Europe in Denial, UK Benefits

Throughout the unfolding of the Greek crisis, European officials have repeatedly failed to get ahead of the curve of market expectations and events and this is the case once again. The impression that officials had given was that funds would be there once Greece formally requested assistance, but now it seems that Greece’s formal request simply opened the door to a new round of negotiations. Germany is not speaking with one voice, but the Finance Minister appears to be seeking detailed plans for 2011/2012.

There was concern expressed by some German officials as well as by Canada’s Flaherty that the funds earmarked for Greece are insufficient for the task. Although denied by officials, there seems to be an arguably growing number of market participants that suspect that some kind of debt restructuring for Greece will be necessary. Estimates suggest that Greece’s debt servicing costs could be as much as €50 bln for the next five years. The cumulative cost (€50 bln x 5) is roughly a year’s worth of output (GDP). ECB officials seem to be in denial about the contagion risks, and this is preventing preemptive action. Meanwhile, the weekend polls warn that support for the Greek government is thinning and the resistance to more cuts in wages and pensions may stiffen, just as Europe and the IMF will seek additional concessions.

Europe’s problems are illustrated too in the collapse of the Belgium government at the end of last week. On the face of it, the Belgium political crisis is a domestic problem, little to do with Europe. Yet on closer examination, it appears that the selection of former Prime Minister Van Rompuy as European Council President last November, as a compromise formation, set the stage for the return of the center-right Dutch-speaking government which antagonizes the French-speak south.

The coalition unraveled last week and Prime Minister Leterme submitted his resignation. Belgium holds the rotating EU presidency in the second half of the year. Recall that the Czech government collapsed in H1 09 during its EU presidency and this curtailed the agenda. Belgium’s political woes expose yet another potential vacuum in the center of Europe at a time when strong leadership is necessary.

There was no closure on the European debt/deficit issue and there was no settlement on the yuan issue either. Some reports suggest that the yuan was not even discussed formally. The 12-month non-deliverable forward market implies about a 3.3% appreciation of the yuan over the next 12 months. We have not been among the voices claiming the Chinese move was imminent. Yet we do recognize that another important pre-condition is moving into place. Specifically, we have argued that in addition to renewed growth in exports and rising inflation, Chinese officials also wanted to be recognized as a major economic power. In that context we note that the members of the World Bank approved a $5.1 bln capital increase, the first in more than 20 years. Approximately $1.6 bln will come from developing countries, including China. China’s voting share at the World Bank will increase and it will move into third place behind the US and Japan.

The latest polls in the UK suggest that the Tories may have gained ground and this seemed to help sterling. Judging from the price action, the market seems to prefer a Tory/Lib-Dem coalition to a Labour/Lib-Dem coalition. Of course, a coalition government for some means a hung parliament for others. As journalists and analysts review the historical record of coalition government and their ability to enact fiscal reforms, some more favorable near-term assessment of sterling has emerged.

Meanwhile, the latest Hometrack report found that UK house prices rose at their slowest pace in three months as the new supply was brought to the market. The waning of the property market’s momentum may reflect a weakening of confidence, which is precisely what a separately report by Rightmove. Its survey found a falling number of people that expect prices to be higher next year.