Europe takes the strain

In the midst of the financial firestorms raging right across Europe, we are reminded of that classic wartime poster, exhorting the people of Britain not to panic and to hold their nerve in the face of unbearable pressure and ever-present threats. No matter where you look in Europe right now, politicians are under extraordinary strain.

In Greece, they have lost a Prime Minister and are set to have a stab at a unity government ahead of fresh elections and with the threat of default hanging thick in the air. In Italy, Prime Minister Berlusconi must be close to stepping down as Italian bond yields soar and the country faces up to the prospect of a team of IMF inspectors setting up camp to monitor implementation of promised reforms. Later today Berlusconi faces a critical test of his leadership with a key budget vote – many from his own party have already defected and/or called for him to resign.

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In Paris, France has announced new austerity measures (see below) in a desperate bid to maintain its credit rating against a backdrop of rising bond yields. And in Brussels, European finance ministers have been meeting again in an attempt to hammer out the details of how the EFSF’s firepower will be raised and, given the many thorny questions to resolve, this process will undoubtedly drag on.


More Swissie selling. Notwithstanding the incredibly troubling developments both in Italy and Greece, it is the Swissie that has experienced some significant selling pressure this week. Not helping the mood on Monday was the news out early in the day that inflation in Switzerland fell 0.1% both MoM and YoY in October, much weaker than expected. Clearly, the strength of the exchange rate has contributed to significant downward pressure on prices, to the point where the Swiss economy is now experiencing deflation. For the SNB, this development will be of deep concern. At the very least, it will trigger a re-examination of the 1.20 EUR/CHF ceiling. Recently, speculation has been mounting that it may be lifted to at least the 1.25 level, and quite possibly 1.30. Overnight, EUR/CHF almost reached 1.2450, up from 1.2150 on Friday. SNB President Hildebrand warned yesterday that more action may well be required, echoing remarks made by fellow board member Danthine at the back end of last week. Overnight, SNB Vice-President Jordan reinforced the message, claiming that policy-makers were “permanently monitoring” developments and that the crisis in the euro area would probably drag on for some time. How successful any further intervention by the SNB would be  the second time around remains to be seen.

France forced to announce further fiscal austerity. Amidst clear signs that the economy is slowing, and with the country’s credit rating under serious threat, French Finance Minister Fillon announced further austerity measures yesterday totalling EUR 7bn for 2012 and a further EUR 11.6bn for the following year. Fillon delivered a EUR 12bn fiscal consolidation package just three months ago. Despite these new fiscal commitments, investors seem unconvinced – the French government 10yr yield rose to 3.09% yesterday, with the spread to comparable Bunds out a further 8bp at 130bp. Faced with fresh elections next year, President Sarkozy, already well behind in the polls, is attempting to do everything possible to ensure that his country does not lose its AAA credit rating by then.

Merkel signs off on tax cuts. While most of southern Europe burns, Angela Merkel announced a package of stimulatory budgetary measures over the weekend that included EUR 6bn of tax cuts, to be implemented in 2013. Reducing the tax burden on Germans had been a major sticking point for the CDU’s coalition partner, the FDP. Wolfgang Schaeuble, the Finance Minister, had insisted previously that Germany should focus its attention on fiscal consolidation. Other measures announced over the weekend included a EUR 1bn increase in transport infrastructure and increased funds for childcare. In contrast to virtually every other member of the euro, Germany’s fiscal circumstances are still improving. Last week there was the revelation that Germany’s public debt had been overstated by a massive EUR 55bn. The single currency’s southern members would be delirious if they were to uncover a similar error.  

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