The euro has opened lower this morning, sitting below the critical 1.30 barrier as markets remain nervous as to the steps that the eurozone will take to curb the crisis. In major trading, the US Dollar managed to gain further strength last week trading to a low of 1.2860 at the end of 2011, which was the lowest in the final quarter of 2011.

Data from the region, saw manufacturing figures come in from France, Germany and Switzerland, which was higher than previous months for all countries, though not reflecting a drastic expansion as it lay below the median figure of 50.

With regional banks stepping up their deposits in the ECB, panic had started to set in, but the announcement from the ECB last week that these deposits were receding, have calmed fears momentarily.

We have had some positive data from Germany, as far as unemployment figures go, pushing the euro towards the critical support level of 1.30 against the greenback.

As we go into the week, we expect further data from Europe on Services PMI and construction figures, which will lend to trading patterns of the Euro, intermittently.

We are straight back into a busy week for the US Dollar with ISM manufacturing out this afternoon along with the minutes of the previous Federal Reserve meeting from the 13^th December.

On Friday the US non-farm payroll number is also released, with the consensus for around 150K jobs being added over the previous month.

Today also marks the official start of the presidential elections with the voting beginning in the first republican primary in Iowa. A victory by the favourite, Mitt Romney may mean the race is over before it began with Mr Romney holding a 20 point lead in the next state to vote, New Hampshire.

The ECB is set to flood the eurozone with cheap money on 3 year loan terms.  The money will be lent at the average of the ECB’s benchmark rate- currently one percent over the period of the loan.

Basically this is free money for banks and the aim is to keep the liquidity cycle moving on to companies and households- the danger and likelihood is of course that the banks take a piece of the cake and do not share.

However the aim seems to be to sure up the banks’ capital requirements.

The euro has pushed higher against the US Dollar on speculation for this move- hitting a high of 1.3185 and yields on Spanish and Italian government bonds have dropped.

The USD which is the largest safe haven currency at the moment has also weakened on the positive news; the risk appetite currencies notably the AUD, NZD completed the cycle and gained.

Over to the UK and the Bank Of England as expected voted 9-0 to keep interest rates and Quantitative Easing unchanged in December.

Overall the MPC saw little change for growth and inflation and thus the news was largely positive for the Pound. In addition UK November public sector net borrowing data came in slightly better than expected again helping the Pound.

Looking at the markets after a crazy year we are amazingly at exactly the same levels as 12 months ago for EUR/USD and very similar on GBP/USD after much volatility in the year.

2012 will start with a heavy focus on US payroll numbers on January 6.

The euro continues to underperform especially against the US Dollar and the Japanese Yen- where it hit a two month low. There is a growing concern that rating agencies will downgrade European sovereigns in the near term.

In addition the lack of a clear plan moving forward from the EU summit is denting confidence in the single currency.

The market was also fearful in advance of this morning’s bond auctions from euro sovereigns- it is understood that appetite was ok but there was rumours of a little help from the ECB.

Asian stocks have also declined in line with the growing concern for Europe.

The key level for EUR/USD is the 1.31 barrier- a move below this level could open the door for a push under 1.30; this would help GBP/EUR push towards the key 1.20 level.

Data from the UK was largely ignored with UK CPI coming in for November at + 0.2%, that is + 4.8% year on year- this was largely in line with expectations.

Following last week’s isolation from Europe- so far the Pound has reacted positively.

The Pound could actually perform better moving forward; last week we saw the European Central Bank cut interest rates again and we now have the threat of downgrades for European sovereigns.

One aspect the UK government has managed is to be clear in their strategy to the markets- the austerity plans for the UK have been very clear for some time and this has helped to sure up the UK’s AAA status.

It may transpire of course that enforced austerity was the wrong call but for the markets the UK has embarked on a course of action with clarity.

In the eurozone it has been a prolonged mess and we are still no nearer to seeing a full solution- this could spell further problems for the Euro and as a result the Pound could shine.

The UK markets are AAA, have high liquidity and recently bond yields have fallen indicating more demand as a safer shore.  In the unlikely event that the Bank of England ceased their QE programme, then the Pound could come to life.

The “euro survival package” produced by EU officials on Friday has not lived up with the high expectations before the EU Summit. However, production of a fiscal compact, the stepping up of the European Stability Mechanism (ESM) to July 2012, no compulsory private sector involvement in debt reform and a possible boost to the IMF of up to €200 billion, are all positive moves.

The fact that David Cameron has decided to reject a joint tender to revise the EU Treaty should not detract from the steps forward made.

Nevertheless, the methods may not be adequate to calm market worries, with frustration at the lack of European Central Bank (ECB) response in terms of stepping up to the plate as “lender of the last resort” still weighing heavily on sentiment.

Data could add to the disappointment this week as “flash” Eurozone purchasing managers indices (PMI) fall further this month.

Over to the US and under the spot light this week will be the Fed’s FOMC meeting, November CPI and retail sales data plus manufacturing confidence gauges with November industrial production too.

It’s unlikely the Fed will change its policy stance at this time however the language may sound a little more positive on the economy based on recent headline data.

Inflation will likely remain subdued while the other data will continue to indicate a steady recovery.

As we approach the Christmas break liquidity is likely to thin further, with ranges likely to dictate without of little directional force.

The single European currency will probably struggle to make much advancement in current market conditions.

