G20 Says 'Do More'

At the latest meeting in Mexico, the G20 has told the EU to do more to help itself before turning to the international community for support. It’s not the first time it has heard this message, but it underlines the ongoing vulnerability of the rescue mechanisms in Europe, namely that the firewalls currently in place are insufficient to provide a sufficient backstop to Italy and also Spain.  On paper, Europe can afford to do so, but in practice there are major political and institutional barriers.  Germany remains most opposed, not surprisingly given it will have to stump up the most funds towards any increase.  This is going to be a growing issue as we head into the next EU summit at the end of this week. 

Commentary

Aussie leadership issue put to bed for now.  The leadership storm in the Australian Labour Party between the current PM Gillard and former PM (and foreign minister) Rudd has resulted in victory for Gillard, with Rudd saying that he will now fully support her.  The Aussie was only marginally bothered by last week’s political events, but the issue may not be put to bed as the Labour party lags behind in the polls and, although elections are not due until next year, this does leave enough time for more political ructions along the way.  The Aussie dollar has started the week on a modestly softer footing, nudging back below the 1.07 level during Asian trading, but by and large it has managed to shake off the political drama.

Not the best time for an oil crisis.  Oil (Nymex) was marginally softer Friday, following on from eight consecutive days of gains. There’s never a good time for an oil crisis, if this can be called one, but the squeeze higher we are currently seeing (Brent up over 12% on the month) comes at a time when inflation rates are set to fall. This is most prominent in the UK, where the falling out of the VAT increase from the YoY calculation has allowed headline inflation to fall to 3.6%, having been at 5.0% three months previously.  With rising oil prices, there is always the debate as to whether the move higher will feed through into wider price levels as higher costs are passed on to consumers, or if the consequent squeeze on real income will dampen spending. In reality, it’s always a combination of the two. The former depends on the pricing power of those with rising costs and the latter on the ability of consumers to offset the squeeze in real incomes via other means (such as borrowing, working longer hours or reducing spending on energy). For both the UK and US, most of the means by which households may offset rising energy costs are either limited (borrowing, working longer hours) or exhausted (reducing energy spending). As such, our suspicion is that a sustained move higher in oil prices is likely to see consumer spending take more of the pain. In the US (where retail prices are more sensitive to wholesale developments), spending on gasoline as a proportion of personal consumption spending has been on a rising trend since 2009 (just below 6% currently). As yet, rising oil prices don’t have the potential to derail the better US real sector picture, but they do have the scope to dent it, given the limited safety valves for relieving the pressure on consumers.

Fighting the south-north flow.  Over the course of Friday the euro built upon the new highs vs. the USD made Thursday, although this had more to do with action on other majors such as sterling and the Scandis. If we were to look for a positive it’s that, with the legislation agreed, the Greek debt swap started Friday. It’s also interesting to note that the Greek Finance Minister is urging people to repatriate deposits that have fled the country. He noted that 35% of deposits that have left the country have been moved to the UK. But of the EUR 65bln of deposits lost since December 2009, data shows that only EUR 16bln has moved out of the country. So the remainder is either sitting in cash somewhere or has left the country without involving the banking system. This in itself is pretty remarkable, if true.  But it also highlights something we have noted for some time, namely the impact of fragile faith in many southern European banks that has seen a steady stream of deposits out of the more vulnerable countries. Given all the other hardships currently being endured by the Greek population, it would be remarkable if the Finance Minister’s pleas have any impact, but you have to admire him for trying.

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Simon Smith, Chief Economist
Michael Derks, Chief Strategist

 
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