Royal Alliance Capital Currency Review

Berlusconi exits as debts spiral

The 17-year political career of Silvio Berlusconi came to an end on Saturday, whilst Italy attempts to contain its current debt levels from spiraling out of control.

Berlusconi’s departure came after the country's lower house of parliament approved an urgently needed package of economic reforms designed to tackle the country's €1.9 trillion debt, revive its sluggish economy and prevent it from going the way of Greece. Sunday saw the appointment of Mario Monti. His task is to form a new government in an effort to shore up Italy’s government bond market; the third largest in the world.  

Euro fears escalated on Thursday as Italian bond yields went through the critical 7% level, prompting concerns a bailout will be needed. Sterling reached intra-week highs of €1.1784, taking the exchange rate to its highest level since March.

Euro zone economic data offered little support to the single currency. Investor confidence data weakened to a two-year low, whilst there was a 0.7% decline in European retail sales for October. There was also a 2.7% slide in German industrial production, whilst the EU Commission cut the 2012 growth outlook sharply to 0.5% from 1.8% previously.

Sterling fell to lows of $1.5864 versus the US dollar, before reversing losses on Friday to finish the week at $1.6080.  As widely expected, the Bank of England (BoE) left both interest rates and quantitative easing (QE) on hold in Thursday’s meeting. Markets will await the release of the meeting’s minutes on 23 November to find out the voting pattern of the Bank’s policymakers. Industrial production remained flat in September, whilst manufacturing rose 0.2%; its first rise since May this year. However, the UK’s trade deficit widened from £8.6bn to £9.8bn, increasing the risk of a downward revision to UK economic growth in the third quarter of 2011.

In a sparse week for economic announcements, the US dollar found itself tracking investor sentiment and the performance of global stock markets. With mid-week developments in Italy taking a turn for the worse, the US dollar added over three cents versus the euro. However, the dollar’s gains were short lived. Rumors of Berlusconi’s departure buoyed global markets, as the dollar pared gains made earlier in the week.

The Chinese yuan was unable to make any headway during the week as consumer inflation showed a decline in September. The Swiss franc continued its recent decline against both the pound and euro as Swiss consumer inflation data proved weaker-than-expected. Global commodity prices remained fragile, hindering the performances of both the Australian and New Zealand dollars. An increase in the number of new homes being built in Canada helped the Canadian dollar gain over half a cent versus sterling.

FTSE rebound stalls as Italy debt jitters flare again

Other stock indices in Europe also pull back, after markets send Spain, France and Austria’s borrowing costs higher. 

A tentative rally in Britain’s FTSE 100 stalled on Monday after Italy was forced to pay a high price to sell five-year bonds, amid mounting uncertainty over the ability of the country’s new government to resolve its debt woes.

The UK index of blue-chip shares eased 0.47%, or 26 points, to 5,519 and the All Share index gave up 0.44%, or 13 points, to 2,844.

Markets had earlier welcomed the resignation of former prime minister Silvio Berlusconi, and were also cheered by news that former EU commissioner Mario Monti had been given the task of forming an emergency government in Italy.

But Angus Campbell at Capital Spreads said that despite political changes in both Italy and Greece, investors remained sceptical that the eurozone debt crisis ‘could actually be resolved’.

‘The sombre mood was caused primarily by uncertainty that a new Italian administration would find itself with enough support in order to push through badly needed reforms,’ he said. Gains for equities would remain ‘hard to come by’ until there is more detail on how Monti would manage to achieve that, Campbell added.

Italy paid 6.29% in its €3 billion (£2.6 billion) auction, a euro-era high, up from 5.32%. However, the sale was covered 1.47 times, reflecting slightly better demand than at the earlier sale.

The yield, or interest rate, on benchmark Italian 10-year government bonds subsequently climbed 20 basis points to 6.72% – close to levels seen as ruinous in the long-term – after earlier retreating as low as 6.34%.

‘The unelected Mr Monti may well regret taking on this job and I don't expect him to last terribly long (like most Italian governments),’ warned Louise Cooper, markets analyst at BGC Partners. ‘I will be cutting and pasting scary Italian bond yield charts in the months, if not years, to come.’

Other stock indices in Europe also pulled back, as markets sent Spain, France and Austria’s borrowing costs higher in a sign that the crisis is continuing to spread. Germany’s DAX index fell 1.2% to 5,985, France's CAC 40 index slipped 1.28% to 3,109, and the FTSEurofirst 300 index of top European shares was 0.86% lower at 976.

Resources stocks were among the biggest fallers, amid the concerns over global demand and as commodities prices dropped. Vedanta Resources (VED.L) dropped 42p to £11.20 and Glencore International (GLEN.L) slid 12p to 429p.

Financials also suffered: Standard Chartered (STAN.L) weakened 46p to £13.56, Barclays (BARC.L) was off 5p at 174p and Royal Bank of Scotland (RBS.L) slipped 0.5p to 21.9p.

ITV (ITV.L) topped the leader board on the FTSE 100, taking on 2p to 67p, after a bullish third-quarter trading update from the broadcaster. Burberry (BRBY.L) claimed second place, taking on 44p to £14.21, ahead of interim results from the luxury goods maker.

Wall Street halted a two-session rally, tracking losses in Europe. The Dow Jones Industrial Average eased 0.17% to 12,133, the Standard & Poor's 500 index lost 0.58% to 1,257, and the Nasdaq Composite index shed 0.19% to 2,674.

