Currencies | Feb 13 2012
Euro May Not Rise On Greek Accord, Pound Braces For More QE
By Ilya Spivak, Currency Strategist, FXCM
Talking Points
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Overnight Price Action Hints Traders Bet Greek Bailout Deal to be Reached
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Euro May Struggle to Find Support if ECB Dithers on Boosting Bank Defenses
- British Pound Threatened with Bank of England Likely to Expand QE Efforts
Greece remains in focus heading into European hours as traders continue to wait for a final deal on the country’s second EU/IMF bailout. Eurozone finance ministers are set to meet today in Brussels in an attempt to hammer out remaining differences, with the latest discussions reportedly marred by disagreement regarding cuts to Greek pension plans. For their part, traders appear relatively sanguine. The Euro rose to the highest in two months overnight while the safe-haven US Dollar and Japanese Yen traded broadly lower, reflecting expectations that an agreement will be reached.
As we noted yesterday, this makes some sense. EU banks borrowed just shy of €500 billion via the ECB 3-year LTRO in late December while Greece’s has close to €300billion in outstanding bonds, meaning a market-wide credit crunch (akin to the one sparked by the 2008 collapse of Lehman Brothers) is now relatively unlikely even in the case of an outright default. Greek politicians no doubt understand this means their ability to hold the EU hostage with the threat of region-wide meltdown has been diminished, so officials from the so-called “troika” (the EU, ECB and the IMF) are likely to be less accommodative of their demands than previously. From that perspective, Athens must choose which option – deeper austerity or an outright default – poses greater political risks, with markets seemingly reasonable in their estimation that the latter will be judged as harder to sell to the electorate.
Importantly, it is by no means guaranteed that the Euro will necessarily find support in a Greek bailout deal being finally complete. Indeed, the single currency’s buoyancy over recent days suggests much of that may be priced in already. With that in mind, the spotlight turns to the European Central Bank monetary policy announcement. Markets expect no movement on benchmark interest rates, which generally makes sense considering regional economic data has been on a cautiously improving trajectory relative to expectations since September. The larger point of interest will be what (if any) additional measures are taken to strengthen the firewall keeping a sovereign default from becoming a wider banking and credit crisis.
As mentioned above, the banks have been given enough through LTRO to cover Greece. Another similar outing at the next 3-year repo later this month will probably cover Spain (close to €500 billion in outstanding debt). Crafting strong-enough defenses to withstand serious stress in Italy, where the size of the hole left on banks’ balance sheets in the worst case scenario is somewhere between €1.5-2 trillion, will prove substantially more difficult however. Rome must refinance €54.5 billion in maturing debt over the next 30 days alone and boasts the dubious honor of having the highest debt-to-GDP ratio after Greece in the Euro area, so traders would not be hasty in asking how the ECB plans to protect the banks if Italy begins to totter.
Elsewhere, the Bank of England is expected to expand its quantitative easing (QE) program with another £50 billion in asset purchases, an outcome that may prove to weigh on the British Pound as traders size up the exchange-rate implications of further dilution of the money supply. Economic data has performed increasingly poorly relative to expectations since early December. Meanwhile, priced-in medium term inflation expectations declined (albeit narrowly so) over recent months despite Mervyn King and company’s £75 billion boost to QE in October. Economists’ median expectations for UK economic growth in 2012 have been in precipitous decline for some time, so the risk of overshooting with too much stimulus at this point is arguably far smaller than that of being too timid.
The views expressed are not FNArena's (see our disclaimer).
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