Many facets of the EU treaty still need to be clarified to help secure market confidence again.

Expect EUR/USD to trade 1.3260-1.3550 over the short term before Christmas.

In light of further warnings by S&P the ratings agency on the possibility of downgrades to a whole host of European banks as well as the triple-A rating of France and Germany, the wise money markets are beginning to ask if the rating agencies actually matter any more. Why are they six months late to the party?

The market has been asking questions about the health of European banks for long enough for it to be widely accepted, even by the general public.

John Heimann, former vice chairman of Merrill Lynch, suggests the function of the rating agencies is to “visit the field at the end of the battle and shoot the wounded”.

Let’s hope the market shrugs of the news as quickly as the announcement earlier in the week and moves onto the more pressing matters of an ECB interest rate decision today and the announcement tomorrow over further fiscal integration of the eurozone.

Regarding the latter there was fierce debate in the House of Commons yesterday over how any treaty changes would impact on the British economy with several Tory’s including the Mayor of London calling for a referendum on the matter.

The two day meeting has not started but Britain has already been told off by Jean-Claude Juncker, head of the group of euro nations.

He was quoted as saying he does not want the UK setting aside entire pages to say the UK will not do what the others have to do.

Sterling remains relatively unchanged as a storm blows around it, but that may change against both the Dollar and Euro if the ECB, as expected, cut interest rates again.

The Bank of England is certain to keep rates unchanged but may increase the size of the asset purchase scheme (QE) in reaction to the slowdown in the British Economy.

The ratings agency Standard & Poor’s left the growing mood of optimism about the eurozone debt crisis in ruins last night by warning the wise money markets that 15 of the regions 17 countries face credit downgrades if politicians do not gain control of their economies. S&P blasted Brussels “defensive” management of the crisis blaming the prolonged dispute among European policymakers for destroying investor confidence.

All of the AAA rated sovereigns which includes Germany and France have been placed on “negative credit watch”.

S&P highlighted that the French banks were a particular worry as the amount of external debt has risen above France’s GDP.

The timing could hardly have been worse as German Chancellor Angela Merkel and French President Nicolas Sarkozy sent investor sentiment soaring earlier.

Their united front had led to a significant drop in the borrowing costs for many of the struggling Eurozone nations including Italy, whose 10 year yields dropped below 6%.

The other announcements due out this week have been made rather insignificant though the central bank meetings due out on Thursday will maintain some weight in the markets.

The Bank of England will keep their base rate on hold at 0.5%, but any comments from the MPC Committee will be looked into.

The ECB will reveal their decision 45 minutes later and they are expected to cut their rate back to the 1% it was reduced to during the height of the credit crunch.

If this is the case, it will show a remarkable turnaround in the fortunes for the eurozone as the interest rates seemed to be on an upward curve in the 2nd quarter of this year.

The under fire Greek Prime Minster George Papandreou sensationally performed a u-turn yesterday by cancelling his controversial idea of a referendum into whether the Greece should accept the latest bailout package. This has left the Greek government on the brink of collapse as infighting has led to the PM losing his majority.

The political skirmishes spread to the latest G20 summit in Cannes where numerous politicians have balked at the idea of putting up more cash to support the ailing Eurozone economies through the IMF.

The main discussion of the summit is whether to double the size of the International Monetary Fund.

Prime Minster David Cameron has maintained his view that it was in Britain’s economic interest to offer to underwrite billions of pounds in IMF loans.

Even if Greece can avoid default through its current bailout and the support of a beefed-up IMF, world leaders have for the first time spoken about the possibility of Greece exiting the Euro.

French President Nicolas Sarkozy said it was up to the Greek people to decide their future- through his clenched teeth.

The other big announcement yesterday came in the shape of the latest ECB rate decision.

New President Mario Draghi surprised the markets by cutting the base rate from 1.5% to 1.25% in a bold move looking to increase growth across Europe.

In the subsequent press conference, the new president discussed inflation in the Eurozone stating that it is currently over 3%, but will fall below the target level of 2% in 2012.

At least one more cut is predicted over the months ahead as the ECB continues to battle a rapidly worsening economic outlook.

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.

Things seem, for once, to be moving quickly in the eurozone. After high drama in Slovakia over ratification of the enlarged bail-out fund last week, this week looks set to be all about leverage.

More specifically, it will be about how the eurozone makes sure the EFSF has enough fire power to assure the markets that if things begin to unravel, Spain and Italy will be able secure funding without leaving the cupboard bare.

The plan gaining most traction was proposed by Allianz and involves the EFSF guaranteeing the first wave of losses on Greek, Portuguese and Irish bonds.

This would see the funds boosted to around €3 trillion.

Sounds good in theory doesn’t it? Except the structure looks eerily similar to the instruments at the heart of the sub-prime meltdown – collateralised debt obligations or CDO’s for short.

The CDO’s were supposed to spread risk around the system making it safer overall.

What they did, along with industrial scale securitisation was disconnect the borrower from the lender, mask the risks behind complex mathematical formulas and in turn removed all due diligence procedures about the credit worthiness of the borrower.

The risk with the EFSF insuring debt is that if we move back into a serious recession and other eurozone countries look to default because it is suddenly easier to do so, all the losses will simply have been moved from lots of smaller place to one huge pot.

Despite the worries over the structure of the newly enlarged bail-out funds, euro sentiment continues to improve and lift the Euro against both the Dollar and Sterling.