Merkel's blunt message: Save the euro to save Europe

Angela Merkel: No one should think peace
and prosperity…

German Chancellor Angela Merkel gave a blunt assessment of the stakes as European leaders struggle to solve their continent's government debt crisis and save their common currency, the euro.

"No one should think that another half-century of peace and prosperity is assured" if leaders in the European Union fail in this crisis, Merkel said last week to German legislators before a key vote on the latest financial rescue package.

The comment by Merkel, who grew up in the former East Germany and, as head of Europe's biggest economy, has taken the leading political role in steering Europe through its turmoil, alluded to the European Union's fulfillment of its main goal.

That goal was to bind Germany's fortunes to those of Western Europe to pacify the nation that had dragged the continent through two devastating world wars.

Merkel's dogged leadership, especially her speech on Wednesday to her own parliament, is noteworthy. She might lead the mightiest of Europe's nations, but Germany simmers with the rest of Europe in a cultural stew spiced by bitter memories of militarism and bloodshed. It is a mix of national sensibilities, bound by an abstract cultural heritage, that can be variously described as disciplined, casual, and reckless.

Backed by the economic might of the United States, Germany evolved from its status as a nationalist trouble-maker in the first half of the 20th century to the expected, though somewhat reluctant, saviour of Europe today, though it, too, has violated financial rules meant to ensure the euro's stability.

"If the euro fails, Europe fails," Merkel has said repeatedly, trying to convince Germans that their nation's long-term success depends on the prosperity of an ever-more unified Europe, even as her government takes baby steps toward fixing the problems.

One reason for Merkel's incremental approach is the increasing resistance in Germany - which prided itself on financial conservatism, at least until state-owned banks fell hard for subprime-mortgage bonds in the last decade - to opening its wallet to bail out countries that borrowed more than they could afford.

The counter-argument, by analysts in France and elsewhere, is that Germany, as the biggest European economy and one powered by exports that drew wealth from weaker economies to the south, now has to pay.

Bank of England injects further £75bn into economy

The Bank of England has said it will inject a further £75bn into the economy through quantitative easing (QE).

The Bank has already pumped £200bn into the economy by buying assets such as government bonds, in an attempt to boost lending by commercial banks.

But this is the first time it has added to its QE programme since 2009. There have been recent calls for it to step in again to aid the fragile recovery.

The Bank also held interest rates at the record low of 0.5%.

On Wednesday, data showed the UK economy grew by 0.1% between April and June, which was less than previously thought.

"In the United Kingdom, the path of output has been affected by a number of temporary factors, but the available indicators suggest that the underlying rate of growth has also moderated," the Bank said in a statement.

"The deterioration in the outlook has made it more likely that inflation will undershoot the 2% target in the medium term. 

"In the light of that shift in the balance of risks, and in order to keep inflation on track to meet the target over the medium term, the committee judged that it was necessary to inject further monetary stimulus into the economy."

Sterling fell by almost two cents after the announcement to $1.5280, its lowest since late July 2010.

'Warranted'

The CBI and the British Chambers of Commerce (BCC) business groups welcomed the Bank's move to expand the QE programme to £275bn, but said that on its own, its impact would be limited.

"This measure will help support confidence, but we need to recognise that its impact on near term growth prospects is likely to be relatively modest," said Ian McCafferty, the CBI's chief economic adviser.

"Only once the turmoil in the eurozone is resolved will confidence be fully restored."

David Kern, chief economist at the BCC, said: "Higher QE on its own is not enough and we urge the MPC [Monetary Policy Committee] to look at other radical methods.

"There is a strong case for the MPC to help boost bank lending to businesses by immediately raising its purchases of private sector assets."

The manufacturers' organisation, the EEF, said that the Bank's decision to act now, before the third-quarter estimates of GDP and its latest inflation forecast were released, "would indicate that members believed immediate action was warranted in order to head off a deteriorating growth outlook".

However, the National Association of Pension Funds (NAPF) is calling for an urgent meeting with the pensions regulator to discuss ways of protecting UK pension funds from the negative effects of QE. 

QE tends to push down long-term bond yields, therefore reducing the return on the investments made by pension schemes.

