WISE MONEY

Rising bank shares have lifted European stock markets amid hopeful economic signals, results from US banks and a report suggesting the ECB was providing more loans to banks than had been thought.Successful French and Spanish bond auctions and falling US unemployment claims also helped improve sentiment.

Bank of America and Morgan Stanley’s results were better than expected.

Commerzbank shares rose 15% after it said it would be able to increase its capital without government help. Also in Frankfurt, Deutsche Bank rose 8%.

In London, Barclays shares rose 10% while Lloyds and RBS were both up 9%.

In Paris, Societe Generale rose 13%, Credit Agricole rose 9% and BNP Paribas gained 8%.

The soaring bank shares helped Europe’s benchmark indexes to strong closes, with the FTSE 100 ending up 0.7% at 5,741 points, its highest closing level since the start of August.

The Cac 40 in Paris closed up 2% while the Dax in Frankfurt gained 1%.

Some of the gains in banking shares were sparked by a report from Morgan Stanley, which said that the European Central Bank was flooding the eurozone banking system with even more cheap loans than had previously been thought.

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.

Banks jumped at the chance of “free money” yesterday as the European Central Bank flooded the markets with low interest 3 year loans. A total of 523 banks borrowed €489.2 billion in the ECB’s biggest ever funding exercise.

The total surged over €100 billion above the expectations as regulators encouraged lenders to take advantage of the cheap money on offer.

The upswing in demand for funding comes as Europe descends into another credit crunch where banks have been refusing to lend to each other for fear that the borrowing bank could be insolvent.

This comes as many banks have continued to write down the value of the sovereigns bonds they hold. Italian banks are believed to be the biggest borrowers as data came out revealing their economy shrinking by 0.2% over the 3^rd quarter of this year.

Apart from this, there has been very little out in the way of news or data.

With the year coming to a close, volatility on the markets has slowed and we’re expecting stable trading over the holidays.

The euro’s fallen 5% over the last month looks set to go into 2012 on the back foot with the US Dollar remaining strong as the global favourite “Safe Haven”.

Sterling has been in limbo over the past few weeks as it has strengthened against the weak currencies while losing ground to the strong ones.

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.

European finance minsters are struggling to finalise a plan to give extra money to the IMF, with the plan then to lend the money European governments. The hope was for €200bn to be pledged by euro Area governments plus money from those outside of the Euro including Britain and Sweden, but the amount committed so far is only €150bn.

Britain, quite rightly, feels since the IMF is a global institution any increase in funding should be global in nature and not confined just to European countries.

The constant disappointment the markets are showing over the lack of any clear resolution is keeping the Euro depressed and stock markets on the back foot.

Traders hoping for a Santa Claus rally look set to be disappointed as the markets wind down into Christmas.

You can tell the various statistic agencies are also preparing for a two week break, as data releases this week are few and far between.

The Bank of England minutes are due tomorrow and continue to be important in gauging when the MPC will expand its QE program, currently expected to be early next year.

Finalised Q3 GDP numbers are also due on Friday expected to show 0.5% growth, not enough to stop the UK re-entering a technical recession in the first quarter of next year.

US Q3 GDP is also due on Thursday along with durable goods orders which will almost certainly show the US economy plodding along at a rate neither low enough to force the Fed to act or improving enough to warrant withdrawal of the current monetary stimulus.

Expect the Dollar to hold on to its strength into the New Year.

The US dollar has gained against the majority of its peers after confirmation came from North Korean state television that leader Kim Jong II had died of a heart attack. The US Dollar gained due to its attraction as a safe haven currency as fear is now growing that instability may arise in the region. The Yen fell against the USD as concern rose for Japan’s economy and security as destabilization of the Korean peninsula will now be a concern.

The Euro has seen no real improvement and is still floundering against the USD. This week the concern for the Euro remains that some of the regions largest economies may have their credit ratings slashed. So we have fear mode prevailing in the markets with the USD akin to gold as it soaks up demand from investors with a lack of appetite as we close the year.

The huge demand for the US Dollar as a safe haven does to a large extent dumb down the fact that the US was stripped of its AAA credit rating by S&P four months ago- maybe Europe need not worry about downgrades!

Mario Draghi the ECB president has certainly not helped ease concerns for Europe as he breached the taboo subject of discussing a Euro break up. His point in discussing was that countries who exit the euro will suffer more than if they remained.

He also sought to play down the ECB’s role in suring up the debt crisis; the financial markets are looking for a more prominent role by the ECB to effectively end the crisis and Draghi has sidestepped this potential solution consistently.

For this week, we will see final readings on third quarter growth for the US, UK and France with no changes expected. On Wednesday we have the Bank Of England minutes and the markets will be looking for more clues on further QE for the UK.

However in reality economic numbers will be of little importance this week as investors shelve risk and await the new year payroll number from the US on Jan 6.

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.

