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EU Confusion Piles Pressure Onto Euro

Market CommentaryEU Confusion Piles Pressure Onto Euro

The outlook for the euro remains less than sunny this morning.

The latest figures from the EU indicate that credit default swaps for government bonds (insurance rates that investors pay to protect themselves in the event that banks default) have increased not only for EU periphery states but core states too. This means investors must pay more for government bonds in EU pillar nations including France and Germany.

This is pessimistic news for the euro. It indicates that the bond crisis now threatens to envelop the euro zone entirely, and confidence in the common currency is not high.

The reasons for this disheartening development are multiple. For one there are conflicting reports within the EU about the need to expand the EFSF bailout fund. EU officials inside the European Commission for instance have commented that the fund should be increased to protect Spain in the event it needs a bailout.

Yet other officials inside Brussels have denied this report, stating that the present €440 billion EFSF rescue pot is sufficient. In addition, the German Chancellor Angela Merkel has expressed an unwillingness to contribute more to the fund. She faces a backlash from the German public if she contributes to rescuing other EU states while imposing benefit cuts on the German public.

However, the most important reason for pessimism toward the euro is a market recognition that the present crisis has exposed fundamental flaws in the common currency.

This is: The euro unites member states in a common currency without binding them to a common fiscal policy. Hence, the comparative economic weakness of some member states can bring down more robust states. The fact that France and Germany now face increased insurance rates for government bonds because of events inside Ireland and Portugal demonstrates this.

This has led some economic commentators to claim that the euro now faces collapse. At the very least, important revision to the way the common currency works seem inevitable.

Elsewhere on the currency markets in the UK, a public argument between two members of the Monetary Policy Committee dampened confidence in sterling yesterday. Speaking to the Treasury Select Committee, MPC member Adam Posen accused the Committee’s Chairman Mervyn King of political bias.

These comments, coming from one of King’s senior policy makers, will undermine confidence in the Chairman’s policy making decisions.

King stated yesterday that he doesn’t intend to increase interest rates in the UK nor initiate a second round of quantitative easing, unless export demand in the UK drops. But Posen’s comments might make the markets question whether this is the correct tactic.

Finally it was a quiet day in the US yesterday because it was Thanksgiving. The dollar though gained against sterling and the euro because risk appetite on the exchange markets is low. This could continue until officials inside the EU decide the exact course of action they’re taking.

Upcoming later? The German Consumer Price Index figures are released accounting the average prices of goods and services consumed by the German public. Strong numbers are traditionally strong for the euro, though on the current market they could increase German desire to unshackle themselves from currency partners that are proving a liability.

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