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Much is being made of the UK’s refusal to be taken along with a new treaty change, meaning that the 17 eurozone members must go it alone (although some other euro ‘outs’ may be included), but this should be welcomed from all sides.

Given the extensive provisions on monitoring, sanctions and (hopefully) a path towards fiscal union, it was fanciful to think that the non-euro EU members should be included in such a treaty, unless it contained numerous exclusions and provisos. Video:


Going it alone at least allows the eurozone to work on something that is best for its members.   Otherwise, overnight developments have seen a push ahead on the proposal aired late last month for national central banks to lend up to EUR 200bln to the IMF. It is hoped that this move will encourage others to contribute and also allow lending to be channelled though the more experienced and internationally-accepted IMF.

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Furthermore, it was confirmed that the permanent rescue facility (ESM) would start earlier than planned and that further private sector involvement has been buried. The EU is headed in the right direction, but only slowly.

Commentary

The ECB roller-coaster.   The volatile reaction to the ECB press conference was understandable. Firstly, the ECB is now prepared to accept an even wider set of collateral on its liquidity-provision operations. This collateral could also be sitting on its balance sheet for up to three years, with the ECB now having introduced three-year repos with the option of repaying after the first year.   The second reason is that, as we expected, there were no fresh commitments on bond-buying.   Furthermore, Draghi was critical of some of the interpretations of his remarks last week, saying other things will follow once a “fiscal compact” was in place.   He was keen to point out that this did not necessarily mean further bond-buying.   It was this clear-cut response with respect to further bond purchases which knocked the single currency lower.   But it was a big stretch to expect that his stance would have shifted ahead of the summit which started yesterday evening. The ECB has been burnt before when taking as read the promises of politicians (read Berlusconi) which failed to come to fruition. The other factor of note yesterday was the decrease in reserve requirements, from 2% to 1%.   This move will have no real material impact but will mean that the ECB has one of the lowest reserve ratios in the world.   Not a very prudent thing to do in the midst of an unfolding credit crisis.

China’s currency conundrum. Understandably, the focus of global attention these days is on the euro and whether European leaders can somehow cobble together a cohesive response to their debt crisis. However, it is also worth keeping a very close eye on developments in China, where the currency is under much more pressure than it has been for some considerable time.   In recent weeks, the PBOC has been fighting hard to keep the yuan relatively stable. For instance, over recent days it has set the daily reference fractionally higher in an attempt to discourage capital outflow. Worried by slowing growth in China and falling property prices, and with credit conditions tightening not just in Europe but all over the world, some investors have started to pull capital out of the country. In October, for only the second time in the past eleven years, the PBOC sold dollars in order to ensure that the yuan did not decline. In Hong Kong, twelve-month yuan forwards are trading at a 1.1% discount to the onshore rate.   If only for political reasons, it is a very bad time for the PBOC to permit the yuan to depreciate. That said if capital outflow continues over coming months then the PBOC will be forced to dip into its enormous reservoir of FX reserves in order to prevent the yuan from declining. In addition, the offshore/onshore yuan discount could widen further.

Weak Aussie jobs data raises rate cut prospects.  Although Australia’s central bank has lowered the cash rate twice in recent weeks, there is a strong prospect of further interest rate-cuts in the first half of next year. Wednesday night’s employment data certainly helped to reinforce that view. Employment fell by 6.3K last month, worse than expected, and the third decline in the past five months. In the first eleven months of this year, the number of people employed rose by 44.7K, or around 0.4%, the worst performance for fifteen years. The unemployment rate is edging higher as well, now 5.3%, up from 5.0% six months ago. Policy-makers next meet on February 7th – a rate-cut of at least 25bp looks likely. Indeed, a 50bp reduction in the cash rate cannot be ruled out.Economic Calendar