Risk assets and currencies have been placated since the start of the new week by news that G7 finance ministers and central bank governors will hold a conference call later today to discuss how they should respond to Europe’s worsening sovereign debt and banking crisis. Frankly, given the incredibly fragile sentiment evident over recent weeks, the G7 needs to come up with something fairly convincing to soothe the nerves of traders and investors alike. The Fed, the BOJ and the BOE may well declare their preparedness to implement further QE, while the ECB should consider both reducing rates and announcing more LTRO. More urgent however is attempting to stem the tide of those pernicious bank runs that have accelerated in southern Europe over the past few weeks. Short of implementing a Europe-wide deposit guarantee scheme, this will require a huge injection of capital into ailing banks, especially those in Spain. However, without Germany’s imprimatur, it remains unclear just where the money will come from. Although the fact that global policy-makers are weighing up their options is encouraging, they cannot afford to prevaricate for much longer. Time is in short supply.
Germany’s choice. Over the weekend, talk shifted from growth to unions, be they banking, political or of debt. The Spanish PM Rajoy called for a robust “banking union” in Europe, probably from the realisation that the Spanish government alone cannot deal with the overhang of bad loans currently weighing on the Spanish banks. Meanwhile, the Welt am Sonntag newspaper in Germany reported that EU leaders and the ECB were drafting a ‘master plan’ to deal with the sovereign crisis, with the paper reporting talk of banking and political unions, together with more integration of budget policies. From one angle this is modestly encouraging. But markets are unlikely to buy this because all of them involve straying into areas which have consistently been out of bounds for the single currency. Furthermore, to varying degrees, Germany will perceive itself as the one that loses out in all three initiatives. On the plus side, the reported ‘master plan’ at least seeks to tackle the fundamental short-comings of the eurozone, which were evident at the start but the implications of which were masked by easy credit and decent growth. Until there are signs that Germany is prepared to stump up then such speculation will not make it onto the policy agenda. The choice is pretty clear though, because the fact remains that policy makers in Europe have pretty much run out of road and these are the only viable options open to them.
RBA continues to cut rates. Citing a worsening in Europe’s economic and financial prospects, and slower growth in Asia, especially China, the RBA’s decision to lower rates by another 25bp overnight was expected. Since the beginning of last month, the cash rate has been lowered by 75bp, to 3.5%. RBA Governor Stevens remains conscious of the ongoing caution exhibited by both consumers and businesses. As such, with both the international and domestic economic environment deteriorating, and inflationary pressures easing, there is plenty of potential for a further easing of monetary policy down under over the second half of this year. The currency is actually a little stronger since the rate decision was announced, in part because there was some speculation that the Australian central bank might just opt for another 50bp rate reduction. The Aussie traded above 0.98 overnight, after briefly falling through 0.96 on Friday.