Tensions intensify in the euro area on possible Greek default, U.K. continues the release of weak fundamentals

Last week, worries intensified in the markets that Greece will face a default, adding to concerns as global economies, meanwhile, experience a slowdown in growth pace.

Prime Minister George Papandreou, said he will slash one month’s wages from all elected officials and impose an annual charge on all property for two years, to meet the budget deficit targets for 2011 and 2012 which are 17.1 billion euros and 14.9 billion euros, where the new measures will help in reducing the shortfall by 2 billion euros to offset the slowdown in activities.

The Greek government is doing more attempts to become eligible for receiving the next tranches of the EU-IMF bailout to avoid default.

Tensions returned once again to markets with the rise in Greek bond yields and cost of insuring against default, which raised the possibility that the debt contagion could spread to other large highly indebted nations in the region, especially Italy and Spain.

The Italian government sold 3.9 billion euros of five-year notes while the Spain sold 3.95 billion euros long-term sovereign bonds.

Moreover, with speculations that Germany is ready to kick Greece out of the euro area, the unexpected resignation of European Central Bank's chief economist Juergen Stark, no clear action from the G7 in their meeting and expected downgrade to France's top banks due to their exposure to Greek banks, markets went on the rampage.

However, the sentiment started to improve into the week as expectations increased that the ECB bought Italian bonds and the European Commission's President Jose Manuel Barroso said he is close to proposing options on joint euro-area bond sales. 

Merkel and Sarkozy also said they are “convinced that the future of Greece is in the euro zone.” While we saw the flare of confidence gain more and more momentum with the unexpected coordinated action from the ECB along with the Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank to conduct three more US dollar liquidity-providing operations with a maturity of around three months till the end of the year.

This move was preemptive from the ECB to prevent the freeze of money markets with the signs of strain starting to appear after banks started to access the ECB facilities for money as European banks started to struggle in dollar funding.

In the U.K., fundamentals continued to add to worries as annual CPI for August accelerated to 4.5% in August from 4.4% in July. Unemployment in the three months ending July rose by 80,000 to 2.51 million and employment in government jobs fell by a record in the three months through June.

Retail sales with auto fuel slipped 0.1% compared with the revised 0.2% in July, while the reading excluding auto fuel dropped 0.1%, lower than the prior 0.2% rise.

This week, BoE minutes for the month of September will be available with some expecting to see some members joining Adam Posen in calling for an APF increase to boost the sluggish growth

ECB Hold Rates Steady in September as Investors Bet Trichet to Drop Hawkish Stance

The European Central Bank met market expectations and held key rates steady in September as market pressures intensify and growth slows, where the bank is cornered between slowing growth and deepening debt woes.

The Governing Council voted to keep the main refinancing rates steady at 1.50%, while also maintained the marginal lending facility at 2.25% and the deposit facility at 0.75% as widely expected. The ECB moved twice on rates this year raising rates by 25 bp in April and in July.

Growth slowed into the second quarter and now starting the third quarter with broad downbeat signals. The economy expanded a slim 0.2% in the second quarter down from 0.8% where leading economies slowed with Germany expanding a slender 0.1% and France stagnating! This is more downside pressure on the bank and on inflation which will prevent the ECB from any hasty decision at this critical phase!

With the slowing growth and deepening debt agony the bets actually are rising for the bank to alter its stance, and that is what investors are waiting for today! Recent comments from Trichet that the central bank will reassess inflation threats at the time it took the toll of restoring financial stability by extending liquidity lines and intervening in bonds markets.

Eyes are not on the decision as much as they are on the speech and expected new ECB projections for growth and inflation. The ECB shadow council already called on the bank to reverse the rate increases delivered this year to avoid recession while expectations are now for Europe and its leading economies to falter in the coming quarter with odds for Germany and France to at least stagnate after barely expanding in the second quarter which seriously questions the growth power in the aggregate area!

The flash August CPI estimate assured inflation is slowing and held at 2.5% after it peaked at 2.8% this year in April. The slowing growth and rising downside pressures over the outlook for the recovery is keeping the pressure on the ECB and supporting expectations that the bank might not move till the end of the year, and now possibly reverse its stance!

The hikes came amid deepening debt problems in the euro area and intensifying problems that are threatening the monetary union. Fears recently intensified with the doubts around Greece in particular after the EU/IMF suspended its mission and lenders are at odds whether the nation has met the requirements for the new tranche of aid.

Italy is also center stage with investors not convinced of its measures to tame the debt and reduce the deficit with the new amended 54 billion euro austerity plan that was approved by the Senate last night. More bad news for the euro area and for the ECB is the political tension in Germany with Merkel losing support more and more each day with the fifth election loss this year and now barely escaped criticism as the German Federal Constitutional Court today rejected lawsuits seeking to block the nation from participating in the euro area bailouts, yet the court still assured that it does not mean Germany can provide unlimited support and requested that future bailouts should require parliamentary approval.

For now, the focus is on Trichet to confirm the next step. The ECB President today undoubtedly will not signal any move and eyes are on the magic words whether “closely monitor” or “rates are appropriate” or “downside pressures” are clear which should determine the outlook for the policy by the bank.

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