Friday, 8 June 2012

Week in Review: Weak is the new strong

This is the first Week in Review for three weeks after a two-week French sojourn.  Since the last WIR the FTSE has risen nearly 3% and the pound is down against the euro, making my foreign exchange purchase look like one of my better-timed investments.

Despite the rosy-looking returns eurozone stress has not dissipated.  This week’s industrial production data for Germany and Italy were weak, suggesting that GDP in these regions is not poised to accelerate again soon.
Source: Brewin Dolphin, Datastream

I commented on Wednesday about the cultural flaws in the eurozone (for example Germany’s employers enjoy a constructive relationship with their unions whilst France’s is highly antagonistic). This week, however, has seen concerns over the Spanish financial sector finally push the country, and the zone, to the brink.

As part of a weak-is-the-new-strong theme driving markets this week, Spain dramatically announced it was losing access to the debt markets. This attempt to shock their euro-cousins into recapitalising Spanish banks (without the dirty €40-100bn, or 4-9% of GDP, passing through their national accounts) seems to have been partially successful.  Keeping the debt completely off Spanish books remains a long-shot, but funds look likely to be advanced with Spain only submitting to reform of the banking sector, rather than wider austerity programmes inflicted on Greece or Portugal.

Banking Unions…
It is widely believed that these injections will have to be in place before the summit at the end of this month to discuss a banking union.  The agenda seems set to include a centralised regulator and deposit guarantee scheme for European banks.  These proposals are already enlivening the fractious relationship between most of Europe and the UK (which wants no part of such arrangements).  Indeed, after I quipped that the French have no word for Laissez Faire, I note that this morning’s FT contains an un-knowing rebuttal from an unnamed European official: “I’ve been told that solidarity is not an English word. Today I realise that is true.” On that, at least, we agree.

...and Unions’ banks
With the markets rallying on hopes of a deal for Spain, eyes turned to the central banks for further support. Within the currency union the European Central Bank made accommodating noises but left the pressure firmly on the politicians in terms of mending the zone’s flaws.  The United Kingdom, meanwhile, left policy unchanged despite some expectations that a further £50 billion of gilt purchases would be announced.  Finally, in the United States, Chairman Bernanke’s testimony lacked the pessimism that would imply further quantitative easing – causing markets to retreat from their previous gains.

This US market weakness resulting from relative economic strength was reversed in China as the authorities surprised the world with a cut to interest rates and a liberalisation of rates at which banks can lend.  With the cut coming so soon before a slew of Chinese data due tomorrow (inflation, industrial production, retail sales and investment) we are naturally inclined to temper our hopes for these announcements. Nevertheless the market strengthened following this implied economic weakness.

Looking ahead…
As well as the market’s reaction to those Chinese numbers, Monday will also see the results of the first round of the French legislative elections.  After that the week unfolds with various industrial production and inflation figures.  Industrial production is a reasonable indicator of where quarterly end GDP figures are likely to settle and in Germany and Italy, who announced this week, they continue to deteriorate.  Finally the focus turns to the Greek election re-run on the 17th (and the final results of the French législatives).

Guy Foster
Head of Portfolio Strategy

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