"Quantitative easing makes it more expensive for employers to provide pensions and will weaken the funding of schemes as their deficits increase," said Joanne Segars, chief executive of the NAPF.

"All this will put additional pressure on employers at a time when they are facing a bleak economic situation."

Complementary actions

The governor of the Bank of England, Mervyn King, wrote to the chancellor earlier on Thursday, setting out the MPC's case for expanding the asset purchasing programme.

In his letter of response, in which he authorised the move, Chancellor George Osborne said: "I agree that an increase in the ceiling would provide the MPC with scope to vary the stance of monetary policy to meet the inflation target."

In his speech to the Conservative Party conference earlier in the week, Mr Osborne said that the Treasury would look into "credit easing" - a way to underwrite loans to small businesses who are struggling to get credit now.

He confirmed this in his letter to Mr King: "Given evidence of continued impairment in the flow of credit to some parts of the real economy, notably small and medium-sized businesses, the Treasury is exploring further policy actions. Such interventions should complement the MPC's asset purchases."

Royal Alliance Capital Currency Report

Euro slips on Greece woes

Sterling found some momentum against the euro last week, reaching highs of €1.1662 on Friday. Concerns Greece might ultimately default on its debts, prompting large losses for European banks which own Greek government bonds, continued to weigh on the euro.

The German parliament voted to approve a higher contribution to the European Financial Stability Fund, the region’s communal bailout fund.

The Fund’s expansion is required for the second Greek bailout which was arranged in July, but is yet to be endorsed by votes in Malta, the Netherlands and Slovakia. 

Greece remains in talks to secure the next installment of 8 billion euros which it needs to avoid bankruptcy in October.

Euro zone business and consumer confidence deteriorated in September, whilst a surge in euro zone inflation to a three-year high of 3% weakened the case for the European Central Bank (ECB) to cut interest rates this week.

Despite the euro zone’s crisis, the sterling/euro rate is little changed compared to a year earlier. 

This suggests markets are wary of the UK’s close ties to the euro zone via banking sector and trade links. 

Nationwide house price data and Confederation of British Industry retail trade data gave little encouragement over the domestic outlook; house prices continued to ‘tread water’ last month, whilst trading on the high-street was the weakest for 16 months.
 
Sterling gained versus the US dollar, but still ended the week more than 6% lower than its recent peak at US$1.6618 on 19 August. Falls in sales of new and existing homes highlighted the US housing market’s continued malaise. 


US house prices were 4.1% lower in July compared to a year earlier. US second-quarter Gross Domestic Product (GDP) growth was revised up from 1.0% to 1.3% on an annualized basis, helped by stronger than previously estimated exports and consumer spending.

Commodity-bloc currencies such as the Australian, New Zealand and Canadian dollars dropped versus sterling; tending to lose ground as commodity prices weakened owing to concerns over the global growth outlook. 

Australian and Canadian domestic influences were limited; Australian jobs vacancies data gave some encouragement to the employment market outlook, whilst Canadian GDP growth of 0.3% in July was in line with market forecasts. The New Zealand dollar lost some support after a surprise credit rating downgrade by the Standard & Poor’s and Fitch credit rating agencies.

The EUR/CHF rate traded in a range between 1.2122 and 1.2263, having held above the 1.20 ‘minimum’ rate set by the Swiss National Bank on 6 September 2011. This enabled sterling to rise as high as 1.4177 versus the Swiss franc; its highest level since May.

Germany, France reach agreement on Europe's banks

French President Nicolas Sarkozy, right, reacts to
German Chancellor Angela Merkel after a meeting on
the financial crisis in Berlin, Germany, Sunday,
Oct. 9, 2011. The two leaders of the eurozone's two
biggest economies, say they have reached agreement
on strengthening Europe's shaky banking sector.

BERLIN - The leaders of Germany and France, the eurozone's two biggest economies, said Sunday they have reached an agreement about how to strengthen Europe's shaky banking sector amid the region's debt crisis.

"We are determined to do the necessary to ensure the recapitalization of Europe's banks," German Chancellor Angela Merkel following talks with French President Nicolas Sarkozy in Berlin.

