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from MacroScope:

Euro election fever

We will return on Monday knowing whether the Greeks have elected a pro-bailout government and probably to find socialist Francois Hollande – the man leading the growth strategy charge – as the new French president. 

An Hollande victory could cause some jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than incumbent Nicolas Sarkozy would. Contrary to some reports, he is not intent on ripping up the EU's fiscal pact and of course the bond market will only allow so much leeway.

The heavyweight Economist magazine may have labelled socialist Hollande “dangerous” but the reality is likely to be that he will rule from the centre and his demands for a dash for growth -- and a change to the ECB's mandate to aid it -- will be tempered. Spain has shown everybody that too much fiscal loosening will be pounced upon by the bond market and while there is a lot of talk about a growth strategy for Europe, what we've heard so far amounts to tinkering.

 While an Hollande victory looks priced in, Greece still has some power to shock the euro zone.

If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to  stick with the austerity terms demanded by its international lenders. However, the threat of contagion, while still alive, has shrunk. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly to be in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is diminished. The caveat to that is, if it has to be cut some slack by the EU and IMF, Portugal and Ireland would presumably demand the same and then the whole austerity edifice starts to look wobbly again.

Despite the much vaunted growth strategy, the focus remains on structural reforms (which will take years to bear fruit) plus reconfiguring of some EU funds and a beefed up European Investment Bank. It will help, or at least can’t hurt, but what’s being discussed so far does not look like anything like a game changer, breaking the spiral of debt-cutting  deepening economic downturns which in turn will make it yet harder to cut debt.

And those who really count -- Merkel and Draghi at the top of the list -- insist the austerity drive must not be dimmed. The markets would probably respond well to growth measures which did not undermine debt reduction. But that's some trick.

from MacroScope:

Austerity light? Maybe a shade lighter

There is a groundswell building in the euro zone that austerity drives should be tempered.

France’s Francois Hollande, favourite to take the presidency next month, said last night that  leaders across Europe were awaiting his election to back away from German-led austerity, and even ECB President Mario Draghi called yesterday for a growth pact.

He was rather opaque on how - although he was clear the European Central Bank would not be doing anything more -- but his colleague Joerg Asmussen was a little more forthcoming, saying some EU structural funds could be funneled to countries in crisis to boost employment. These sort of ideas are actively part of the mix and could well be enacted at the June EU summit.

Thay also tally with some of Hollande’s policy slate. He is promoting joint European bonds to finance infrastructure projects, greater investment by the European Investment Bank more efficient deployment of EU regional development resources and a financial transaction tax levied help fund youth and education projects. Some of those options are quite likely to happen. Others much less so.

Reality check: The EU’s German paymasters and the ever-present bond market will only tolerate a marginal shift in direction – you need look no further than at what has happened to Spain and its borrowing costs since it upped its deficit target in March -- so there will be not much let-up on the debt-cutting front.   Nonetheless, there has been a distinct shift in the rhetoric. Even Angela Merkel is pushing for a more broadly-based minimum wage in Germany, which could be construed as a growth tactic.

Dutch finance minister De Jager says multi-party talks about the 2013 budget have been constructive. They will continue today.

The Netherlands is supposed to hand Brussels its budget deficit target next week – the government was targeting 3 percent of GDP but lost its coalition partners, who demanded a softer goal, and collapsed earlier in the week. With elections not due until September, a failure to cobble together a budget deal by the main parties would lead to a dangerous period of uncertainty.

from MacroScope:

ECB to the rescue? Hold your horses

ECB policymakers from Mario Draghi down will come at us from all angles today. Expect a united front on the main theme of the moment; calls for it to consider yet more liquidity operations essentially creating money and/or resuming its government bond-buying programme. That call was first heard at the IMF spring meeting over the weekend and the ECB president’s response could hardly have been clearer, saying: “None of the advice of the IMF has been discussed by the Governing Council, in recent times at least".

Since then a number of his colleagues have followed up. The message: they are looking more to inflation now and banks and governments have to put their own houses in order after the ECB gave them time with its colossal three-year money-creating exercise. The ECB's man in Spain, Gonzalez-Paramo, is already out this morning saying Spain will not struggle to meet its debt issuance target this year despite its rising yields.

