Euro, equities plunge again on increasing prospects for Greek euro exit and Spanish banking problems

Tom Tong14/May/2012Currency Updates

The US Dollar continued to benefit last week from increased risk aversion worldwide. Equities, commodities and EM currencies joined the Euro in the generalized sell off. Investors were unnerved by the failure of the fragmented Greek parliament to form a Government and the likelihood that the leftist coalition will win the repeat elections next week. The nationalization of Spain’s fourth largest bank, and the lack of faith in official estimates of the capital needs of Spanish banks did not help matters. Finally, a spate of weaker than expected data out of China added to the general gloom.

GBP

As we and most observers expected, the MPC did not change policy at last week’s meeting. The interest rate was kept at 0.5%, and the gilt purchase target at 325 billion GBP. All eyes turn now to next week’s release of the Inflation Report, which will provide much information as to the mindset of UK policymakers. Inflation has continued to surprise to the upside, while growth has come in significantly lower than expected by consensus. The MPC’s view on these issues will be one of the drivers of sterling’s short term performance. The other driver will continue to be the evolution of the European crisis, which appears to be spiralling out of the control, such as it was, of European authorities. We think that sterling will continue the trend of the last two weeks, rising against the Euro while dropping against the Dollar. We look to the Inflation Report to provide clarity as to which of these two trends will dominate.

EUR

Bad macroeconomic news out of the eurozone were eclipsed last week by even worse political and financial news. Greek parties failed to reach a coalition agreement, and new elections loom next month. The leftist party Sryza appears to be the likely winner, and it has made it clear that the current program is unacceptable. ECB and German sources have made it equally clear that they will not renegotiate the program, and therefore Greece appears to be set to be the first country to exit the eurozone and go back to a national currency. It will not be the last, unless Frankfurt and Brussels change radically their disastrous policies of austerity, can-kicking and magical thinking, and do so fast. Another fault opened up in Spain where the fourth largest bank, Bankia (as a result of the merger of several savings and loans) was nationalized in order to avoid its failure. It is now clear that Spanish regulators have refused to deal with the true state of Spanish banks’ balance sheet; the announcement of the fourth plan in two years to force them to recognize the true extent of their real estate losses did little to restore confidence, and Spanish bank shares continued to plunge. European authorities are quickly running out of time, the threat of bank runs in the periphery looms, and absent a radical change in the mindset of European authorities we expect to see the common currency considerably lower against the Dollar.

USD

Second tier data out of the US were overshadowed by the momentous events out of Europe, and had little discernible effect on FX trading. Nevertheless, both weekly jobless claims and consumer confidence came out better than expected, and were supportive of our view that the US economy will remain relatively isolated from the European crisis. The trade report showed surprising strength in exports, further encouraging us to maintain for now our forecast of moderate growth of around 2.5% in the US for the full 2012 year.

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Written by Tom Tong

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