June 29, 2012
The ongoing shambles of Euroland sovereign debt and politics has festered for another month with no fresh sign of resolution. In Britain David Cameron and his cabinet colleagues have taken it in turn to make embarrassing revelations to the Levy inquiry, unsupported by their LibDem coalition colleagues. Little kudos has accrued to either side, as reflected by the lack of change in sterling’s value against the euro. The last month has seen the pound wander back and forth across a two-and-a-half-cent range that has led nowhere. The euro is very slightly weaker than it was before the first abortive Greek election six weeks ago but the difference is minimal.
At the beginning of June the Bank of England’s Monetary Policy Committee decided to keep the Bank Rate steady at 0.5% and to refrain from any new quantitative easing – “printing money” as the tabloids would put it. The minutes of the meeting, published a fortnight later, showed how close a call it was. Four of the nine members – including the governor himself – wanted to increase the asset purchase programme beyond the 325 billion of government bonds already in the scheme.
Investors were surprised by the narrow majority and concluded that it might be no more than a couple of weeks before the Bank rolls out the next phase of its monetary stimulus. That anticipation was reinforced by data the previous day showing that UK inflation had fallen back into its 1%-3% target range in May. It was the first time in two and a half years that consumer prices index inflation had been below 3%. It is possible that the Bank of England governor had such numbers in mind the previous week when he announced, together with the chancellor, a new scheme to feed low-cost money to the country’s banks, conditional on them making cheap loans to individuals and small businesses.
The central banks of Spain and Italy are green with envy at the low borrowing costs enjoyed by Germany and Britain. For its five-year loans Britain pays roughly 0.7% and Germany pays 0.6%. Investors charge Italy 5.5% and Spain 6.4% for the same privilege. Proportionally the difference is enormous and it exists because lenders fear Spain and Italy could go the same way as Greece, defaulting on their obligations and leaving private sector investors in the lurch.
The EU is trying to dispel this fear and, by doing so, to make it more affordable for Spain and Italy to borrow the money they need. But so far they are fighting a losing battle. Brussels’ approval of a €100bn bailout for Spain in mid-June simply drew attention to the country’s troubled banks and raised the question of how much more support it might need further down the line.
In Greece the New Democracy party has managed to form a three-way coalition after the second general election in six weeks but the new government is almost certain to approach Brussels – and Berlin – with a request for an easing of the onerous austerity imposed as a condition of its financial bailout.
At the G20 conference in Mexico there were heartening rumours that Germany would subscribe to a €600bn (or €750bn, depending on the source) support fund for Spanish and Italian government bonds. Much as investors liked the concept, they have yet to hear any confirmation from the most important player; Chancellor Merkel.
So investors don’t like the eternal disarray in Euroland and the recycling of old pledges and reassurances. Equally importantly, they are nervous about the prospect of a further dilution of Britain’s currency and the close relationship of the UK and Euroland economies.
Paradoxically, the failed Greek election in early May marked the end of sterling’s ten-month rally. Since then it has made zero forward progress against the euro. Without some new and major development – on either side – the impasse is likely to continue.