The ECB will, of course, act if the crisis drives Europe right back to the brink, it's mandate will pretty much demand it at that stage but we’re not anywhere near there yet – contrary to what many in the markets believe.

That things are not good is not in dispute.

The Netherlands pushed itself further into the mire yesterday when its opposition parties refused to back an austerity budget which the government collapsed over earlier in the week. That leaves the prospect of the Dutch failing to present the EU with a budget plan by an April 30 deadline and, more seriously, a period of policy paralysis stretching to elections which will not be held until September.

That vote is also quite likely to usher in an administration opposed to the austerity drive, a theme that is gathering pace within the euro zone, with socialist Francois Hollande, a warm favourite to take the French presidency next month, staking out similar ground and also suggesting the ECB should adopt pro-growth policies.

However, if there is any shift away from debt cutting – and as the IMF says, that is eminently sensible given many of these countries will drive themselves further into recession which would likely add to debt piles – it will be marginal. German opposition and the bond market will only allow a small shift in emphasis.   The lessons are already there for all to see. Italy pushed back its balanced budget goal by a year, a small shift, and investors were not alarmed. Spain substantially cranked up its 2012 deficit target and has been slaughtered by the bond market ever since, to the point where many now expect it to need a bailout.

from MacroScope:

The pain in Spain falls mainly on…

Spanish 10-year bond yields are within a whisker of breaking above six percent for the first time since December and are dragging Italy’s up with them. The balmy days of first quarter calm are well and truly over. “Markets step up the attack”, El Pais blares from its front page this morning.

Spanish risk premiums have leapt since Prime Minister Mariano Rajoy defied Europe by unilaterally easing Madrid's 2012 deficit target and investors seem to have lost faith again as the impact of the ECB’s massive liquidity injection begins to fade.

BUT, and there is a but, there are good reasons to believe Spain will not fall over in the way Greece and others have. One silver lining for Madrid is that it has taken advantage of the benign market conditions early in the year to clear almost half its 2012 debt issuance needs so rising secondary market yields may be less damaging than they were last year.   As usual, confidence is key. The ECB three-year money has not vanished. Look at the 800 billion or so euros deposited back at the ECB by banks every day and it’s clear that if sentiment improved some of that money could be put to use once again to buy Spanish and Italian bonds, though there’s no sign of that for now.   Markets are resolutely “risk off” although weak U.S. jobs data last week have a part to play here. European stock futures are flagging a further 0.5 percent loss following a 2.5 percent tumble on Tuesday. The most reliable euro zone barometer – the Bund future – has edged lower at the open, probably in anticipation of Germany auctioning a new 10-year bond later. Given the climate, it should be snapped up despite yields already at record lows: While Spain faces a 6 percent price to borrow for 10 years, Germany can do so for 1.6 percent.

Perhaps the biggest problem for Spain is the state of its banks, ravaged by a property market collapse. The central bank admitted yesterday they probably needed more capital. There is little prospect of them raising it on their own and the government has ruled out more state aid but there is a distinct possibility that the EU’s bailout funds could do the job at some point this year. The numbers should be manageable and shoring up the banks would not completely invalidate Madrid’s insistence that it will not require a sovereign bailout.

Furthermore,  Rajoy is pushing through sweeping labour reforms and savage spending cuts. The trouble is that policy mix is likely to drive Spain further into recession – a recipe for national debt to rise not fall.

The other big question is what the ECB may do if push comes to shove. There is now very strong internal opposition to reviving the bond-buying programme again and everyone from President Mario Draghi down has warned markets not to expect another round of long-term money creation. Again, the bloc’s rescue funds could fill the gap. EU leaders agreed last year that the EFSF could intervene in the secondary bond market if the ECB deemed it a sensible move.

Italy, now under threat of being caught up in Spain’s negative backwash, will try to sell a whopping 11 billion euros of short-term debt this morning – the type of paper that has flown out of the door so far this year. More testing will  Thursday’s sale of up to five billion euros of longer-term debt.

from MacroScope:

The euro zone today – strikes, reform and recession

The euro zone economy looks to have contracted at a faster pace in March, according to the latest purchasing managers' data, hours after ECB President Mario Draghi declared the worst of the debt crisis to be over. A mild recession appears to be in prospect with the probable exception of Germany.

