EUR: Are EU Policymakers Prepping for Something Big?
The euro soared against the U.S. dollar today after German Chancellor Merkel, Finance Minister Schaeuble and French President Hollande joined ECB President Draghiâ€™s pledge to do everything within their power to protect, save and secure the euro. While no policy actions have actually been announced, all this talk creates expectations for greater activism by European policymakers in the coming weeks. Investors around the world will now be looking to Thursdayâ€™s European Central Bank monetary policy meeting for potential stress relieving measures. Thereâ€™s a number of things that the ECB could do to help the euro but the real question is whether they will hold back given the recent decline in Spanish bond yields.
We know that the German Finance Minister supports the idea of using the EFSF to buy government bonds and the French paper Le Monde claims that coordinated action is being planned by the ECB and European bailout fund to lower borrowing costs by buying Spanish and Italian debt. As a result, the most likely decision by European policymakers would be to allow the EFSF/ESM to purchase bonds on the primary and secondary market and to reactive the Securities Market Programme which would help reduce sovereign yields and funding pressure. The Germans oppose the idea of giving the rescue fund a banking license and until they concede, it cannot become a reality. Taking the deposit rate to negative levels and introducing a third round of long term refinancing operation (LTRO) are also options but Europe probably needs another near death experience for either of these to become reality.
While todayâ€™s decline in Spanish and Italian bond yields have bought policymakers more time to come up with a long term solution to Europeâ€™s problems, it also reduces the political will to get things done. Spanish 10 year yields are now much closer to 6.5% than 7% and Italian yields are back below 6%. As long as Spanish yields remain below 7%, we donâ€™t expect Spain to make a formal request for a full scale bailout. Deputy Prime Minister Saenz confirmed that the government would not seek a rescue because it â€œisnâ€™t an optionâ€ but there have been reports by Reuters that a discussion about a sovereign bailout occurred between Spain and Germany. Aside from the ECB meeting next week, German retail sales and unemployment numbers are also scheduled for release along with Eurozone final PMI reports.