The International Monetary Fund produces a report urging governments to delay austerity until growth returns

In this week’s bulletin:

  • Talks between Greece and Germany still seek a solution to the sovereign debt crisis
  • Key members of the eurozone once again state their willingness to include Greece within the single currency
  • Share prices buffeted by concerns over the eurozone and the pace of US economic recovery
  • September should provide investors with some signposts for the year ahead
  • The International Monetary Fund produces a report urging governments to delay austerity until growth returns
  • The Chairman of the Federal Reserve, Ben Bernanke, makes a speech this Friday which should clarify the timing of the next round of quantitative easing
  • Doubts remain over its potential effectiveness compared to QE1 and QE2

 

Greece appeals for yet more time

  • Talks between Greece and Germany still seek a solution to the sovereign debt crisis
  • Key members of the eurozone once again state their willingness to include Greece within the single currency

“I want Greece to remain part of the eurozone… [and Germany] will remain as helpful as possible.”

Angela Merkel, German Chancellor

After a period of relative calm, investors have been reminded that the Greek sovereign debt crisis is still very much rumbling on. Angela Merkel declined to support the request for more time to implement austerity measures and pay back eurozone loans, but did pledge to help Greece “as much as we can”. In a speech in Berlin, the German Chancellor was keen to stress that Greece was still welcome in the single currency but that key eurozone members were frustrated by a lack of progress from Athens. She went on to say that talks with her Greek counterpart had shown that much remains to be done, adding that Greece must stick to the promises it made when receiving its second bailout in February (Athens must reduce its budget deficit below 3% of gross domestic product by 2014). Antonis Samaras, the Greek Prime Minister, once again emphasised his own determination to fulfil the reform pledges made at the beginning of the year and said any speculation over a Greek exit was “toxic”.

“We need a bit more breathing space. We are a proud nation and do not like having to rely on other people’s money.”

Antonis Samaras, Greek Prime Minister

At this point, it seems inconceivable that Greece will not require a third bailout if the country is to retain any hope of remaining part of the single currency. This is something that, with an election looming in 2013 and a population increasingly against the single currency, Angela Merkel is unlikely to agree to without a fight. The Greek coalition is asking for an extra two years to take it to 2016 but the calculations do not seem to add up for Germany. The Bundesbank has also stepped up the pressure, with Jens Weidmann, president of the German central bank, reiterating its opposition to the plan by warning that the ECB’s bond-buying plan could become “addictive” for struggling eurozone members. The Greek coalition was formed on the back of a pledge to renegotiate the bailout terms; but with no concessionary terms on the table, its ability to succeed looks questionable. The International Monetary Fund estimates that Greece would need a further €14 billion to cover its financial needs in 2015 and 2016 even if it is not granted more time. We remain concerned that Greece is locked in a vicious circle of austerity measures and falling GDP, which in turn reduces the tax base, creating still greater need for further bailouts. Despite their fine words, European leaders still appear reluctant to take the decisive action needed if Greece is to remain as part of the eurozone.

“They have to deliver, otherwise financial assistance could stop, not because we want it to stop but two sides of the bargain have to be in place.”

Klaus Regling, head of the European Stability Facility

 

Equity rally tempered for now

  • Share prices buffeted by concerns over the eurozone and the pace of US economic recovery
  • September should provide investors with some signposts for the year ahead

The summer share rally slowed last week as political wrangling in Berlin and Brussels took centre stage. European markets closed down 1.6% for the week as hopes of quick European Central Bank (ECB) action faded slightly; although it must be pointed out that the region’s equity markets have increased around 15% since the trough in early June, posting 11 weeks of consecutive gains over this period. This slowdown wasn’t confined to Europe; markets globally were subdued amid eurozone concern as well as signs of a slowdown in China. The US market experienced its first weekly decline in two months after reaching a four-year high earlier in the week (having gained over 20% over the last twelve months); while the Chinese market slumped to a level last seen in 2009, amid diminishing expectations of central bank action to stimulate growth in the world’s second-largest economy. The jitters were more obvious in bond markets where costs of Spanish and Italian borrowing rose, while the yield on a German 10-year Bund dropped to a three-week low.