A "comprehensive response" to the eurozone's debt crisis will be finalized by month's end, including a detailed plan on recapitalizing the banks, Sarkozy said at Berlin's chancellery.

"The economy needs secure financing to ensure growth. There is no prospering economy without stable banks," he said. "That is what is at stake."

However, both leaders declined to name a price tag for the new measures or elaborate further, saying the proposal must first be discussed with other European leaders.

Analysts have urged the eurozone to identify all the banks in the region that need to replenish their capital reserves, then decide whether to compel them to raise that money on the open markets and to provide government financing to the ones that can't.

Many experts say the capital cushions of many European banks must be strengthened in order to withstand a possible government bond default by Greece. Some analysts fear that a Greek default could cause a severe credit squeeze that would even threaten banks not exposed directly to Greece's debt because banks could be afraid to lend to each other.

The credit freeze following the collapse of U.S. investment bank Lehman Brothers in 2008 choked off lending to the wider economy and caused a deep recession.

Merkel did not provide details Sunday about how the recapitalization would work, saying only that all banks across the eurozone would be measured by the same criteria in coordination with, among others, the European Banking Authority and the International Monetary Fund.

Any solution must be "sustainable," Merkel added.

Sarkozy said the French-German accord on the proposal "is total."

Germany and France will now submit their proposal to shore up Europe's shaky banking sector to other European Union governments ahead of an Oct. 17-18 summit of the bloc's 27 leaders in Brussels, they said.

Both leaders expressed confidence that a comprehensive European response to the crisis will be finalized before a summit of the G-20 most developed nations in France Nov. 3-4.

"The global economy needs this summit to become a success, and the European Union will do its part" to ensure a positive outcome, Merkel said.

The IMF has said banks across the continent might need up to euro200 billion ($267 billion) in new capital. The EU disputes the IMF's estimate, but has warned that lending between banks and from banks to businesses is threatening to freeze up.

Earlier this week, Merkel said that banks must first seek to raise new capital on the market before turning to their government, insisting that the eurozone's newly strengthened euro440 billion ($590 billion) bailout fund would then only serve as a backstop if a member state can't cope with shoring up its banks' capital.

France, however, was reported to favor turning to the fund's resources right away instead of relying on a national facility to re-capitalize its banks , who are among the biggest holders of Greek bonds.

But Sarkozy sought on Sunday to dispel the notion of different approaches regarding the European Financial Stability Facility, saying "there are no disagreements."

German Finance Minister Wolfgang Schaeuble and his French counterpart, Francois Baroin, also took part in the two leaders' discussions.

Merkel and Sarkozy were set to have a working dinner following the news conference they gave at the chancellery.

Germany and France, which together represent about half of the 17-nation currency zone's economic output, regularly hold talks before EU summits to chart out joint positions.

The implosion of Belgian lender Dexia following its sizable exposure to Greek and other eurozone sovereign debt, meanwhile, added a sense of urgency to the talks.

France, Belgium and Luxembourg announced Sunday they had approved a plan for the future of the embattled bank, but they offered no details. France and Belgium became part owners of the bank during a euro6 billion ($7.8 billion) 2008 bailout.

While an all-out Greek default appears unlikely, bondholders might still face severe losses, with some analysts maintaining that Greece's debt must be cut by about 50 percent or more to attain a sustainable level.

Private bondholders agreed in July to take about a 20 percent cut on their holdings of Greek bonds as their participation in a second international euro109 billion bailout for the country.

But Finance Minister Schaeuble on Sunday joined Merkel and other eurozone officials in hinting that the agreement might have to be renegotiated.

"It is possible that we have so far assumed an insufficient percentage of debt reduction," he told German newspaper Frankfurter Allgemeine Sonntagszeitung.

Such a move will be discussed after the so-called troika of Greece's international creditors , European Central Bank, European Commission and IMF , submits its next progress report later this month, Schaeuble was quoted as saying.

Greece is currently struggling to meet budget and reform targets, but it needs an over all positive progress assessment by the troika to qualify for the next euro8 billion ($11 billion) installment of its euro110 billion package of international bailout loans to avoid bankruptcy.