ECB Fails To Gauge Gravity Of Debt Crisis

ECB Fails To Gauge Gravity Of Debt Crisis

Good morning and welcome to today’s foreign exchange market commentary on Monday, the 30th of April.

The European Central Bank has again failed to gauge the gravity of the ongoing debt crisis. It was hoped that the ECB’s near $1 trillion Long Term Refinance Operation will provide temporary relief to the region’s banks. Unfortunately, it proved to be palliative. Following Greece’s forced write-down of sovereign debts, investors have sold their stakes in weak Spanish banks that are already struggling with stricken Spanish banks. Markets are nervous seeing dubious debts of sovereigns on the balance sheets, pushing Europe and the global economy on the brink.

The current strategy of flooding markets with short-term loans seems to be ineffective and contrary to the monetary union. The current premise of the ECB, that the prevailing high interest rates are affecting the indebted nations, and hence the combination of austerity and low cost funding that will arrest the slide, is flawed. Except Greece, this is not the root problem. Ireland and Spain had lower debt to GDP ratio than Germany’s five years ago. Italy had a high debt ratio, but a favorable budget deficit.

The current high deficit is more of a symptom than cause. Lack of growth is Europe’s problem. In any economic situation, when borrowing costs outpace growth rates, debt problems go out of control. In a demand constrained economy, cutting deficits have a larger adverse effect on the GDP since the growth reduction is disproportionately higher due to the multiplier effect. In other words, austerity measures may prove counter-productive despite record low short-term interest rates.

Yes, there is a requirement for raising retirement ages, initiate tough labour market reforms and restructure state benefits program. But since a country’s income is determined by spending, a country on endless austerity drive isn’t better placed to repay its creditors. Europe should refocus on growth as austerity is a step in the wrong direction. And it needs to be a collective responsibility.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2232
GBP/US$ – 1.6212
GBP/CHF – 1.4698
GBP/CAN$ – 1.6022
GBP/AUS$ – 1.5706
GBP/ZAR – 12.569
GBP/JPY – 129.28
GBP/HKD – 12.5787
GBP/NZD – 1.9911
GBP/SEK –  10.898

EUR: The single currency received little support at the start of the week after Spanish Q1 GDP confirmed yesterday that the country was the latest entrant in the 10-member double dip recession club. The euro was further weakened following news of downgrading of 17 Spanish banks by ratings agency S&P. However, the German retail sales for March came in at 0.8 percent, after posting -0.9 percent growth in the prior month, providing some relief to the common currency. Also the yield spread of Spanish and Italian bonds versus the bund narrowed, supporting the currency further. The Sterling jumped to a 22-month high of 1.2310 against the euro before dropping to 1.2253 as profit taking took hold. There’s no economic data expected from Europe today and the focus will remain on UK manufacturing PMI data. GBP/EUR opens at 1.2221 today morning.

USD: The cable plunged to 1.6230 yesterday against the greenback after hitting a fresh eight-month high of 1.6304 in early Monday trading as profit taking and risk aversion spiked dollar demand. After ten consecutive winning sessions against the dollar – the longest streak since 1992, a pullback looked imminent and weak US economic numbers provided the trigger. The Chicago PMI index fell to its lowest level since Nov 2009 while the Dallas Fed Manufacturing Index touched a seven month low, putting question marks over US recovery. The April ISM numbers are expected from the US today while in UK we have the April manufacturing PMI reading. The GBP/USD pair opens at 1.6216 today morning.

 

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