The remaining months of 2012 should be interesting, especially with the US elections in early November. However, the immediate fate of stock markets could be dictated by a busy September, with a crucial ruling by Germany’s constitutional court on Europe’s new bailout fund, Dutch elections, and decisions expected over Greece and ECB action in the bond market. Investors were hoping that the ECB president, Mario Draghi, would use a speech on 6 September to announce radical intervention, but the German court ruling is not due until 12 September. With the ‘Troika’ – the International Monetary Fund, European Commission and European Central Bank – also expected to publish a report on Greek reform next month, investors are likely to have a clearer picture of the way forward by the end of September.

 

Pressure remains on George Osborne

  • The International Monetary Fund produces a report urging governments to delay austerity until growth returns

In a paper from the International Monetary Fund (IMF) focusing on the US, Europe and Japan, governments were urged to delay austerity until growth returns, or at least shift the burden of any programme on to higher taxes and larger benefit cuts. However, the report did acknowledge that some countries have no choice but to cut their debts as soon as possible. Last month, the IMF said the UK Chancellor might have to relax his austerity programme in next March’s Budget if the outlook had worsened, though they were supportive of the balance of policy. Around 40% of George Osborne’s £123 billion consolidation plan is scheduled to come from tax rises, benefit cuts and lower debt interest costs, according to the Institute for Fiscal Studies. The government is thought to be examining further benefit cuts to redirect funds into infrastructure spending such as council housing.

The latest IMF study emerged as official figures showed that the recession in the UK had not been as deep as originally feared. Gross domestic product contracted by 0.5% in the second quarter of 2012, according to the Office for National Statistics; less than the 0.7% initially reported but still the largest quarterly decline in three years. Stripping out the effect of the Diamond Jubilee bank holiday, growth was unchanged for the three months ending in June. Most economists now expect the UK economy to contract this year and for the Bank of England to respond with further stimulus.

 

The week ahead

  • The Chairman of the Federal Reserve, Ben Bernanke, makes a speech this Friday which should clarify the timing of the next round of quantitative easing
  • Doubts remain over its potential effectiveness compared to QE1 and QE2

The focus this week will be on Ben Bernanke’s speech at the Federal Reserve’s annual Jackson Hole retreat on Friday. Given the unexpectedly strong signal in the latest Fed minutes that QE3 is coming fairly soon, it is expected that Bernanke will reinforce the case for more action. Although a few of the non-voting regional Fed presidents still appear to have reservations, it seems likely the recent economic data will have softened Bernanke’s resolve. In particular, the minutes state “many members judged that additional monetary accommodation would be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.” This is clearly a more dovish position than before when it seemed that further policy support would depend on a significant worsening in economic and financial conditions.

However, a third injection of the same medicine is unlikely to be anywhere near as effective as the first two were in supporting equity and commodity prices. Julian Jessop, Chief Global Economist at Capital Economics, commented, “We are sceptical that QE3 would have anywhere near as big an impact as QE1 or QE2. For a start, the asset purchases worked in the past largely by reducing long-term borrowing costs and improving the availability of credit. These costs are now very low and financial conditions are healthier than they were in 2009–10, in the US at least. Secondly, QE1 and QE2 were accompanied by a strong rebound in the global economy. Of course, the additional monetary support played a part in these rebounds, but this support may be less effective now given policy is already so accommodative. What’s more, the earlier recoveries were also being supported by looser fiscal policy, whereas now the pressure almost everywhere is for budget deficits to be cut. Above all, yet more purchases of US Treasuries or mortgage-backed securities by the Fed will do nothing to address the underlying economic and financial problems in the eurozone, or the growing dependency of China’s growth on an unsustainable investment boom. These, and not the health of the US financial system, are now the biggest challenges facing the global economy.”

As ever, trying to predict the future can be a futile exercise. Remaining diversified, whilst seeking yield, remains key to successful long-term investment strategies whilst politicians across the globe continue to seek solutions to the slowing global economy and European sovereign debt issues.

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