Elsewhere, sterling sank 1.13% versus the dollar to $1.59 ahead of UK inflation data on Tuesday, and strengthened 0.14% against the euro to €1.166.

 

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Political tensions hurt euro

European political tensions again dominated headlines last week as the euro endured further losses against both the US dollar and sterling.

Greek Prime Minister, George Papandreou, called a referendum to seek wider support for the new bailout package, despite having undertaken protracted negotiations to agree its terms with other European leaders. However, Papandreou later withdrew the plan for a referendum after intense opposition. 

The added uncertainties prompted the euro to fall to intra-week lows of 1.1698 against the pound. Further political developments on Sunday saw the Greek Prime Minister announce his imminent resignation as Greek political leaders sealed a pact to form a national unity government. 

The new coalition comes in an effort to show that Greece is serious about taking the steps needed to stave off bankruptcy. Concerns Italy could become further embroiled in the crisis intensified on Monday morning, as fears grew over Italy's political uncertainty ahead of a second vote on Tuesday regarding the country's budget and a potential confidence vote on Prime Minister Silvio Berlusconi.

In his first meeting as President of the European Central Bank (ECB), Mario Draghi and the ECB council unexpectedly lowered interest rates from 1.5% to 1.25%, compounding the euro’s woes. The ECB's move reversed its decision to lift interest rates in July, at which time the sterling/euro rate had fallen to lows below 1.12. Although the pound has found it difficult to break through €1.17 in recent months, this resistance level might be broken if the ECB decides it has to cut rates further in the coming months.

A first estimate of UK Gross Domestic Product (GDP) indicated the UK economy grew by 0.5% during the third quarter. This represented a bounce in activity, after a second quarter performance which had been weighed down by the early Easter timing and an extra public holiday for the Royal wedding. 

However, this meant the year-on-year growth rate was also just 0.5%, which still points to a very subdued pace of recovery. A third fall in manufacturing activity in four months in October underpinned some pessimism over the outlook for the final quarter of 2011.

The US dollar lacked a clear direction against sterling last week, generally following wider stock market trends and changes in investors’ optimism levels. There were relatively few domestic surprises for the currency. 

The US Federal Reserve repeated its commitment to keep interest rates close to zero until at least mid-2013, although one Committee member wanted the central bank to take further measures to stimulate the economy. The latest non-farm payrolls jobs report fell slightly short of expectations, although revisions to past data suggested the employment picture might not be quite as bleak as previously thought.

The Australian dollar fell more than three cents against sterling last week as the Reserve Bank of Australia (RBA) lowered interest rates for the first time in more than two and a half years. In a move to bolster the Australian economy, the RBA cut its key interest rate to 4.5% as weaker global growth threatens to slow the nation’s resource-driven economy. 

The Japanese yen carried on its recent decline amid rumours the Bank of Japan is continuing to intervene to prevent its currency from appreciating further. The Canadian dollar lost support versus the pound as Canadian employment fell by 54,000 in October, contrary to the 15,000 rise expected by forecasters. Worse-than-expected employment data in New Zealand saw the New Zealand dollar fall to intra-week lows of 2.035 versus sterling.

 

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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.

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Sterling rallies 12% against the franc

 

The pound has rallied more than 12% against the Swiss franc since falling to a historic low of less than CHF1.15 on 9 August 2011.

However, the franc remains the best performing major currency over the past year.

Perceived as a safe-haven, the franc’s rise has largely reflected market concerns the euro zone debt crisis is intensifying and the global economic recovery is running out of steam. However, the Swiss National Bank (SNB) has been keen to curb the franc’s rise, which it fears will act as a headwind to domestic growth and erode exports.

The SNB again repeated its view the franc remains overvalued, whilst increasing the supply of francs in money markets in order to weaken the currency. Speculation the SNB might adopt more aggressive tactics, such as temporarily fixing the franc’s value to the euro, also helped pare the franc’s gains.

The pound enjoyed another positive week against the US dollar, hitting a three-month high above US$1.66. However, economic data remained mixed. The UK's unemployment rate rose and the number of people claiming jobless benefits posted its largest rise in more than 18-months in July, as the labour market increasingly reflects the struggling economy.

The Bank of England minutes revealed a 9-0 vote for unchanged interest rates at the August meeting. Policy members Weale and Dale dropped their preference for higher interest rates, as the meeting noted the first unanimous interest rate vote since May 2010. Sterling gained some support as the majority of members (in an 8-1 vote) did not consider it appropriate to expand quantitative easing in the short-term.

The US dollar suffered at the hands of further global market uncertainty. There was little confidence in the US economy during the week as US jobless claims data were higher-than-expected. The Philadelphia Federal manufacturing survey showed heavy declines in its latest release. The US dollar came under further pressure as existing home sales also declined during July.

The euro endured another mediocre week; slipping just under a cent against the pound, but adding over two and a half cents versus the US dollar. Tensions remained high as discussion between German Chancellor Angela Merkel and French President Nicolas Sarkozy about ways to solve the euro zone debt crisis appeared to achieve little agreement.

Euro zone economic data also disappointed as Germany’s economy slowed sharply between April and June. Core euro zone inflation was also a weaker-than-expected, falling to 1.2% in July. Diminishing inflation and weaker growth will maintain pressure on the European Central Bank (ECB) to reverse recent interest rate rises. 

The Australian dollar fell after the Reserve Bank of Australia’s policy meeting minutes suggested diminishing confidence in the global and domestic economic outlooks. The Canadian dollar was hindered due to poor manufacturing shipments data, along with a drop in foreign investments in Canadian securities.