We are set for an extremely busy and important week for the eurozone.The main event looks set to be the announcement of a deal on fiscal union between member states on Friday night, but what the market expects this deal to look like and what the deal actually looks like may well turn out to be two different things.

What the euro needs is further fiscal integration between members with the plan of a centralised treasury to eventually raise and distribute taxes.

What the French and Germans are likely to propose is the fiscally stronger countries get a greater say in how the weaker periphery run their economies.

Thursday sees the ECB monthly meeting, with another reduction in interest rates expected.

ECB head Mario Dragi has also hinted in a recent speech of large scale bond purchases by the bank.

The much softer tone suggests a deal on government budgets might be closer than the market thinks.

Keeping with all things Europe, we also have a large amount of data to digest this week including eurozone retail sales, German CPI and the closely watched ECB monthly report which will detail the size and scope of lending to European banks by the central bank.

Sterling continues to hold its ground versus the euro and Dollar despite the dire announcement by the Chancellor last week, who downgraded his growth projections for the UK economy.

The resulting changes to the UK outlook now mean the Government will not balance its books until 2016 at the earliest.

The reason for Sterling not pushing lower in the face of a worsening outlook is probably that it is the least bad option in the face of the continuing European problems and the potential for QE3 in the US.

That said the Bank of England looks set to announce an increase to its own asset purchase scheme on Thursday at the MPC meeting.

Governor Mervyn King was in very gloomy mood as his announcement the Banks financial stability report last week and it is likely that the BOE will take action this month rather than waiting for the New Year.

Fairly dovish comments by Bank of England officials and weak data will keep the Pound on the back foot over the short term. BoE governor King highlighted the risk of an inflation undershoot while Fisher noted that the BoE expanded QE by a minimum in October and can do more.

Yesterday’s Autumn statement was a mixed bag for the markets.

George Osborne announced two more years of austerity measures following official figures indicating that the national debt was spiralling out of control due to rising unemployment and flagging economic growth.

Fitch reacted by suggesting that the UK was now the most indebted AAA country in the world with the exception of Uncle Sam who lost their full status earlier this year.

The Greenback was dealt a blow by Fitch, the rating agency, as they changed their outlook on the US AAA long term rating to negative.

Nevertheless, Dollar reaction has been strong, with long positioning moving to multi week highs.

The Dollar could face a struggle from the rumour that the Fed is about to embark on a fresh round of QE by buying mortgage backed securities.

The strong start to the week in terms of risk appetite aided a brief Euro rally but the currency remains susceptible to event risk.

High among them the Eurogroup and Ecofin meetings this week, which will decide whether or not to approve Greece’s next loan tranche as well as EFSF leveraging options.

Development is expected to be restricted leaving the euro defenceless to a fall.

Under the spotlight today will be Italy’s sale of up to EUR 8 billion of Italian Bonds and the likelihood that the country may have to face a yield above the critical 7% threshold.

An increase in funding costs will not bode well for EUR sentiment especially following warnings by Moody’s about potential downgrades to sovereign ratings across the region.

At the time of writing there are rumours of ECB again getting involved in bond purchasing.

EUR/USD failed to follow through on gains overnight but as reflected in the IMM; speculative positioning may have some scope for further short covering given that the net EUR short position reached its highest since June 2010 last week.

Nonetheless, upside potential for EUR/USD is likely to be restricted to resistance around 1.3415.

Compare and contrast: the interest rate on the three month note issues by the Spanish yesterday was 5.11%, the interest rate on the US equivalent was 0.01%. Spanish borrowing costs jumped from last month’s auction partly because we are in between governments and the incoming party is still unsure if it will be able to pass the necessary austerity measures to (hopefully) reassure the markets but also because eurozone sovereign debt markets are now completely dysfunctional.

The Euro, after a bit of a rebound yesterday, has opened today on the back foot because of the Spanish problems yesterday and also due to a story overnight about the potential renegotiation of the bail-out of Dexia Bank.

Chinese PMI was also lower than consensus estimates and risk sentiment, which has been falling over the past week, will be further reduced and that means US Dollar strength, Euro and GBP weakness and stock markets continuing to fall.

The Federal Reserve minutes from last months meeting were released last night, and in light of the US GDP revision downward yesterday afternoon were surprisingly neutral in tone.

Only one member, Chicago president Charles Evans, voted in favour of QE3 with several unnamed members suggesting further action may be warranted.

The mere fact that further easing was not ruled out was enough to produce a bounce in US equity markets before normal service was resumed in the asian session.

The Bank of England will follow their Central Bank compatriots in the US by releasing their own minutes from this months meeting.

Again the market will be looking for signs of further monetary stimulus early next month.

Usually tight fiscal and loose monetary policy translates into a weak currency, but Sterling has remained fairly steady over the last year.

The size of any further QE will  be an important factor in whether Sterling stays within or breaks out of it recent range.