The two aren't mutually exclusive. Even if the existential threat to the currency bloc has passed, many of its members face years of economic hardship yet. With China's equivalent report also coming in weak, the short-term signs are not auspicous.

Italy’s largest trade union has called a strike for the near future over Prime Minister Mario Monti’s labour reforms which have been rehardened to make it easier to fire not just workers in new jobs but right across the labour force. The prime minister says he won’t negotiate further given he has the support of other unions as well as employers groups. However, there is room for “fine tuning” today and tomorrow. The CGIL union has called for an eight-hour general strike with more to follow.

This is big stuff. A number of key factors have helped move the euro zone debt crisis on from critical to chronic; top of the list was the ECB’s creation of a trillion euros of three-year money but not far behind came the elevation of Monti and the hope invested in him that he can turn the Italian economy around. If the euro zone’s third largest economy fell over, the currency bloc really would be on the skids.

Monti must convince markets – which continue to give him the benefit of the doubt for now - that he can raise Italy’s trend growth rate if its 120 percent of GDP debt pile is ever to be eaten into. If faith in the technocrat premier wanes, it could have a significant effect on currently benign investor sentiment towards the euro zone.

Today, bailed out Portugal also faces a general strike protesting at austerity measures which the government is doing its best to stick to, without much prospect that it will turn the economy around. Data on Wednesday, showed Portugal's core public deficit nearly tripled in the first two months of 2012, showing a deepening economic slump is denting tax collection and stoking concerns it will  follow Greece in requiring more rescue funds. The difference is there is much greater euro zone goodwill towards Lisbon, so those funds will be provided without much grumbling.

Ireland, the country that seems to have a chance of riding the austerity wave successfully, produces Q4 GDP data which will show whether the government met its 1 percent growth target next year, while Germany continues to look like an economy on a different planet to its currency peers. It expects to balance its budget for the first time in more than 40 years in 2016 thanks to strong growth and full tax coffers.

from MacroScope:

Europe’s wobbly economy

Things are  looking a bit unsteady in the euro zone's economy.  Just ask Olli Rehn, the EU's top economic official, who warned this week of  "risky imbalances" in 12 of the European Union's 27 members. And that's doesn't include Greece, which is too wobbly for words. 

Rehn is looking longer term, trying to prevent the next crisis. But the here-and-now is just as wobbly. The euro zone's economy, which generates 16 percent of world output, shrunk at the end of 2011 and most economists expect the 17-nation currency area to wallow in recession this year and contract around 0.4 percent overall. Few would have been able to see it coming at the start of last year, when Europe's factories were driving a recovery from the 2008-2009 Great Recession. And it shows just how poisonous the sovereign debt saga has become.

Not everyone thinks things are so shaky.  Unicredit's chief euro zone economist, Marco Valli, is among the few who believe the euro zone will skirt a recession -- defined by two consecutive quarters of contraction -- in 2012. This year is "bound to witness a gradual but steady improvement in underlying growth momentum," Valli said, saying the fourth quarter was the low point in the euro zone business cycle.

That could still happen. Business surveys support the idea that the worst is behind us, while European Central Bank President Mario Draghi agrees that last year's collapse in confidence has now steadied, albeit at low levels. So far, the ECB has not given a strong signal on whether it will take interest rates below the 1 percent level for the first time, but the bigger risk is whether a disorderly Greek default or the threat of a severe credit freeze -- which the ECB's nearly 500 billion euros in loans has so far helped avoid --  come back to crush the green shoots of growth.

The ECB's latest lending survey showed for the last three months of 2011 reinforces the concerns of a credit crunch, as banks are still not passing the money on to the real economy. Thirty-five percent of banks reported they had tightened the standards they apply to loans to businesses, compared to only 16 percent in the third quarter. The ECB is set to make its second offer of three-year loans at the end of the month and that could ease credit risks, but may also discourage banks with bad loans on their books to reform.

So, in economist-speak, the risks are still on the downside and uncertainty remains high. Basically, things are still looking wobbly.

from Hugo Dixon:

Italy’s super Mario brothers

The Super Mario Brothers need to work together to save Italy and the euro.

Even if Mario Monti can form a strong government in Italy, the euro zone is vulnerable to bank runs and a deflationary spiral. Stopping that is the role of Mario Draghi, the European Central Bank’s boss. The zone needs vigorous supply-side reform but looser monetary policy. With Silvo Berlusconi gone, the duo and Germany’s Angela Merkel should try to forge a new grand bargain based on this.

