Of most interest today with respect to the ECB meeting is not the decision on monetary policy, which analysts unanimously expect will result in the refi rate remaining unchanged at 1.25%, but the language used by President Trichet in the press conference. Indeed, part of the explanation for the euro’s improved performance in recent trading sessions is due to an expectation that Trichet will express a need for ‘strong vigilance’ on inflation, which in ECB parlance is code for a rate hike next month. Notwithstanding the fact that inflation is above the 2% level, the ECB’s Governing Council would be advised to tread more warily on rates at this time. Firstly, there is the deepening debt crisis in Greece, which poses clear systemic risks for the eurozone in the near term if it results in default. Secondly, there are signs that the global recovery is losing altitude, especially in the US but also in Asia and Europe. Finally, a rate hike from the ECB at this extremely delicate time would inflame the increasingly fractious relationship between monetary policymakers and eurozone finance officials.
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Commentary
Germany confronts ECB on Greek debt restructuring. Last week’s assumption that Germany had relented slightly on its push for immediate private sector burden-sharing as part of any additional bailout package for Greece has been rendered wide of the mark by developments over the past couple of days. German Finance Minister Schauble has thrown down the gauntlet to the ECB and the European Commission with a demand that Greek bond-holders make a ‘substantial’ contribution to a second aid package through a 7-yr debt swap for maturing bonds. As made clear by both Moody’s and Fitch, a debt-restructuring such as this would constitute a coercive or distressed exchange, and thereby be considered by the rating agencies as a default. Although this particular debate is generating an enormous amount of friction amongst European policymakers, it needs to be stressed that neither the position of Germany nor that of the ECB really makes any difference to the fundamental issue, namely that Greece is almost certainly incapable of servicing its enormous and ever-growing debt mountain. The EU summit, to be held in a couple of weeks, will attempt to thrash out differences on providing Greece with additional aid in what is likely to be a very heated discussion. The Greek debt crisis ought to remain deeply troubling and unsettling for investors and traders alike.
Sterling stumbles on the all too apparent. It remains ironic that markets hang on every word of the ratings agencies, not least when they were so slow to react to events in the run-up to the credit crisis. Some could say that they are trying to make up for lost ground by at least keeping on top of the sovereign credit crisis. But they are also putting out more scenario-based commentary vs. pre-crisis, along the lines of the one we received yesterday on the UK. To be honest, there were no great revelations at all in what they said. We know there are “implementation risks” given the scale of the austerity measures and of course this is combined with the risk that the economy does not perform as well as currently expected. In this scenario, deterioration in the data metrics “would be inconsistent with an AAA rating”. From this perspective, sterling’s reaction looks a little overdone. That said, the comments do serve as a reminder of the consequences of fiscal slippage and the risks that the sterling markets could go into a credit rating worry-fest, as happened in the early part of last year ahead of the election. We don’t appear to be at that stage yet, but 2011 is turning out to be similar to 2010 in many ways, so it’s not out of the question.
More woe for the Aussie. The Aussie continued to slide overnight in response to the latest labour market data, which showed that employment rose by just 7,800 last month. Not only was this outcome much lower than expected, but it is confirms the slowing in the labour market evident since the start of 2011, there has been very little growth in jobs whatsoever. Combined with other signs that the economy is losing traction, it is little wonder the AUD is feeling the pinch. That said, although the Aussie has fallen below 1.06 overnight, it remains within the 1.05-1.10 trading band that has been respected over the last couple of months.
MOF on heightened alert as USD/JPY breaks 80. With USD/JPY back at the critical 80 level once again, it is no surprise that Japanese finance officials are expressing increased concern, especially at a time when the economy is attempting to recover from the aftermath of the tragic March earthquake and tsunami. USD/JPY has been creeping lower progressively since the end of May. In the last two months, USD/JPY has fallen by almost 7%. Part of the explanation for the yen’s recent strength is the latest episode of risk-flight, triggered by increased concern over the pace of the US recovery and worries over Europe’s deepening debt crisis. The dollar’s renewed weakness was not helped by the Fed Chairman who seemed to rule out any additional quantitative easing as a response to the recent phase of slower growth. Contributing to the continued resilience of the Japanese yen over recent months is the consistent buying by Asian sovereign wealth funds, especially China’s. In April, China purchased another USD 16.6bln of JGBs, a record monthly haul. This powerful source of yen-buying is unlikely to go away any time soon, as these sovereign wealth funds remain extremely motivated to diversify out of the declining dollar. For the MOF, currency strength is the last thing the economy needs at this time. Kan’s government is losing political traction at a time when there is consternation over how long it has taken to calibrate a proper fiscal response to the massive restructuring requirement post the March events. The IMF has also weighed into the policy debate by criticising the BOJ for failing to offer sufficient support for the ailing recovery. It is too early to be too worried about imminent intervention from the MOF. That said it is very likely that local finance officials will start voicing their concerns about currency strength much more audibly should the yen continue to strengthen.
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