The weekend polls in Greece have shown the pro-bailout parties gaining ground, with two showing that they could receive enough of the votes to form a viable coalition. This has given the euro a modest lift in Asia trade, allowing a break above the 1.26 level, up from the 1.2496 year low carved out last week.
Still, it’s another three weeks until we will have the election results, so the road ahead remains fairly daunting for the single currency. We also have the Irish referendum on Thursday of this week on the European Fiscal Treaty. Meanwhile, as the Spanish government moves to inject fresh capital into Bankia, there are also moves to greatly enhance the deposit guarantee scheme protection offered to savers in European banks.
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These modestly encouraging developments, together with the fact that last week was the worst of the year for the single currency, increase the risk of some short-covering rallies this week, but there can be little arguing that underlying sentiment remains decidedly fragile.
Germany is warming to Eurobonds. To characterise Germany’s view on eurobonds as outright opposition is both inaccurate and an exaggeration. For some considerable time, Chancellor Merkel and Finance Minister Schaeuble have stated that any discussion of eurobonds was premature without the implementation of a eurozone fiscal pact. The latter has been agreed by European leaders and is now in the process of being voted on by various national legislatures and parliaments. For instance, Angela Merkel held a meeting with the Opposition Social Democrats in Berlin yesterday to discuss passage of the fiscal pact, which requires a two-thirds majority in both houses to pass through. At the same time, Germany is putting forward an alternative to the eurobonds idea. Six months ago, the German Council of Economic Advisors recommended that a European Redemption Pact (ERP) be established, under which a participant country could refinance itself through the European Redemption Fund up to the point where the debt refinanced (under the ERF) reached the current difference between the debt outstanding and the hypothetical debt that would equate to 60% of GDP. The ERF would have a limited duration (for instance, 25 years) and would require participants to sign up to debt brakes (in other words, it would need to be inserted into national constitutions). Also, each participant would guarantee their own debt in the fund by submitting a 20% deposit in the form of FX reserves and/or gold. This proposal has a lot of merit and it is being pursued by Berlin as an antidote to those ideas being generated by members of the Latin-bloc. The whole idea is to incentivise and encourage debt redemption rather than debt accumulation. It remains to be seen whether this proposal gets traction amongst European policy-makers. At a time when few other ideas are circulating, it deserves consideration.
The inflexion point on the euro. We wrote earlier this month about inflexion points, whether the European leadership was going to get a grip on the crisis or whether the single currency was going to lose on most of the euro crosses, as well as on the dollar. Despite the modest recovery this morning, last week did see the market inflexion point reached as the euro had its worst week for the year and made a new near two-year low. After three weeks of Aussie depreciation against the euro, last week saw a reversal, notable given the broader dollar gains of around 1% (on dollar index). Furthermore, European leaders cannot put this down to ‘speculators’ as is their wont. These are pension funds and other long-term investors whose clients would no doubt be rather upset if they lost significant sums on a Greek exit, an event which they now see as a real possibility.