Sunday, March 7, 2010

FX Briefing : Greece - Cautious Relief

  • Greece unveils further austerity measures, market jitters subside
  • Snow storms thwart US labour market recovery
  • ECB signals end of full allotment in October
The situation in Greece has eased somewhat. Despite the ongoing strikes, the Greek government this week unveiled plans for additional austerity measures which go even further than those demanded by the EU. This has prompted some market speculation that Greece could be paving the way for more concrete aid from its EU partners. That speculation was fuelled by the fact that Greek prime minister George Papandreou is meeting German chancellor Angela Merkel this Friday. Greece thus saw strong demand for its €5bn 10-year bond launched on Thursday, yielding a whopping 6.4%. The bond was three times oversubscribed.

The euro rose initially on the slightly more favourable assessment of the Greek debt situation. The euro was probably also supported by the impending ECB governing council meeting, at which the next steps to an exit from the unconventional liquidity measures were to be discussed. The uncertainty could have made market participants more cautious in the run-up to the meeting. Thus towards the middle of the week, EUR-USD firmed to over 1.37. After the meeting, however, the euro began to tumble, probably mainly because the ECB had not made any unexpected announcements. Towards the end of the week, the euro was back around 1.36 again and thus almost at the previous week's level.

The news from the US was mixed again this week. The assessment of the economic situation in the Fed's Beige Book remained basically unchanged. It was reported that economic activity had improved in nine of the twelve regional districts, but in most cases the increases were modest. Consumption, construction activity, production and the agricultural sector had been hampered significantly by the severe snow storms.

Nevertheless, manufacturing activity had continued to strengthen in most regions, and demand for services was positive. In some areas not quite so badly hit by the winter weather, the housing market had firmed, whereas the commercial property market and construction activity as a whole were described as weak or declining.

The latest data confirm for the most part the description in the Beige Book, which is more anecdotal. The ISM index for the manufacturing sector fell slightly in February from 58.4 to 56.5, but is still indicating solid expansion; the decline was primarily due to the fact that the extraordinarily high levels of the new orders and production components in January could not be sustained. The ISM non-manufacturing index rose significantly over the expansion threshold, from 50.5 to 53.0, which is encouraging. During the last few months, the important service sector had been lagging far behind the manufacturing sector, also from an employment point of view. Now the employment component in the nonmanufacturing index is approaching neutral, which raises hopes that a turnaround on the labour market could be just round the corner. Bearing in mind that weather conditions probably had a decidedly negative effect on employment, the decline in non-farm payrolls by 36,000 in February is quite moderate.

ECB continues exit
The ECB has for the most part confirmed its assessment of the economic situation. It is expecting a modest recovery and sees risks to price stability as balanced. The new staff projections for the euro area foresee growth rates of 0.8% for this year and 1.5% for 2011. The forecast for next year has thus been raised by 0.3 percentage points. The inflation rate for 2010 has been adjusted marginally downwards to 1.2% and slightly upwards to 2011 to 1.5%.

The ECB governing council has announced further steps towards normalising money market conditions. As from April, 3-month tenders will be offered at variable rates again, whereby the main refinancing rate will serve as the minimum bid rate. By contrast, weekly main refinancing operations and 4-week tenders will still be conducted as fixed rate tenders with full allotment. However, the ECB is only offering this unlimited access to liquidity until mid-October.

The main thing, in our view, is that the ECB is continuing its exit strategy - slowly but surely. When the negative impact of the exceptionally severe winter weather in the northern hemisphere diminishes, the upward trend in both the US and Europe's economies will become more evident. That is likely to support the euro to some extent, particularly if Greece makes further progress in reducing its budget deficit.

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.
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