There’s no doubting that eurozone politicians have a monumental task ahead on various fronts, but this is made all the more hard by the growth outlook. Ultimately, this is what budget sustainability hinges on. With no growth, it’s pretty difficult to pay down debt and if you push too hard for it, you just kill the economy even more.
Yesterday’s GDP numbers in Portugal showed a 4th consecutive decline and whilst the French and German numbers this morning were in line with expectations, both are likely to slow significantly in the current quarter. Indeed, with eurozone Q3 GDP expected to show a rise of just 0.2% QoQ when data is released later this morning, a negative reading for the 4th quarter looks more likely than not.
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The task ahead for Monti. There’s was strange calm in markets yesterday, the two previous Mondays having been characterised by crisis. Two weeks ago it was the Greek proposal to have a referendum on the latest bailout package and we all know where that ended up. This time last week it was the impending fall of the Italian government and the related monumental rise in bond yields. Much has been made of the Italian bond auctions, but these were for below-average amounts and were five-year paper, so should not seen as a huge test of international investor confidence. As we wrote last week, Italy will have to see yields move to somewhere around the 5% region to allow investors to breathe a little easier. But that won’t be sufficient to secure long-term confidence in the world’s 3rd biggest bond market. Monti’s biggest challenge now is to avoid tipping the economy into recession via huge fiscal austerity. Italy’s low growth that has been one of (but by no means the only) major factor holding it back over the past decade or so. But to really stand a chance of avoiding debt restructuring, the ECB will have to step in further and get its hands dirty. This will mean more interest rate cuts and more bond-buying. Of course, the ECB remains constrained by its mandate which stops it from printing money in the true sense, but at some point it will have to roll up its sleeves with the others in an attempt to keep the euro together. After all, as well as maintaining price stability, it is tasked with supporting the EU’s objectives of ‘high employment and no-inflationary growth’, both aims of which are under threat by the current sovereign crisis.
Obama raises the temperature in China currency debate. During most of his Presidency, Barack Obama has generally played a fairly straight bat on the China currency question, perhaps reasoning that there was huge risk in antagonising America’s largest creditor. However, with Washington increasingly absorbed with the issue once more, and the Presidential electoral cycle now getting started, Obama has clearly decided that enough is enough on the question of the renminbi. Since the middle of last year when China decided to allow the currency to more closely reflect market forces, the yuan has strengthened by 8% in nominal terms. In response, China has pushed back, imploring America to realise that its problems of high unemployment and large deficits are of its own making. China’s President Hu Jintao remarked that “China’s foreign exchange policy is a responsible one” and that the exchange rate mechanism will continue to be reformed. This is a debate that will remain in focus over coming months, especially with President Obama struggling in the polls.
Comfortable increases in German and French GDP. The German GDP numbers for Q3 were in line with expectations, growth up 0.5% QoQ, although there was modest good news with the upward revision to the previous quarter, from 0.1% to 0.3%. In France, the 0.4% rise in GDP masks what was a marked slowdown in data seen in September which is likely to be carried through for the remainder of the year. Naturally, it’s fairly key that both Germany and France continue to see positive growth going forward if the eurozone is to stand a chance of escaping the current crisis. For France especially, this is going to be a close run thing.
UK Inflation. The decline should begin today, all being well. From 5.2%, inflation is anticipated to fall sharply into next year, with the decline really kicking off in January when the base effect from the rise in VAT last year falls out of the calculation. For today’s October number, the street is expecting a modest fall to 5.1%. There are still some increases in household utility prices to feed through, but this should be offset by some declines in food and other commodity prices. Naturally, the Bank of England is more than keen to see inflation to fall back, easing the pressure on negative real income growth.Get the 5 most predictable currency pairs