MacroScope

Event risk

By Mike Peacock
August 1, 2013

If you’re hankering after “event risk”, look no further. Europe can offer top central bank meetings, front line economic data, a debt auction and more political risk than you can shake a stick at today.

This could be almost a perfect storm of a day after the Federal Reserve said its bond-buying would continue unabated for now and gave no new firm steer as to when it might begin rowing back, although its choice of adjective to describe the pace of growth – modest rather than the previous moderate – could be a hint that it is in less hurry to taper.

Now, it’s the European Central Bank’s turn. Given its forecast for recovery in the second half of the year has some evidence behind it, an interest rate cut is unlikely. Instead, for the second month running, Mario Draghi may have to focus primarily on the backwash from the Fed.

History shows that it’s dangerous to read too much into very marginal shifts in central bank language. The likelihood is still that the Fed will begin slowing its pace of money creation later this year. European stocks are expected to climb on the Fed’s “dovish” language and German Bund futures have jumped about half a point. But it will only take a strong U.S. jobs report on Friday to shift market expectations again.

As a result, the pressure will be on Draghi to convince that just because the Fed is on the move doesn’t mean the ECB is too. His stab at “forward guidance” last month was partially successful in calming markets but this is an ongoing process, not least because the ECB’s steer – that it expects rates to stay at record lows for an extended period – is vaguer than the Fed’s, which has attached any move to an unemployment target.

There have also been some mixed messages since the last policy meeting.

The Bank of England under Mark Carney will probably tack closer to the Fed than ECB when it issues its forward guidance plan with its quarterly inflation report next week. Thursday’s policy meeting will almost certainly not change interest rates or sanction more money-printing but – having broken with the tradition that no policy change is followed by silence – there may be another statement which moves the story forward.

Full manufacturing PMI surveys for euro zone countries and Britain will show whether glimmers of economic hope for Europe are persisting. For investors, most of the positive surprises are currently coming from Europe (what with China’s slowing growth and credit problems and the fact the U.S. recovery is a well-entrenched theme). China’s PMI showed factory activity stayed weak in July although there was a small improvement in the index.

With tentative signs of a turnaround in the euro zone and Britain more certainly starting to turn the corner, the odds are that both Carney and Draghi will look to forward guidance to keep a lid on market rates, thereby avoiding the need for more dramatic policy action.

Still, 30 of 47 economists in this week’s Reuters poll said the UK central bank had yet to rule out topping up the 375 billion pounds of bonds already purchased. In a separate poll of 70 economists, only a quarter of respondents forecast a further cut to the ECB’s main refinancing rate from its record low 0.5 percent in this cycle.

Spain will sell up to three billion euros of three- and five-year bonds after Italy successfully got away 6.75 billion of longer-term debt earlier in the week. Markets have recovered their poise since Bernanke spelt out in words of few syllables that “tapering” does not mean rate rises and won’t happen abruptly.

But Spain has an unfortunate confluence of events with today’s auction coinciding with Prime Minister Mariano Rajoy appearing in parliament to answer questions about his involvement in a corruption scandal.

The arrested former treasurer of the ruling People’s Party claims he ran shadow accounts for the party for many years and that Rajoy was the recipient of hand-outs from a fund created from business contributions. True or not, opinion polls are showing an increasing level of disenchantment.

For the euro zone’s major flashpoints – Portugal and Greece – things have calmed a little, though probably only for the remainder of the summer. But Italy could upset the apple cart. Its Supreme Court is expected to rule today whether Silvio Berlusconi – the man who has dominated Italian politics for 20 years – should have his conviction for tax fraud upheld, which could mean a ban from public office and even jail, or overturned.

The court could also swerve a final decision but if it does confirm the sentence, the fractious coalition government of Prime Minister Enrico Letta’s centre-left Democratic Party and Berlusconi’s centre-right PDL could be plunged into crisis.
Some of Berlusconi’s acolytes are demanding withdrawal from the government if he is not exonerated and, perhaps more dangerously, a chunk of the centre-left may refuse to work with him.

Summer lull? We’re not there yet.

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