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Weekly CZK Report: Verbal intervention from ECB

Weekly CZK Report: Verbal intervention from ECB

30.7.2012 12:32
Autor: Tomáš Vlk, Patria Finance

The koruna has firmed to both the euro and the dollar. The currency was mostly influenced by the situation on the global markets as no local events were scheduled. All the CE currencies profited significantly from the growing expectations the ECB will announce new measures to tackle the debt crisis. 

The markets started the week in a negative mood amid worries that Spain and Italy may soon need an external financial aid and that Greece is heading for a default. The Spanish yields spiked after financial strain in the regions and a forecast of longer recession suggested a bigger pressure on the country´s public finances. The Italian yields increased significantly, too, driven by similar problems in the regions and concerns that the Eurozone will not be able to contain the spreading crisis. Moreover, Greece still fails to meet the bailout conditions, which supports bets on another default.

Macro data from the Eurozone fell short of expectations and also weighed on the market sentiment. The manufacturing PMIs in the Eurozone and its two biggest members dived even deeper below the 50 mark, while they were predicted to improve slightly. The German Ifo business climate index has also worsened. Furthermore, Moody´s has worsened its rating outlook for Germany, the Netherlands and Luxembourg and the UK posted a significantly worse GDP figures. On the other hand, the US data was not bad; the 2Q GDP came out slightly above estimates.

The surge in the Spanish yields raised a real threat that the country will soon need a financial aid. However, the country cannot rely on the ESM that will have a delay due to a longer approval procedure in Germany. Moreover, the Italian yields also reached levels that the country can hardly bear for a longer period of time. This is even a bigger problem than Spain, because the Eurozone rescue funds are insufficient to support such a big debtor. Both countries have several bond auctions scheduled for next week. That is why the surge in bond yields was alarming and motivated the ECB to step in.  

Two important ECB comments came in. The council member Ewald Nowotny said that there were arguments in favor of giving the ESM a banking license. This would greatly increase the fund´s firepower, connecting it to liquidity from the ECB. Although there is still a strong opposition to such an idea in the central bank and there are also legal obstacles, the comment had positive impact on the financial markets, suggesting that the ECB will not stay inactive.

The second comment had even much bigger effect and gave markets significant boost. ECB´s President Mario Draghi said that the bank will do whatever is needed to preserve the euro and assured that “it will be enough”. Draghi pointed to sovereign risk premia that hamper the functioning of the transmission mechanisms, which indicates that the ECB might resume buying the sovereign bonds. However, due to a strong opposition to massive bond purchases, the central bank might opt for only some temporary interventions in order to reduce the bond yields until the ESM starts working. That would likely be disappointing for the markets as expectations that a big action is coming are already very high.

Next week, a big focus will also be on the US macro data and the Fed decision. The most important releases of the month, the labor market report and the ISM indices, are on the agenda. Recently, the Fed has not further encouraged bets on another QE. However, the expectations that another stimulus will come are still quite strong and the FOMC meeting will, therefore, be an important market mover of the week.

In the Czech Republic, the PMI should show how significant is the negative impact of the weakening Eurozone on the local economy. The retail sales should confirm the continuing weakness of the domestic demand. The CNB will decide on rates and is expected to keep them unchanged. Another cut would be justifiable, but the bank is not under pressure to do it. Moreover, Governor Singer, who voted for the cut last time, will miss the monetary meeting. The event may be neutral to slightly negative for the koruna, depending on how dovish the statement will be.

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