Europe’s North-South Divided Seen Also in Two-Tiered Banking System

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The Bank of Japan made a surprise announcement overnight during Asian trading as they added another round of easing.  The Asset Purchase Program was extended by 6 months to the end of 2013 and the size was increased by JPY 10 trillion to JPY 55 trillion.  This increase will be evenly split between JGBs (Japanese Government Bonds) and T-Bills.

The JPY was sold off immediately after the announcement and reached a high of 79.23, before drifting back towards the 79.00 level.  Technical resistance points are at 79.25 and 79.50.  The selling off of the JPY was not surprising given the way traders sold off the USD following the announcement by the FED last week after their announcement on easing.  According to the central bank, this move is expected “to help ensure that Japan’s economy resumes a sustainable growth path with price stability”.

Guest post by Matthew Lifson, Foreign Exchange Trader, Market Analyst of Cambridge Mercantile Group.

Most analysts were expecting the BOJ to act in the near future and were somewhat surprised at the timing of the action.  The difference between the actions of the BOJ and the FED and ECB are simply that the FED and ECB moves are unlimited while the BOJ move is limited in its terms.

The EUR seems to have eased its upward climb as traders are beginning to wonder if the decisions made in the last few weeks are going to be able to sustain the EUR value.  Adding to this problem is a report that shows deposits moving out of banks in the “problem countries” of the EU totaling EUR 326 billion.  According to the report these deposits came out of banks in Spain, Portugal, Ireland and Greece over the last 12 months that ended July 31.  Irish and Greek banks began the drain in 2010 and then Spain and Portugal continued it last year.  This pretty much matches the inflow of deposits that have flowed into Germany and France over the same time period.  Deposits moving from the troubled countries to the more stable countries of the Eurozone is creating a “two-tiered” banking system which isn’t helping the economic recovery of the Eurozone.

This “two-tiered” system has created a funding disparity in Europe.  Rates for loans in the troubled countries are as high as 7% in Greece, while similar loans are around 4% in Germany.

The ECB is ready to purchase government securities as the European Stability Mechanism (ESM) is about to begin.  Market skeptics are now wondering if the ECB will be able to pull there plan off.  Since the ECB announcement and after the FED announced QE3, the EUR had managed to improve by 7%, as bond yields in Spain and Italy had improved.  While market optimism has helped the EUR in the last few weeks, reality is beginning to set in.  Will Spain finally ask for aid under the new guidelines set out by ECB President Draghi?  Can the Greeks get their act together to enable them to receive the next set of bailout money?  When do the Italians get involved in the “bailout act”?

Once again it seems as though everything will fall on the shoulders of German Chancellor Merkel and French President Hollande to get things in order.  They are scheduled to meet later this week.  There meeting will hopefully come up with some suggestions as to how avert the recession the Eurozone is headed into.

While many look at the Eurozone situation as being stabilized over the last few weeks, problems remain and traders are beginning to see that.  What will Spain do?  How will that affect what Italy does?  Can Greece finally get the aid it needs?

As long as these questions remain, the EUR upside has probably been seen for the near term. Adding to all of this is a report that the Ruling German Coalition Lawmakers have proposed that the ECB rules on bank restructuring only apply to cross border banks and that bank deposit insurance not be applicable throughout all of Europe.  This “watering down” attempt has put pressure on the EUR.

Elsewhere, as commodity prices remain strong, the AUD and CAD, the commodity currencies remain well bid.

Asian equity markets are mixed in overnight trading, while European markets have mostly turned lower over the last few hours.  DOW Futures are lower than they were earlier, but still positive at 5:30 am, indicating a higher opening to the US equity markets.

Look for the EUR to remain rangebound today, but the downside at the moment seems the vulnerable side.

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About Author

Matthew Lifson is a Foreign Exchange Trader and a Market Analyst. with Cambridge Mercantile Group.

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