A change of stance at the ECB

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So, the farce in Greece continues, but there is good news in reports emerging (e.g. Wall Street Journal) that the ECB is going to give up some ground in relation to its bond holdings, although no official comment on this as yet.

The issue has proven to be a key sticking point (see blog last week ‘The ECB will have to yield on Greece’), but it now appears that the central bank will undertake an exchange with the EFSF (for EFSF bonds), so that the ECB will not make any profit on its holdings.  Greece will then repay the EFSF at the ECB’s original purchase price. Video:

It sounds complicated, but it’s important because, if true, it would mark a more pragmatic approach from the ECB, certainly compared with the stance of its previous president.  Furthermore, it should make agreement on private sector involvement, more likely.

Meanwhile, the missing of another deadline in Greek austerity talks by Greece simply represents the manifestation of one of the key weaknesses of the eurozone.  French President Sarkozy reiterated yesterday that allowing Greece to go bankrupt “isn’t an option”, whilst Germany’s Merkel stated: “I will have no part in forcing Greece out of the euro”.  Without these ultimate sanctions or a proper system of fiscal transfers we remain in an untenable situation.

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Commentary

The euro’s continued squeeze higher. New highs for the year were seen on EUR/USD yesterday, with the single currency the strongest performer of the majors during the European trading session.  Once again, it was hopes around Greece that were supporting the single currency and this support has continued overnight.  The dollar was also weaker against most currencies (the main exception being the yen), with comments from US Federal Chairman Bernanke adding to the softer tone. He downplayed some of the recent strength in the labour market numbers, which reflects our opinion of last week that there are still worrying underlying trends in the US jobs data. The dollar index was some 0.6% softer yesterday and reached a new low for the year at 78.6.

Swissie needs more than stealth intervention.  Markets are becoming increasingly nervous at the prospect of fresh SNB intervention, not least because EUR/CHF has been perilously close to the 1.20 floor and there is a new (interim) president at the helm of the SNB whom at some point could well flex his muscles to prove he means business. His comments yesterday essentially reiterated the SNB’s commitment to buy unlimited quantities of foreign exchange to defend this level, although the Swissie initially strengthened on the news, some fearing something more significant from his speech. The SNB introduced a cap to CHF strength early in September, but has not been as explicit as Japan in detailing exactly what interventions have taken place. Furthermore, the SNB is more inclined to conduct forward and swap operations, as well as spot transactions, in order to quell currency strength. The latest data show reserves falling some 10% in Swiss franc terms. Taking the level of reserves prevailing at the end of August (the cap was announced on 6th September), reserves are down around 10.3% in Swiss franc terms. Around three-quarters of this decline is down to the weaker value of the Swiss franc, rather than direct intervention. If we take the period after the floor was set however, i.e. October to January, then we see reserves down around 7% in CHF terms, which is more than was suggested by the underlying composition of reserves valuations. In other words, from what we can discern (this caveat a requirement in relation to the SNB), the authorities have not been undertaking ‘stealth’ intervention to keep the CHF from rising.

The problem with Portugal. In extremely difficult circumstances, the government of Prime Minister Pedro Passos Coelho deserves fulsome praise for the gusto it has displayed in attempting to rectify the gaping hole in Portugal’s national balance sheet. With an electoral mandate based on austerity, he has implemented measures that are expected to reduce the budget deficit to around 4.5% of GDP this year, after it reached almost 10% back in 2010. Having received bailout assistance of EUR 78bln last year from the troika, Portugal is essentially fully funded until late next year.  However, despite its best endeavours the government is still likely to fall short in terms of placing Portugal back onto a more sustainable financial footing. Based on rather questionable assumptions, the EC has calculated that debt/GDP will stabilise next year at 113%. This projection will certainly be proved wrong. Even if the government succeeds in delivering a fiscal deficit of only 4.5% of GDP this year, and 3% next year, debt will grow relative to GDP because the denominator will be falling. Nominal GDP in Portugal has declined in the past four years, with another deep recession likely in 2012.  Although Portugal is no Greece, nevertheless there are justifiable concerns. Without significant structural reform and a substantial internal devaluation, the economy simply lacks the necessary wealth creation to underpin a meaningful recovery. Despite yesterday’s vehement denials from the Finance Ministry, a significant restructuring of debt is highly likely at some point in the next couple of years.

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