World First Morning Update 1st November 2011: Greek referendum pledge destroys euro optimism

The euro has continue to pile lower overnight but this time as a result of an unexpected move by the Greek PM George Papandreou with him throwing the cat amongst the pigeons and announcing that Greece will hold a referendum on the terms of the latest bailout. Why he has done this is a bit of a mystery to be honest although the sensible and most reasonable answer is that he is getting pressure from his own party to renegotiate these terms. It was certainly a surprise, even to political allies, and is being cited as a huge gamble in the Greek newspapers.

Recent opinion polls suggest that over 60% of Greek voters disagree with the terms of the latest bailout and a failure of the referendum would destroy the only market sweetener from the last week’s meeting that was the 50% haircut on Greek debt. The

glaring fact was that a viable firewall to protect Italy and Spain from further downturns in credit markets was not established. The meeting was a sham and soon I expect we’ll be talking about Portugal needing additional funding and Italian bond yields will continue to head north.

The effect on the single currency was swift and brutal. EURUSD is now down 4.5 cents in just over 2 trading sessions and is now trading in the mid 1.37s whilst GBPEUR is now at a near 4 week high as it trades above 1.16. Getting above 1.17 will be difficult given the risk from today’s GDP report but we may now see the cross camp out in the upper portion of the 1.14-1.17 range. The markets are really starting to get short European risk now i.e. looking for further losses. The difference in yields between Italian and German debt is used as a measure of risk in Italy and this morning it hit a record level of 434bps i.e. that the yield on Italian debt over a 10yr span is now 4.34% higher than that of Germany. Not encouraging at all.

Today is All Saints day in Europe so the docket is fairly quiet and focus will turn to today’s UK GDP number at 09.30. Surveys from purchasing managers in the manufacturing, construction and services industries have been mixed over the past three months. Manufacturing has spent most of the time below the important 50.0 level, before recovering in September, whilst growth in construction has remained consistently positive, albeit at a dwindling rate. The important services sector was going great guns in July before slumping in August and bouncing back in September highlighting the confused nature of consumer spending and confidence at the moment in developed economies. In rather stark contrast to the relative negativity of recent confidence surveys retail sales in the UK rebounded strongly in September although it is unlikely that this will continue through the 4th quarter as the High St remains at the behest of high unemployment, squeezed wages and a stagnant housing market.

Our belief is that UK GDP in the 3rd quarter will have expanded at a rate of 0.4%, up from the Q2 figure of 0.1% that was weakened by the Royal Wedding’s affect on productivity and the supply chain reaction to the Japanese tsunami. As far as the number’s effect on sterling, we would expect upside to be muted for the pound unless the number is above 0.5% (consensus 0.3%) and to sell-off on a disappointing figure.

Alongside the GDP figure we receive the latest reading of UK manufacturing PMI from the UK. The PMI is expected to decline to 50 according to the consensus forecast, after an increase to 51.1 in September. Manufacturing continues to dip globally as well with China’s manufacturing sector growth slowing last month as the government attempts to control inflatuionary bubbles in country. A similar decrease is forecast in the US as well at 14.00.

Latest exchange rates at time of writing