Highlights
EUR-USD plunged to a fresh 1-year low of 1.3114 this week as the debt crisis intensified. The European single currency could have bottomed out, however. In our view, the euro is unlikely to fall further, for the following reasons:
1. The escalation of the Greek debt crisis after S&P cut Greece's rating by three notches to BB+ (i.e. junk status) had little impact on the forex market. Although the market for Greek government bonds had virtually collapsed and the panic - additionally fuelled by the downgrading of Portugal and Spain - increasingly spread to the government bonds of other “shaky candidates” in the eurozone, causing risk premiums on their sovereign debt to rocket, the euro fell less than one cent below last Friday's trough. Apparently, at around 1.31/32, there is substantial demand, from Asian central banks for example, according to rumours.
2. All official bodies, which are involved in the negotiations with Greece, have stated quite clearly that a Greek debt restructuring is not an option at the moment. Furthermore, their comments suggest that the financial support from the eurozone and the IMF should cover Greece's funding requirements for the next three years, reputed to be around €100 to 120bn.
The negotiations with Greece are likely to be concluded this weekend, so markets will then have additional information about the rescue package. The political procedure will take a few days longer, however. The German Bundestag (the lower house) is due to decide early next week, and the Bundesrat (the upper house) next Friday. Apparently, an extraordinary Eurogroup meeting is planned for 10 May, at which member states are to give their final approval to the aid package. At this stage, there could still be the odd uncertainty here and there; in our view, however, policymakers are now well aware that the situation is serious. On the whole, we see a good possibility of things calming down a bit now.
3. In the last few months, economic data in the eurozone have been remarkably robust. Like the Ifo business climate, the European Commission's survey results are now also indicating that the economic recovery is gathering steam in the second quarter. The comprehensive Economic Sentiment Indicator is now above the long-term average again; Germany's economy is particularly buoyant, but the recovery is taking hold across the board. We are expecting growth to have been very modest in the first quarter due to the harsh weather, but to make up for this in the second quarter.
The ECB Council is holding its regular monthly meeting next Thursday. Here too, the focus will presumably be on Greece, both at the meeting and at the press conference. But as the eurozone governments are responsible for the aid package, the ECB will probably try to build up confidence. It will be interesting to see whether Jean-Claude Trichet reiterates the ECB's willingness to implement unconventional measures if necessary to safeguard financial stability in the euro area: as a last resort, the central bank can purchase government bonds, in the same way as it buys, or has bought, covered bonds.
As far as the economic risks are concerned, given the improvement in the economic environment, the assessment could gradually become more positive. A few days ago, Bundesbank president Axel Weber stated that, while the medium-term outlook for inflation is still low, he now sees the upside risks as being somewhat higher than in the last projections in March. That also ties in with the slight increase in money market rates in the euro area. In the last few days, the three-month Euribor has risen by 2 bp to over 0.66. However, in view of the debt crisis, the markets are probably not expecting the ECB to adopt a more restrictive stance for the time being.
Conclusion
Against a backdrop of aid for Greece materialising, the pressure on the euro is likely to ease. The economic environment in the eurozone is becoming remarkably favourable, but because of the debt crisis, the ECB will presumably exercise caution with regard to tightening monetary policy. In the short term, the euro could be somewhat volatile until the Greek rescue package is all cut and dried. Furthermore, apart from today's GDP figures for Q1, a number of important US data will be released next week. The ISM purchasing managers index and the labour market report next Friday are set to underline the upbeat picture of the US economy, thus limiting the euro's scope to rise.
BHF-BANK
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