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● Ahead of the European summit the most important facts are:
● Only the ECB can resolve the funding panic linking sovereign debt
and banks.
● In the end it will do what is necessary. However, the ECB cannot
make a public pledge to do so.
● The markets should be able to work this out.
● For now, only the ECB can address the growth problem in Europe. In
the end it will do so.
● Given its past responses to the key PMI data there is a case for the
repo rate to be cut below 0.5% – see chart from our European
economists below.
How much and when …?
Of course, what the markets want to know is by how much and when.
Here the answers are a bit fuzzier.
When headline inflation is above target, as now, the ECB typically
lags the PMI data but catches up eventually. Unlike its role in
stabilising Italian and Spanish debt, the ECB can and does
communicate about interest rates. We assume the ECB will give some
signals on this next Thursday, even if it doesn’t cut until December. So,
in our view, the next rate cut will happen by December at the latest.
The ECB will not regard rate cuts as a panacea for Europe’s problems,
and nor should we. Whether policy rates eventually fall below 1% will
probably be a function of:
(1) whether funding liquidity (for both sovereigns and banks) improves.
(2) whether European manufacturing follows the small bounce in
production/new orders that seems to be happening in China and the
US, or vice versa.
(3) whether (Brent) crude prices fall back as Libyan output improves.
(4) whether the euro (trade weighted) falls sharply or not.
Does this mean that this summit and the decisions likely to be taken in
the run up to the G-20 meeting on November 3 are largely irrelevant?
Not quite, though the most market-relevant issue now is how much
and quickly politicians clear the ECB’s path to do what it has to do.
The way we look at the summit can be summed up as follows:
Clarity on Greece …
Deeper haircuts within the Greek PSI are not a necessary condition to
put Greek debt on a sustainable basis. Nor are they a sufficient
condition. Political changes in Greece – with or without elections – will
be needed to make any real progress in that direction.
Bank recap and funding guarantees …
We think that a plausible guarantee scheme to help banks roll over
their term funding (via bond issuance) would ease the burden on the
ECB and could be very positive for risk appetite but there is scant
detail on this. As for capital, we do not think any amount of recap
could prepare the banks for default by Italy or Spain, but that in
neither case is default at all likely for the foreseeable future.
Ring-fencing Spain and Italy …
The EFSF cannot be reworked in a way that will fully underwrite or
guarantee funding for Italy and Spain. It therefore cannot be a solution
for sovereign funding issues in big countries when taken on its own.
We worry that the guarantee scheme could provide perverse
incentives for default in certain circumstances rather than protection
against it that would be valued by investors. It might, however, be of
some value for reducing short-term funding costs for some countries.
Unlike some of our credit colleagues, we think that the Special
Purpose Investment Vehicle proposal has more merit – but the devil is
in the details, including the amount of investor appetite for the scheme.
In summary
European sovereigns and banks have a funding crisis that threatens
not just recession but outright deflation and major contagion effects to
the whole world economy. This could spark a global depression and
the end of globalisation as we know it. Hence the hysteria.
The only institution that can keep this vicious funding circle at bay and
stave off the wider systemic threat is the ECB. But in the European
political and legal context it cannot do so by pre-announcing QE. Nor
can politicians, investors or commentators tell the ECB what it should
do. The way to judge this summit, its rolling aftermath of detailed
decisions and the G-20 gathering on November 4 is whether it makes
it easier or harder for the ECB to do what it has to do, in our view.
Which is to (1) continue to assure funding for the European banking
system; (2) help set Italian and Spanish funding costs at sustainable
levels; and (3) cut interest rates to help counter the potentially severe
shock to growth Europe now faces. And recognise that all these things
are likely to happen in any case.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● Ahead of the European summit the most important facts are:
● Only the ECB can resolve the funding panic linking sovereign debt
and banks.
● In the end it will do what is necessary. However, the ECB cannot
make a public pledge to do so.
● The markets should be able to work this out.
● For now, only the ECB can address the growth problem in Europe. In
the end it will do so.
● Given its past responses to the key PMI data there is a case for the
repo rate to be cut below 0.5% – see chart from our European
economists below.
How much and when …?
Of course, what the markets want to know is by how much and when.
Here the answers are a bit fuzzier.
When headline inflation is above target, as now, the ECB typically
lags the PMI data but catches up eventually. Unlike its role in
stabilising Italian and Spanish debt, the ECB can and does
communicate about interest rates. We assume the ECB will give some
signals on this next Thursday, even if it doesn’t cut until December. So,
in our view, the next rate cut will happen by December at the latest.
The ECB will not regard rate cuts as a panacea for Europe’s problems,
and nor should we. Whether policy rates eventually fall below 1% will
probably be a function of:
(1) whether funding liquidity (for both sovereigns and banks) improves.
(2) whether European manufacturing follows the small bounce in
production/new orders that seems to be happening in China and the
US, or vice versa.
(3) whether (Brent) crude prices fall back as Libyan output improves.
(4) whether the euro (trade weighted) falls sharply or not.
Does this mean that this summit and the decisions likely to be taken in
the run up to the G-20 meeting on November 3 are largely irrelevant?
Not quite, though the most market-relevant issue now is how much
and quickly politicians clear the ECB’s path to do what it has to do.
The way we look at the summit can be summed up as follows:
Clarity on Greece …
Deeper haircuts within the Greek PSI are not a necessary condition to
put Greek debt on a sustainable basis. Nor are they a sufficient
condition. Political changes in Greece – with or without elections – will
be needed to make any real progress in that direction.
Bank recap and funding guarantees …
We think that a plausible guarantee scheme to help banks roll over
their term funding (via bond issuance) would ease the burden on the
ECB and could be very positive for risk appetite but there is scant
detail on this. As for capital, we do not think any amount of recap
could prepare the banks for default by Italy or Spain, but that in
neither case is default at all likely for the foreseeable future.
Ring-fencing Spain and Italy …
The EFSF cannot be reworked in a way that will fully underwrite or
guarantee funding for Italy and Spain. It therefore cannot be a solution
for sovereign funding issues in big countries when taken on its own.
We worry that the guarantee scheme could provide perverse
incentives for default in certain circumstances rather than protection
against it that would be valued by investors. It might, however, be of
some value for reducing short-term funding costs for some countries.
Unlike some of our credit colleagues, we think that the Special
Purpose Investment Vehicle proposal has more merit – but the devil is
in the details, including the amount of investor appetite for the scheme.
In summary
European sovereigns and banks have a funding crisis that threatens
not just recession but outright deflation and major contagion effects to
the whole world economy. This could spark a global depression and
the end of globalisation as we know it. Hence the hysteria.
The only institution that can keep this vicious funding circle at bay and
stave off the wider systemic threat is the ECB. But in the European
political and legal context it cannot do so by pre-announcing QE. Nor
can politicians, investors or commentators tell the ECB what it should
do. The way to judge this summit, its rolling aftermath of detailed
decisions and the G-20 gathering on November 4 is whether it makes
it easier or harder for the ECB to do what it has to do, in our view.
Which is to (1) continue to assure funding for the European banking
system; (2) help set Italian and Spanish funding costs at sustainable
levels; and (3) cut interest rates to help counter the potentially severe
shock to growth Europe now faces. And recognise that all these things
are likely to happen in any case.
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