Europe: Mov­ing to­wards clar­ity

Financial Mirror (Cyprus) - - FRONT PAGE - ANAL­Y­SIS

Greece’s po­lit­i­cal and fi­nan­cial roller-coaster ride over whether to ac­cept tighter con­di­tions for a third bailout pro­gramme of up to EUR 86 bln fi­nally came to an end dur­ing a week­end sum­mit that ran into the busi­ness hours of Mon­day, July 13, un­der­lin­ing how close a Grexit was.

As the ‘last chance’ dead­line of July 20 ap­proached, fail­ure to re­im­burse ma­tur­ing Greek bonds would have left the ECB with lit­tle choice but to stop its Emer­gency Liq­uid­ity As­sis­tance (ELA) for Greek banks, trig­ger­ing a col­lapse of the Greek econ­omy. Against this back­ground, a broad na­tional unity front in the Greek par­lia­ment ac­knowl­edged eco­nomic re­al­ity and the will of the Greek peo­ple to stay in the eu­ro­zone by coun­ter­ing the ‘No’ vote of the July 5 ref­er­en­dum and ac­cept­ing the tougher con­di­tion­al­ity of the pro­posed ESM pro­gramme.

De­liv­er­ing the first re­form steps by pass­ing the laws it was re­quired by Greece’s cred­i­tors was a con­struc­tive first step. It per­mit­ted ne­go­ti­a­tions on the ESM pro­gramme and bridge fi­nanc­ing to progress. The ECB fa­cil­i­tated the re­open­ing of Greek banks with two EUR 0.9 bln in­creases in the ELA fa­cil­ity.

The roadmap for fast track­ing de­liv­ery of a third bailout pack­age is now be­ing fol­lowed. But is this the end of the Greek saga? We don’t think so. First of all, the devil is in the de­tail. For ex­am­ple, the In­ter­na­tional Mon­e­tary Fund re­it­er­ated its re­quest for more debt restruc­tur­ing, and Greece has a bond due for re­pay­ment on Au­gust 20. Se­condly, even af­ter the ap­proval of a third bailout pack­age, po­lit­i­cal and eco­nomic in­sta­bil­ity could over the com­ing months still trig­ger a down­ward spi­ral in Greece – and re­sult in a Grexit – although we be­lieve this is now less likely.

Also less likely, in our view, is a sce­nario whereby Greece would con­tinue to cap­ti­vate fi­nan­cial mar­kets as it has in re­cent months, be­cause the po­ten­tial chan­nels of con­ta­gion are shrink­ing. There is a clear will to keep Greece in the eu­ro­zone and to sup­port the coun­try. But even if Greece was not to meet the new con­di­tions or mod­ernise its econ­omy, there would be a ‘plan B’. The writ­ing is on the wall, the euro sum­mit hav­ing re­placed un­cer­tainty with some clar­ity. As a re­sult, Euro­pean eq­ui­ties bounced back, pe­riph­eral spreads nar­rowed sub­stan­tially, and the pres­sure on Ger­man Bund yields was muted. The EUR is cur­rently mov­ing in a range of 1.08 – 1.12 against the USD.

Bet­ter vis­i­bil­ity on Greece’s sit­u­a­tion is also re­duc­ing the threat of risk-off mar­ket sen­ti­ment con­ta­gion be­ing chan­nelled more broadly across the eu­ro­zone. The real eu­ro­zone econ­omy has barely re­acted to the neg­a­tive media hype around Greece – in­deed, un­der­ly­ing growth in the eu­ro­zone has, in our view, strength­ened and be­come less vul­ner­a­ble to shocks.

Spain in par­tic­u­lar has en­tered a solid growth tra­jec­tory (un­em­ploy­ment in Q2 fell by 1.4 per­cent­age points to 22.4%, the low­est level since Q3 2011), and data for Italy also points to­wards a re­turn to an up­ward trend. The eu­ro­zone com­pos­ite sen­ti­ment PMI has fallen slightly so far dur­ing July, from 54.2 to 53.7 and is point­ing to a pace of growth in the eu­ro­zone at the start of H2 2015 sim­i­lar to that achieved in H1. Fur­ther strength­en­ing of in­vest­ment and/or fewer head­winds from global trade are needed for growth to ac­cel­er­ate.

The min­utes from the July meet­ing of the Bank of Eng­land (BoE) mon­e­tary com­mit­tee show that un­cer­tainty over the eu­ro­zone led to a unan­i­mous vote for keep­ing UK mon­e­tary pol­icy un­changed. How­ever, this masks an un­der­ly­ing change in the mood of BoE, due to strong fun­da­men­tals, con­firmed by a reac­cel­er­a­tion of GDP growth to 0.7% QoQ in Q2.

The BoE has started to pre­pare mar­kets for a first rate hike, which we ex­pect in Q1 2016. The tim­ing will be more and more data de­pen­dent as stronger growth and ris­ing wages could in­crease the pres­sure on the BoE de­spite the ab­sence of in­fla­tion (0.0% YoY in June).

In any case we would ex­pect only tight­en­ing and no ac­tion be­fore the a grad­ual Fed starts pace of hik­ing.

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