Euro update 2011

Europe

In the last two months, sterling has predominately been stuck in a horizontal trend between €1.1250 and €1.550. However as the early days of September ticked by, the rate moved above €1.16 for the first time since early March, resulting in a 6 month high. The rate even briefly peaked above €1.17 on the 12 of September before falling sharply only a few days later.

So, once again we sit in the range above €1.12 and below €1.16 and Greece is back in the spot light. Merkel and Sarkozy did well to calm investors’ nerves with comments stating they are convinced Greece will remain within the euro mechanism, but this confidence did not last long. A Greek default now looks inevitable as the mid October deadline for much needed funding draws ever closer and the chances of Greece meeting the conditions set out to receive the next instalment of the bailout package moves further away.

Greece said it was close to a deal with the Troika*, but that confidence seems very one-sided as the IMF, ECB and EC were so frustrated with Greek failures that they didn’t even attend the meeting – instead opting for a conference call. The IMF has raised fears further by announcing that the global economy has entered, “a dangerous new phase” of slow growth in relation to the euro zone debt crisis.

With the ECB lowering growth and inflation forecasts, this suggests that the euro zone is suffering an economic slowdown and speculation is increasing that that the ECB will be forced to cut interest rates in the area during the final quarter of the year. This represents a quick turnaround following two interest rate rises since June and will do nothing to alleviate concerns that a single monetary policy across such a diverse range of economies doesn’t work.

The problems in the euro zone continued when S&P fired a shot across the bow of Italy, downgrading the country one notch to A/A1 and blaming political infighting for an ineffective reaction to its financial problems. The bad news for Europe and its banks continued, with a report that Siemens recently withdrew more than €0.5 billion of cash deposits from an as-yet-unknown French bank, and transferred the funds to the ECB due to fears about the health of the bank.

As expected the Bank of England’s Quarterly Bulletin suggested that the UK’s QE policy was a considerable success, adding 1.5-2.0% to GDP (and up to 1.5% to CPI inflation). Whether correct or not, the market has interpreted this as part of a communiqué that more QE is on its way, which could be viewed as either GBP-negative or reassuring that the bank stands ready for action, depending on your side of the fence.

The direction of the sterling/euro will largely depend on how euro zone leaders and the International Monetary Fund deal with the debt crisis and whether the markets view it with optimism or scepticism.

 

*The Troika refers to the group consisting of the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF) that coordinated the financial bailouts of Greece, Ireland and Portugal.