Another week, another reminder that keeping the Euro alive and well, (a generous term), is all just a game of politics. A week in which we witnessed the inexorable creep of recession northwards, exemplified by weak German PMI and IFO numbers and terrible French unemployment numbers, finished with a seemingly extraordinary quote from Chancellor Merkel to the effect that interest rates in the Eurozone were too low for Germany!
This set teenage scribbler analysts, to borrow Lord Lawson's phrase, bashing away on their keyboards about a breakdown in the convention of verbal 'Purdah' which Eurozone politicians, (of all genders), traditionally observe in the run up to ECB meetings. The comment was especially unusual, given the present fever pitch speculation about the possibility of an ECB cut, or cuts, at next Thursday's meeting.
At the other end of the continent and of the Eurozone power spectrum, Spain's continuing unemployment tragedy took another downward lurch, as we learnt that unemployment had risen by more than expected to 27.2%. To address this and the other enormous challenges facing Spain, Prime Minister Rajoy announced measures aimed at reforming the labour market and the pension system, and aiding small businesses.
In so doing, Rajoy was apparently singing from the same song-sheet as the European Commission whose President, Manuel Barroso, observed on Monday that fiscal austerity was 'reaching the limits of public acceptability'. A strident week for German politicians ended with Finance Minister Schauble, (always good for a note of discord), slapping Barroso down by opining that the Eurozone's economic travails did not stem from too much austerity and "somebody should tell Barroso that". However, a moment later he supported the French request for an extra year to reach its deficit target-Germany needs to keep the alliance with France at least on life-support to retain an ally in forthcoming summits, due in May and June.
Spain, on the other hand, is touting novel and accelerated reform as the quid pro quo for an extra two years to hit its programme targets.
Politics, politics, politics. With September's election looming large, Merkel and Schauble have to appear austere and firm. Rajoy and Hollande desperately need to wriggle free of Berlin's fiscal straitjacket and Barroso needs to avoid the unedifying spectacle of unemployed protesters rioting on the simmering streets of Madrid, Athens and even Milan later this summer.
Jaw, jaw, jaw-is always better than war, war, war and these are all just elaborate mating rituals aimed at wooing disaffected voters. Nothing has changed and, as I have previously predicted, the delicate dance will culminate in small gestures of support from north to south this summer, with more, much more, to come after Merkel's re-election.
So wither the Euro and all things Euro, such as peripheral bonds spreads?
The Bundesbank has also been in the news this week, providing the German Constitutional Court with a characteristically critical written opinion on the ECB's miraculously successful, but as yet untested, OMT programme. However, according to Handelsblatt , the Bundesbank stops short of saying the OMT is a downright breach of either the EU treaty or the ECB's mandate and the markets seemed to take this story pretty much in their stride.
This leaves us with Thursday's ECB meeting and the possibility of rate cuts as the next big event. Merkel's intervention has certainly complicated matters for Draghi; we already know that the Bundesbank is at the end of its tether in disgust at the various rubicons which the ECB has crossed to keep the Euro alive and a move to take the Deposit Rate below zero would surely send Herr Weidmann into an apoplexy of indignation and even possibly prompt his resignation. It will be difficult for the ECB to go against both Merkel AND the Bundesbank, so we'll probably get just a cut in the Refinance rate to 0.5%-pretty cosmetic really and, if anything, we could see a relief rally in the Euro, as the market is putting some chance at least on a negative Deposit Rate.
As an aside, whilst there are undoubtedly technical dangers in moving into negative territory, I have to say that I think this is the one piece of 'conventional' policy still left open to the ECB which might just get economically productive lending going. The psychological effects of actually paying money every day to deposit money at the ECB would have quite a dramatic effect upon banks-more than that to be expected from a cut of only 0.25%.
With Cyprus and Slovenia slipping from the markets view , and with slight positive developments such as Slovenia's successful Bill sale this week, the Euro and peripheral bonds could have a relatively positive week.