Delay is hurting the euro.

Shares in Italy’s biggest bank, Unicredit Spa, lost 7.9 percent on what the Italian media have dubbed “Black Friday,” a day which saw a large sell-off in Italian assets. Unicredit Spa, along with several other banks, witnessed a sharp drop in the stock market caused largely by worries about the results of stress tests of European banks, the results of which will be released on July 15th. Friday’s market sell-off has increased fears that Italy, the third largest economy in the euro zone, could be the next to suffer in the debt crisis. This brings major concern to the ECB as the euro zone’s current rescue mechanism, the EFSF, would have insufficient funds to help should Italian bond yields continue to rise and put heavy pressure on Italy’s finances.


A gathering of the European Union’s top finance officials in Brussels on Monday is being described as a “coordination, not a crisis meeting.” Despite Herman Van Rompuy’s (president of the European Council) spokesman claiming that Italy will not be on the agenda, it seems impossible that the situation in Italy will not be discussed in Van Rompuy’s meeting with ECB President Jean-Claude Trichet and Jean-Claude Juncker, chairman of the Eurogroup and a few more.

This small meeting of EU finance officials comes ahead of a larger meeting of the 17 euro zone ministers this afternoon which will focus mainly on discussion of the private sector’s involvement in a second bailout package for Greece. Germany, Austria, Finland and the Netherlands are the main advocates in pushing for banks, insurers and other private holders of Greek bonds to shoulder up to a quarter of the bailout package, but after two weeks of negotiations with bankers, very little progress has been made on a plan agreeable to all sides.

The latest proposal that seems to be gaining credence is a plan which would swap Greek bonds for longer-dated debt that would extend maturities by seven years. However, this would likely be seen as a default by ratings agencies while both ECB and German officials stick tight to their claims that they will not accept any plan that is regarded a default.

Another idea that has been floated around, but would essentially mean euro zone finance ministers’ accepting a Greek default, is a buy-back system in which the EFSF bailout fund would buy Greek bonds from the market and retire them. Another major problem with this idea is that it would require changes to the EFSF’s rules, so it would have to pass through national parliaments.

A key issue in all of this is time. Although Greece says it doesn’t need the bailout until early September, euro zone officials see it necessary to get a deal done within the next couple of weeks as any further delay could weigh heavily on investor confidence in the region. As for the euro, speed is definitely of the essence. It has declined by over two cents against the dollar, and by almost a cent against the pound.

Matt Abraham
Caxton FX
 
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

ECB raises rates and indicates further tightening is possible

The ECB has delivered on last month’s rate rise promise, taking the eurozone base rate to 1.50%. The Bank of England threw up no surprises today, keeping the UK rate at 0.50%.


In line with expectations, the ECB has gone ahead with the rate rise it signalled last month with the phrase “strong vigilance” in relation to upside risks to inflation. The rate rise is the last thing the struggling periphery needs right now, but the ECB sticks to its price control mandate very strictly.

Despite some strong German factory orders data this morning, there is growing evidence of an economic ‘soft patch’ being experienced in the eurozone, in line with a global trend. It will be interesting to see what this rate rise does to eurozone growth in the second half of this year. Trichet was actually pretty hawkish, stressing that the ECB will continue to monitor eurozone inflation closely. The door was definitely not closed to a third ECB rate rise this year. If eurozone inflation ticks up later this year, you can be pretty sure the ECB will move again, unlike the BoE.

The euro has received a slight boost as a result, concludes Driver:

The market has responded fairly positively to Trichet’s comments as the euro has gained a little traction for the first time this week. The Portuguese debt downgrade headlines have really weighed on the single currency this week, but the ECB’s monetary policy gives the euro plenty of upside potential regardless of peripheral concerns. Sterling has climbed against the euro this week, but gains may prove hard to sustain with UK second quarter GDP likely to an awful figure at the end of this month.

We are bearish on sterling; it will benefit against the euro when these peripheral issues weigh in the short-term, but the absence of UK growth or monetary tightening really is the bottom line. Likewise for the euro, peripheral issues may weigh in the short-term but interest rate differentials and sovereign diversification will continue to spur the euro on.

Richard Driver
Analyst – Caxton FX


For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.