Greece – deal or no deal?
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Greece – deal or no deal?

Optimism that all of those lengthy meetings in Athens produced the outline of a deal has provided the single currency with some fresh impetus in the last few days, the euro reaching a two-month high above 1.33 yesterday.

Over the course of yesterday, it was confirmed that there was a memorandum of understanding between the leaders of the major political parties in Greece and the troika. Greek politicians have apparently agreed to the 22% reduction in the minimum wage demanded by the troika. Video:

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Those of a more sceptical disposition would observe that we have heard all of this hyperbole many times before. If there really is a deal, the troika has thus far been remarkably mute. Right at this moment the clock is still ticking and there is little clarity. Even if there was a credible deal, it is not remotely clear that Greek politicians could ever deliver on any agreement, based on the evidence of the past couple of years. If the euro really is rising on expectations of a binding Greek deal then, in our view, this represents a real triumph of hope over experience.


Draghi keeps a straight face. After some morning nerves, news that the major political leaders signed a memorandum of understanding with the troika on the latter’s demands, together with Mario Draghi’s claims that there were “tentative signs of stabilisation” in Europe combined to placate euro longs. Draghi’s demeanour and language at the press conference was understandably careful and considered; he suggested that, although the euro area economy faced downside risks, they were no longer “substantial”. He also claimed that the inflation outlook was broadly balanced, which implied he was disinclined to lower rates again anytime soon, and stated that demand for the next 3yr LTRO (to be held later this month) would be strong. Draghi also expressed his opposition to any proposal that the ECB accept a haircut on its Greek bond holdings.      

UK rebalancing on track. Sterling was helped for a time yesterday by the news that the trade deficit in December was the lowest in nine years. Export volumes in the final quarter of 2011 rose by 3.7%, in contrast to imports which were up by just 0.7%. As a result, the initial GDP estimate of -0.2% for Q4 is likely to be revised higher. Interestingly, given the uncertainties across in Europe, the major contributor to the improved trade picture has been growing export volumes which rose by 6% in the second half of last year. Imports were understandably held back by very weak domestic demand and fell very slightly over the half-year ended December. The Bank will also be satisfied to learn that imports are actually becoming cheaper, which in turn is helping the Bank achieve its inflation objective. Confirmation that the economy is rebalancing needs to be tempered by the weakness still evident in the industrial sector. Industrial production did manage to rise 0.5% in the final month of last year but this follows a run of four declines in the previous five months. Softening local demand and very mild weather weighed on gas and electricity production. Manufacturing production is crawling ahead, with growing external demand almost completely offsetting declining domestic demand.

More BoE QE possible after May. As expected, the Bank of England decided to lift its asset purchases program by another GBP 50bln to GBP 325bln in an operation to be conducted over the next three months. In a statement accompanying the announcement, the BoE cited concern that “a significant shortfall” in the UK economy could persist and that without additional asset purchases, inflation could undershoot the Bank’s target. Moreover, policy-makers expect the economy to remain weak in the near term; as such, in our view further QE cannot be ruled out once this latest batch of purchases is completed in May. In some respects, the BoE’s preparedness to continue to engage in responsible monetary accommodation is gaining it some plaudits at this time of unprecedented fiscal austerity.

The euro carry trade. The ECB’s second 3Y auction of funds takes place at the end of this month, with the first operation being credited (by the ECB President) with staving off a credit crunch in the eurozone and, more tentatively, having contributed to the rally in risk assets seen so far this year. But does this mean that the euro will turn into the carry currency of choice? At first sight, there may be something in this proposition. Since the first auction, settled on 22nd December, the euro has under-performed all higher-yielding major currencies. Of course, the single currency has been beset by a number of negative forces, not least those surrounding Greece. But there are three reasons why the euro is not likely to become the preferred carry currency should stronger risk appetite persist. Firstly, there’s strong evidence that the primary reason for eurozone institutions taking cash is to cover upcoming re-financings. The ECB’s own analysis in its latest monthly bulletin, conducted with the benefit of individual bank data, backed up this view by illustrating a strong correlation between the funding requirements of banks and their take-up of funds at the 3Y LTRO. Secondly, even though market rates have been pushed substantially lower (overnight funds averaging below 0.40% this year), the rate applied to the 3Y auctions is notably higher, being the average of the benchmark ECB rate over the lifetime of the loan, currently at 1%. Compared to the price of central bank funds for sterling, Swissie, dollars and yen, this remains 50bp higher than the next nearest. Finally, there’s relative strength and positioning. The yen and Swissie are both causing discomfort for their respective central banks and there are risks of intervention by both to weaken their currencies. For the dollar, whilst the prospect of further QE may have fallen off the agenda, the fact that the Fed is leaning in that direction is also serving to soften the greenback as risk assets rally. All in all, unless the ECB cuts rates substantially in coming months, there are strong reasons to believe that the euro is not going to become a fully-fledged carry currency, with the internal carry trade being a far more dominant force than the cross-currency one.

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