Greek Drama, UK Developments, German Data

Currency in Crisis

The Greek drama continues to be a key focus in the foreign exchange market. It is expected to rival financial regulation as key topics at G7 meeting and G20 meetings at the end of the week. Officials, Greek and others, continue to play down the risks of default. Even if Greece can muddle through this year, there is growing realization that that will also not mean closure. BBK President Weber, who is a leading candidate to replace Trichet as ECB President, admitted what every one knew to be the case. Greece would likely need more funds than the initial EU/IMF package.

Reports cited Weber as suggesting as much as 80 bln euros may be needed. One of the important issues apparently unresolved are the conditions of drawing on the funds. Meanwhile, many continue to suspect that at some juncture Greece will restructure its debt. However, more immediately, the successfully auction of Greek bills at a yield less than rumored has helped steady the Greek debt market. With the EU/IMF/ECB officials meeting with Bank of Greece officials, the risk is that some additional clarity is achieved that extends the fragile calm. This would also suggest scope for additional near-term euro gains.

Sterling continues to be quite resilient in the face of the economic and political news stream. The success of the Lib-Dems Clegg in last week’s debate appears to be prompting a change in tactics from Brown, who is sounding more sympathetic to electoral reforms, and Cameron who has softened his critique of the Clegg’s manifesto. Clegg’s success, especially if repeated in this week’s televised debate, comes at the greater expense of the Tories. They have to win more seats than it has in any election since the early 1930s. In order to do so, it must not only take seats now held by Labour, but it needs to pick up some (some estimates suggest around 20) from the Lib-Dems.

On the economic front, the UK reported higher than expected inflation, which forces BOE Governor King to write another note to Darling to explain the overshoot. The headline CPI rose 0.6%, twice what the consensus had expected. The year-over-year rate rose to 3.4% from 3.0%. The consensus had expected a 3.1% increase. While no doubt there was an energy component to the increase an base-effects, the fact is that the core rate rose 0.5%, lifting the year-over-year rate to 3.0% from 2.9%. There is beginning to be some questions raised over the BOE’s assessment that inflation will be just a transitory phenomenon. The market recalls the outsized jump in PPI and now CPI and decline in sterling and the QE measures. Nevertheless, it seems unnecessary to jump to that conclusion yet. Commodity prices have risen, but the rise in the UK’s CPI could be a lingering effect of the increase in the VAT.

The German ZEW investor survey was much stronger than the market expected. The gains snap the six month decline with emphasis. The economic sentiment component rose to 53 from 44.5. The market had expected a small rise to 45.1. The assessment of the current conditions rose to -39.2 from -51.9. The consensus had expected a -48.0 reading. This one month’s report unwinds the much of the decline seen in Q4 09 and Q1 10. The report also helped stabilize the euro. After stagnating in Q4 09, the euro zone economy appears to have picked up some momentum as Q1 progressed.

Investors should be prepared for somewhat stronger European data in the coming weeks as late Q1 and early Q2 data are reported. This is also within the context of what appears to be the broadening and deepening of the global economic recovery.