Why the euro may not realise its full potential

Why the euro may not realise its full potential

Good morning and welcome to today’s foreign exchange market commentary on Monday, the 3rd of September.

As the European Central Bank meets on Thursday to decide whether to launch its bond buying program in the secondary market, an important event is due on September 16 when the German Constitutional Court pronounces its verdict on the legitimacy of the European Stability Mechanism, successor to the current emergency lender, The European Financial Stability Facility. The plaintiffs include all parties from the entire political spectrum and a few retired law and economics professors. If the court prohibits setting up of the ESM, Angela Merkel won’t be able to sign the treaty that has already been ratified by the German Bundestag.

The plaintiffs have raised several legitimate objections. First, they claim the ESM violates the Maastricht Treaty which contains a “no-bailout clause.” Germany had joined the currency union on the condition that indebted states would not be bailed out and there will be no direct or indirect socialisation of debts. Indeed the euro came into existence under the assumption that it would not have wealth implications.

The breach of Article 125 of the Maastricht Treaty that prohibits sovereign bailouts, the plaintiffs argue, required proofs that Greece’s exit would pose a greater threat than anticipated when the law was drafted. No such evidence was provided, they assert.

Second, introduction of ESM mandates Germany’s representative on the ESM council to seek prior approval from the Bundestag. However, international laws don’t permit this since if Germany wanted to curb the authority of the governor, it needed to inform other signatories in advance. Since the German representative on the Governing Council is sworn to secrecy, s/he is not accountable to the German parliament either.

Also, even though the liability of any country is limited to its share of capital compared to external partners, this constrain doesn’t apply to other signatory members. Thus a single country can be held liable for the ESM’s entire EUR 700 billion exposure, the plaintiffs argue.

It’s unlikely that the euro will realise its full power if those in authority break the rules selectively, they contend. However, Europe must think of an alternative if the court rules against ESM intervention in the primary market.

CURRENCY RATES OVERVIEW

GBP/EURO – 1.2610
GBP/US$ – 1.5855
GBP/CHF – 1.5154
GBP/CAN$ – 1.5638
GBP/AUS$ – 1.5468
GBP/ZAR – 13.3174
GBP/JPY – 124.18
GBP/HKD – 12.3005
GBP/NZD – 1.9812
GBP/SEK – 10.5436

EUR: The single currency started off on a strong note against the greenback on Friday, triggered by a sell off of the USD, pushing the EUR/USD pair up the 1.26 handle. The EUR/USD rally pushed GBP/EUR pair to the lows of 1.2568, the least since early July. The euro however, failed to maintain the momentum amid reports that beleaguered Spanish bank, Bankia, may require further capital injection despite a previous EUR 30 billion cash injection. Moods were soured further following S&P’s downgrading of Catalonia region of Spain to junk status. The markets may turn choppy this week ahead of the ECB’s interest rate decision and the associated press conference for announcements of the central banks intervention in the secondary bond market on Thursday. The European manufacturing PMI is due today, but unlikely to generate much interest. The GBP/EUR pair opens at 1.2615 this morning.

USD: The greenback came under pressure against the cable on Friday ahead of Fed Chairman Ben Bernanke’s Jackson Hole speech. Bernanke was particularly dovish in his assessment of the economy, stating there has been no net improvement in the labour market since January and non-standard monetary policies should be used for accelerating growth. Precious metals surged following Bernanke’s speech with gold hitting its highest since April even though the FX market seemed undecided after Bernanke’s speech. The week will witness some hectic activity with the Manufacturing PMI due today and Construction and Services PMI coming out later. The BoE rate decision is also due this week even though it’s likely to be non-event. US markets are closed in observance of Labor Day today and the GBP/USD pair is expected to remain range bound. The GBP/USD pair opens at 1.5867 this morning.

Have a great day!

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