ESM hope springs eternal

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When it comes to financial markets, the ECB is the only true eurozone institution with any real power, which is why it has carried such a burden of expectation through the sovereign crisis. The meltdown in peripheral markets seen early in the week was reversed through yesterday’s session, helped by comments from ECB member Nowotny hinting of the possibility of giving the permanent bailout mechanism (the ESM) a banking license.

This matters because it would allow the ESM to increase its firepower by borrowing funds from the ECB. It’s a big ‘if’ though, not least because it would require another change in the treaty which established the vehicle and the current legislation is already having a tough time of it.

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Make no mistake, the ECB is going to find itself under increased pressure over the summer period because, even though rates may be near to zero, they are still seen as having the greatest power to elicit some confidence in markets.

Commentary

Euro back from the big figure.  There were early fears that EUR/USD could be lining up for an attack on the 1.20 level after Tuesday’s hammering of Spanish bonds, but thin trading conditions combined with comments from an ECB board member saw a push up above 1.21 and beyond, as before, the dollar staged a comeback into the European close.  EUR/USD starts the European session near the highs of the past 24 hours, but remains vulnerable to some choppy price action as the summer lull continues.

The foundations of sterling’s safe-haven status.  One of the stand-out features of FX markets this month has been the resilience of sterling in the face of data that would otherwise have been negative for the currency. The Q2 GDP numbers yesterday tested that resolve though, with the economy contracting 0.7% during the second quarter.  There were some one-off factors cited as contributing to this, such as the extra public holiday and (less significant) the rather wet weather, but even leaving this aside, the economy has now contracted for three consecutive quarters having never recovered fully from the drop in output seen after the first recession. Sterling was the weakest performer on the majors, even falling against the yen. Recent retracements following bad news have met with quick buying interest, but not this time around.  Perhaps not surprisingly, some are questioning the UK’s longer-term credentials on the back of this data and asking how long the current Chancellor will be able to stick resolutely with Plan-A (fiscal tightening).

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