The German Constitutional Court gives the euro another boost

After weeks and week of delay, Germany’s top Constitutional Court has ratified the European Stability Mechanism - the eurozone’s permanent bailout fund. The court ruled that the ESM does not conflict with the German constitution and Italian PM Mario Monti has today stated that this “has removed the last obstacle for the implantation of the ESM treaty and the fiscal compact treaty.”

There are a few ‘buts’ though, which probably means Monti is jumping the gun a little. Whilst the ESM treaty does oblige the German government to contribute €80bn up front and further contributions upon bailout requests down the line, the German court has limited Germany’s contribution to €190bn. This is a significant condition and may prove to be insufficient given the refinancing needs of Spain and Italy. Italy could potentially decide to it is unable to contribute to the ESM due to the state of its own finances - Germany is unlikely to step willingly into the void. In addition, the court rejected granting the ECB a banking license and in doing so highlighted a continuing lack of firepower.

However, Germany's liability could be increased with the approval of the Bundestag, though such approval seems unlikely given the momentum of bailout-fatigue sentiment among the electorate. Another condition was included that both German House of parliament must be kept informed of ESM decisions, which does have the potential to delay future decisions.  

The ESM’s governing board will meet in early October for the first time but Eurogroup head Juncker has said it will not be activated before January 1, 2013. The euro has rallied again today, focusing on the disaster that was avoided rather than the considerable issues that remain. The euro may be to climb a little further on the back of a QE3 announcement tomorrow evening but it is fair to say this rally is looking increasingly overextended. 

Richard Driver

Currency Analyst 

Caxton FX

ECB President Draghi calms market fears by pledging the ECB will do “whatever it takes”

The president of the European Central Bank, Mario Draghi, has asserted this morning that, within its mandate, “the ECB is ready to do whatever it takes to preserve the euro, and believe me, it will be enough.” He added that the solution was “more Europe,” which again was music to the market's ears. Unsurprisingly, the euro has rallied on Draghi’s positive comments; EUR/USD has bounced by almost two cents.

These comments build on the relief story that was delivered yesterday by ECB policymaker Nowotny. Nowotny indicated that the European Stability Mechanism could be granted a banking license, which would in turn increase its lending capacity. The eurozone’s inadequate ‘firewall’ has long been a major gripe of investors and the fact that there are members within the ECB looking to address this was greeted with open arms. It goes without saying that Nowotny’s comments are a long, long way from becoming policy and he will certainly meet some stiff opposition within the central bank.

This week’s jawboning really ramps up the pressure on the ECB to deliver some emergency policy response of note at its monthly meeting next Thursday. If it fails to deliver a convincing plan on how to bring down Spanish and Italian bond yields which are threatening to force both countries into bailout territory, the euro is likely to come under some fresh and considerable selling pressure. Restarting the ECB’s bond-buying programme, which has been on hold for several months, would be welcomed enthusiastically, as would quantitative easing. Some action will surely come next week, as the ECB is forced to fill the policy vacuum left by the EU’s dithering politicians.

Richard Driver
Analyst – Caxton FX
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