Eurozone crisis: How 'far left' to go?
“Vows made in storms are forgotten in calm” - Thomas Fuller
The week so far has been a far calmer and more risk positive environment than we witnessed at the end of last week and whilst the eurozone officialdom remains a long way from a solution to the evolving crisis, there seems to have been a subtle change in attitude across the union that has been more warmly received by global financial markets.
Ultimately the election performance of the far left, and the recent rhetoric of its most (globally) vocal proponent Alexis Tsipras (the Syriza Party Leader) has resonated in the corridors of the core European Nations. In effect he has espoused his ‘will of the people’ mandate to pressure for change across Europe and his ‘threats’ of the severity of the situation, should Greece exit the eurozone, appear to have brought a tacit acceptance from as far as Germany that growth measures will inevitably take a more pivotal role in future eurozone policy. Indeed the subtle shift in bias, or perception of increased receptiveness to pro-growth measures, has allowed risk assets (and currencies) to bounce from the fear and deleveraging of last week. This was at least true until the US session last night, where that rally began to falter and today there are a number of key events that could return the calm or exacerbate the fear.
This morning’s Bank of Japan policy meeting was the first of these key events and their inaction, though expected by many, has brought modest disappointment to the markets, especially those short JPY. The statement remained broadly upbeat on Japan's economic prospects suggesting that there is growing evidence that the economy is shifting towards a pickup. However, the statement also expressed renewed concern over the European debt problem
In the UK the picture has become increasing nervous over recent weeks and speculative deleveraging and real money flows have seen GBP weaken as a result. Last week's Bank of England Quarterly Inflation Report provided a more dovish than anticipated central projection, which saw CPI falling below 2% at the policy horizon (usually synonymous with a policy easing bias). However, the previous MPC minutes had highlighted a shift towards policy normalisation, admittedly prior to the further deterioration of sentiment in the eurozone. Today’s BoE minutes, given the increased risk of disorderly events in the eurozone (that were known at the time of the meeting) will give a clearer indication of the near term threat of the impact of the Greek repercussions as seen by the UK policy makers. Recent price action suggests that the market is expecting at least one member to have joined the David Miles QE camp following Adam Posen’s departure in April.
The reality of the situation in the UK, however, is in my view a touch more sanguine than the market fears. Yesterday the IMF suggested that “Further UK Monetary Easing is required” and that “UK economic risks are large, tilted to the downside”. However, whilst it is clear that the risks to the UK, given a disorderly exit or default from Greece, are significant I am an advocate of the view that the MPC (and similarly the government) will await the outcome of the Greek election and its ramifications before acting. I am still of the opinion that the current subtle bias shift across the monetary union is a process on its way to concessions, growth measures and austerity ‘breaks’ for Greece that will likely keep the embattled nation in the eurozone for a while to come.
The last of the day’s major events will be the press conference from the EU summit late in day. Comments from German sources in this morning's FT that Germany retains its opposition to Eurobonds has perhaps halted the growing momentum towards greater fiscal unity and whilst I would not expect anything more than ‘scripted encouragement’ from the eurozone leaders this evening, tighter fiscal unity and even Eurobonds are the only real way forward in the long run if the project is to survive in its current form.
On a technical note there is another reason why German opposition to further support may ease if the situation deteriorates. Claims between national central banks (ncb’s) in the eurozone are aggregated by the TARGET2 settlement system, effectively making ncb’s debtors or creditors to the Eurosystem. Since the start of 2012, German claims on the Eurosystem have risen 30%. If a Greek exit caused a peripheral banking crisis, which is the core prophecy (or fear) of many, then Germany could be risking approximately 25% of GDP.
Whilst I have a more positive bias to the outcome in the eurozone, at least in the near term, I do continue to advocate an underperformance of the EUR. Whilst not predicated on a collapse of the eurozone itself, the economic or growth differential argument (as highlighted further by the OECD Global Economic Outlook forecasts yesterday) will continue to be dominant in my view (as opposed to simply risk on / risk off), which should continue to support GBP and the USD vs. EUR, AUD and JPY.
Neil Staines writes regularly on TradingFloor.com. If you'd like to be notified whenever Neil posts a new article, become a member - it's free, and you can use your Facebook, Twitter, Google+ or LinkedIn identity as a login. You can also bookmark the Neil Staines page.