Last week witnessed both the Italians and the Greeks dragged to the brink, look into the abyss and dislike what they saw. The two countries have or are in the process of forming national unity governments led by technocrats. This is a step in the right direction. But dangers abound.

The biggest risk is of a visible bank run. There has already been massive deposit flight in Greece as savers fear that the country could get kicked out of the euro – a scenario which is still real despite Lucas Papademos’ appointment as prime minister. But so far there have been no queues outside branches as there were with the UK’s Northern Rock in 2007. If that were to happen, television pictures would be relayed across Europe in seconds potentially provoking copycat runs.

Even without visible deposit runs, euro zone banks are debilitated. Many have already suffered runs in the wholesale markets: U.S. money market funds have sharply cut supplies of short-term cash; and hardly any bank has been able to issue unsecured bonds since the summer. The banks are able to get money from the ECB but only for up to a year. Their funding problems now look set to suffocate industry via a renewed credit crunch.

Meanwhile, the banks’ difficulties are exacerbating governments’ funding problems. France’s BNP revealed this month that it had cut its holdings of Italian debt by over 40 percent in the previous four months. Other banks could follow suit, thinking it is better to take smallish losses now rather than get caught in a Greek-style debt restructuring later. This means that, even if Monti gets a mandate to push through structural reforms--which need to be more radical than those planned by Berlusconi--Rome could struggle to finance itself on decent terms. Ten-year bond yields, which ended last week at 6.5 percent after shooting up to 7.6 percent, need to come down to 5 percent for the country’s debt to be sustainable.

from Financial Regulatory Forum:

Major central banks, regulators working on exit strategy system – official

PARIS, Sept 15 (Reuters) - Central bankers are working on a system to ensure they coordinate exit strategies to avoid any untoward consequences of removing stimulus at different times, a Financial Stability Board official said on Tuesday.

The official, who did not want to be named, was speaking after a meeting of central bankers and regulators from G20 countries to prepare for the meeting of leaders in Pittsburgh on Sept 24-25.

"We did discuss the issue of exits from various financial guarantee programs, central bank liquidity support arrangements and so on," the official said at a press briefing after the meeting.

"We are going to come up with some mechanism for making sure that information circulates amongst authorities about what their practices are and various opportunities for communication and coordination."

G20 finance ministers and central bankers met in London earlier this month and agreed that exit strategies needed coordination.

International Monetary Fund Managing Director Dominique Strauss-Kahn said on Monday he expected the leaders to take a similar line.

from Financial Regulatory Forum:

Banks eye clock on tougher capital rules, may face pressure to act soon

By Huw Jones and Steve Slater LONDON, Sept 8 (Reuters) - Banks face pressure to raise billions of dollars in fresh equity to meet tough new capital rules and many European lenders may need to act soon to improve quality even though the proposals will not be fully felt for several years. Finance ministers from the G20 countries on Saturday began formalising pledges their leaders made in April to raise bank capital and map out structures of bank pay packages so that lessons from the credit crunch are applied.  A day later, central bankers and regulators who oversee the Basel Committee on Banking Supervision outlined a second set of anticipated reforms to bank capital rules to turn G20 policy into tougher standards.

U.S. Treasury Secretary Timothy Geithner said on Saturday he wants the new capital rules agreed by the end of 2010 and in force two years later, but others were less specific.

"There's nothing that's come out that wasn't conceptually in the pipeline and the timeline of introduction is better than it could have been," said Exane BNP Paribas analyst Ian Gordon.

Timing will depend on how quickly economic recovery beds down so that lending to aid the economy is not hampered by a need to bolster capital.

"These changes are not going to happen overnight, so the banking sector will have plenty of time to adjust. (They)... will be phased in gradually," Mario Draghi, chairman of the Financial Stability Board, a global regulatory body, said at Saturday's G20 meeting.

The proposed changes to the Basel II bank capital framework will hurt the ability of banks to make money -- but by exactly how much will remain unclear for about a year at least.

The Basel Committee already adopted a change in July to roughly double the amount of capital banks will have to set aside against their trading book activities, even tripling in the case of underpinning securitised products.