Possible Euro break-up remains an extreme tail-risk

Possible Euro break-up remains an extreme tail-risk

By Sayan Guha. Good morning and welcome to today’s foreign exchange market commentary on Wednesday, the 13th of June. Governments should get their act together. After three decades of success, it’s natural to look to the central banks for putting the economy back on the path of sustainable growth, but five years into the crisis, it’s becoming more and more evident that huge balance sheet expansions and unorthodox policy tools can only delay a collapse, but can’t fix structural deficiencies. Government action can’t be replace by monetary policy easing as it becomes ineffective with diminishing returns, both in terms of duration and impact. Steering the economy on the right path is no easy task; a hastily implemented market regulation may result in a chaotic deleveraging of the economy. It’s therefore, imperative to maintain credit channels with sufficient liquidity. In an age of rapidly aging population, fiscal austerity is required, however, if overdone, fiscal contraction multipliers will weigh on real economic growth, pushing the economy in an austerity driven downward spiral. Structural reforms are often unpopular with electorates, making it harder to implement for weak economies. The euro area also has a unique problem; risk sharing. A possible euro break-up remains an extreme tail-risk, but reaching a fiscal and banking union will take time. The like next policy move would be to give the European Stability mechanism a banking license to allow the fund recapitalise banks directly. This will essentially be a stepping stone to secure a banking and fiscal union in the longer run. CURRENCY RATES OVERVIEW GBP/EURO – 1.2418 GBP/US$ – 1.5544 GBP/CHF – 1.4930 GBP/CAN$ – 1.5968 GBP/AUS$ – 1.5618 GBP/ZAR – 13.0484 GBP/JPY – 123.79 GBP/HKD – 12.0607 GBP/NZD – 1.9998 GBP/SEK –  10.9828   EUR: Tuesday witnessed the rout in the European government bond markets with Spanish borrowing costs hitting a euro-era high of 6.8 percent, dangerously close to the 7 percent mark where Greece, Portugal and Ireland were forced to seek external aid. The biggest development of the day however was Italian 10-year bond yields touching the 6.3 percent level, ensuring the EUR/USD remained range-bound for the rest of the day. Yesterday’s range of 1.2450-1.2525 for the EUR/USD fair was well below the 1.2668 level witnessed on Monday following the Spanish bailout announcement. The GBP/EUR pair strengthened yesterday due to strong interbank buying and the pair breached the 1.2480 level on strong demand after opening at about 1.2375 in the morning. The GBP/EUR may advance further today as the European bond markets remain volatile. The GBP/EUR pair opens at 1.2427 this morning.   USD: The pound gained traction against the greenback yesterday with the GBP/USD pair finishing at 1.5575 despite opening at 1.5452 in the morning. The cable’s strength came in as a surprise as Monday we saw UK manufacturing contracting by 0.7 percent in April. Despite the rising borrowing costs of Spain and Italy, the USD underperformed against its global peers over speculations that the Fed would soon initiate the third round of assets purchase program. The economic calendar is light for the UK but May retail sales and producer prices are due from the other side of the pond. The GBP/USD opens at 1.5561 this morning.

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