Week in FX: Europe December 4-9

This week was supposed to be an historic week for the EUR. It’s actually ending on a whimper. The ECB cut rates and delivered more significant measures to improve bank funding conditions. However, the ECB has again stopped short of signaling a level of support for peripheral bond markets. Even the Euro summit progress today towards fiscal union will not trigger an accelerated pace of bond purchases, end result, this will leave the EUR vulnerable. Market participants will now be trying to anticipate any ECB market activity early next week. The market needs to be convinced that the EU actions will be great enough to avoid a credit downgrade from the ratings agencies, which could come as early as next week.

Below are some other highlights of the week:

EUROPE

• EUR: The start of the week saw Italian 10-year yields down to +6.16%, more than +100bp off the November highs. However, the real challenge for the sovereigns comes in Q1, when issuance picks up again, and markets appear to be pricing in a good deal of progress towards fiscal union at this week’s EU summit.
• ITL: The Italy’s government approved new fiscal measures totaling +EUR30b.The package is divided into +EUR20b of budget tightening and an additional +EUR10b that will be pumped back into the economy in the form of measures to help companies and boost growth. The spending cuts come from pension reforms and revenue raisers mostly related to taxation of wealth/real estate.
• EUR: EZ November services PMI was revised lower to 47.5 from of 47.8 and remains in contraction territory. Services PMI was particularly weak in Spain, falling to 36.8 from 41.8. German PMI was revised substantially lower to 50.3 from 51.4. In contrast, Italian services rose slightly while French services were revised higher, but both remained below 50.
• UK: Service PMI surprised strong rising to 52.1 from 51.3 in October. Analysts note that the details were less encouraging with new orders falling to 52.3 from 53.2 and employment down to 48.2 from 49.8. This suggests that the general weakness of the UK economy continues to justify extension of the QE program in February.
• EUR: S&P put 15-Euro zone countries, including Germany and France, on negative credit watch prompting many comments that the rating agency should “stay out of politics” ahead of this weekend’s EU meetings. All six AAA countries were placed at risk, and S&P noted that they could see a two notch downgrade. This creates a 50% probability of ratings downgrades in the next 90-days.
• EU: ECB’s 1-week deposit auction succeeded in fully sterilizing the +EUR207b SMP.
• EUR: German factory orders surprised strong, rising +5.2%, m/m, in October, more than reversing the -4.6% drop the previous month. Digging deeper, foreign orders and capital goods orders were particularly strong. However, analysts still expect “a sharp slowdown in Q4 growth in Germany”.
• CHF: Swiss CPI declined more than expected (-0.2%, m/m), pushing headline inflation to -0.5%, y/y, in November (lowest level in two years). Core-inflation also fell to a record low of -1.0%. Analysts note that deflation risk has emerged earlier and deeper in Switzerland than the SNB’s projection in their Monetary Policy Statement. Much of the deflationary pressure comes from foreign goods (-2.7%, y/y), while domestic inflation remains at +0.3%. However, with the labor market remaining solid, wage growth positive and credit expanding should help fight deflationary pressures.
• S&P: Put the long term credit rating of EFSF on credit watch negative.
• EUR: Event risk fears and rumor mongering had many investors wading to the sidelines ahead of the ECB announcement and EU summit.
• EU: European banks borrow USD50b from Fed via ECB. The funding was conducted at the new lower OIS +50bp rate.
• EU Rumor: That discussions were ongoing on an enhanced ESM which might even be able to borrow from the ECB.
• German Officials: Warned that many countries and institutions will have to change their positions for a deal to be achieved this week, “Nein Bazooka”.
• EUR: EU activity remains weak, with October IP data weaker in Italy (-1%), the UK (-0.7%) and Norway. These numbers are consistent with the soft PMI surveys and suggest expectation of a sharp slowdown in Q4.
• Germany: In contrast, German IP surprised stronger with a +0.8%, m/m, gain, much higher than the +0.3% expected.
• Germany: Officials rule out decisions on IMF aid at summit.
• EUR: Official comments continue to warn against excessive expectations for the summit meeting.
• UK: BoE MPC announcement saw no change in the scale of the asset purchase facility. The minutes gave a clear signal that although the Bank’s projections warranted further policy accommodation, it was difficult to accelerate the pace of purchases. Nothing until February’s meeting. Market is leaning towards the committee announcing an additional +GBP75b of Asset Purchases.
• UK: Next week’s CPI inflation data are likely to confirm that the peak for inflation is past.
• ECB: reduced its benchmark rate by -25bp to +1%, matching a record low and offered banks unlimited cash while steering clear of any signal that they will buy more bonds to stem the region’s debt crisis.
• ECB: The two 36-month Refi-Ops and full allotment for banks at fixed rate in translation is a form of QE. They will ease the collateral rules and accept ABS as collateral. For the first time they will cut the reserve ratio to +1% from +2% effective January 18 and discontinue fine tuning operations at end of maintenance period. Draghi indicated that all non-standard measures are temporary in nature.
• EUR: The European Banking Authority said the region’s lenders will need to raise +114.7b euros in fresh capital.
• EU: The EU Summit agreement was largely in line with expectations and the “draft” released on Thursday. It will represent another step in the direction of an integrated fiscal “compact”.
• EU: There was an agreement on a semi-automatic fiscal rule. Members will bring forward the launch of the ESM to mid-July 2012. They announced the possibility of increasing the size of the ESM above €500b to be discussed next March. The highlight for Germany was the announcement of no PSI in the ESM as a precondition, but adherence to the “well established IMF principles and practices”. Voting is to be done by a qualified majority (+85%) instead of unanimity for the emergency procedure in case of the ESM. Finally, discussion about an IMF provision of an additional €200b of resources is to be confirmed in ten-days
• EU: UK and Hungary are not supporting the agreement for now. The accord is a Euro area plus accord instead of being an EU one.
• EUR: French IP was flat in October, a touch above the expectations for a -0.2%, m/m drop.
• NOK: Headline inflation fell to +1.2%, y/y, this month from +1.4%, weaker than the Norges Bank forecast of +1.6%. Core-inflation also came in weaker than expected at +1%, y/y. The Norges Bank expects the rise in prices to slow ahead for the first-time in two years. It remains a close call if the Norges Bank will ease next week.
• GBP: October UK trade balance came in much better than expected with the trade deficit narrowing to -£1.6b from -£4.3b in September. The improvement was broad based.
• SEK: Swedish IP surprised stronger than expected, rising +0.4%, m/m, vs. the consensus forecast for a -0.5% drop. The trend, however, remains weak, with IP contracting -1.9% on a three-month momentum basis.

AMERICAS Week in FX
ASIA Week in FX

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