The ECB will outline a bond-buying plan at this Thursday's ECB meeting, it has no choice as failure to do so would inflict a terminal blow on the Euro. The bank will, however, also have to make significant compromises and concessions which will dilute the impact and weaken the Euro. Action will also be conditional on Spain agreeing to further economic and political humiliation which at the very least will delay action. Overall, the market reaction is likely to be one of measured disappointment as the game of chicken is extended for another few weeks.
The ECB will have to try and keep the Bundesbank and as a proxy the German government at least partially on board. German representative Asmussen has certainly steered a different tack from his predecessor Stark since becoming the German representative on the Executive Board and this has been an important influence in softening potential German opposition. He too, however, will be aware of the need to stop an open Bundesbank revolt, especially as Chancellor Merkel also has crucial red lines to defend.
Sequencing and conditionality will be a key feature surrounding the proposals. The ECB will certainly lay down conditions for intervening at the short-term of the peripheral bond curve. One demand will be a pre-requisite that countries apply for support before bond buying as the ECB has to keep reform pressures in play. There will be major reservations within Spain and Italy over the conditions being applied and there will, therefore, be the important threat of deadlock following the meeting.
Spain will be an extremely important focus, especially as internal political stresses increase. Prime Minister Rajoy has again called for action to bring down Spanish yields and allow Spain to regain market access. Financing stresses are increasing, there will for example be no 10-year auction this week as Spain has to stick to short-term financing. Rajoy is sounding increasingly desperate as he is squeezed between market and political pressure. The most likely outcome is that RaJoy will eventually bow to external rather than internal pressure and accept bailout terms, but this is a far from guaranteed outcome.
Press briefings will need to be watched very closely both before and after the meeting with a focus on potential signs of dissent, especially within Germany. There are reports that global central banks will be briefed on the plan on Tuesday.
The ECB will also be taking a more orthodox look at monetary and growth conditions within the Euro-zone. In this context, there is certainly the possibility of a further cut in the benchmark interest rate to 0.50% to boost the growth outlook. This would be an important break with ECB tradition as the bank had previously tightened policy when inflation was above 2.5%. The latest bank forecasts will also be watched very closely.
The bank will be extremely wary over cutting the deposit rate to below zero, but this certainly could be considered in order to force funds away from being parked at the ECB. The most likely outcome is that the bank will signal a willingness to take action in October if there is no evidence of improvement.
As far as economic data is concerned, the action comes thick and fast during the week with little chance of a respite. The headline release will be one of the last with the US employment data due on Friday. In his Jackson Hole speech on Friday Fed Chairman Bernanke effectively confirmed that the Fed is very close to sanctioning further quantitative easing.
An important section of Bernanke's speech dealt with labour-market conditions and weakness in employment. With the Fed not seeing a significant inflation threat, the employment data will clearly play a pivotal role in the Fed's thinking. The actual thought process at the Fed will inevitably be more complicated as they ponder the underlying economic dynamics and policy effectiveness, but the market will see it as a more black and white issue; If there is a weaker than expected payroll report on Friday, this will be seen as triggering further Fed action at September's meeting. A payroll increase below 100,000 would make it very difficult for the Fed to resist a third round of quantitative easing this month.
The latest manufacturing PMI data will be released on Tuesday following the Labour Day holiday. Thursday sees three key US releases with the latest ADP employment data and jobless claims, together with the non-manufacturing PMI data.
The Bank of England will hold its latest policy meeting on Thursday and will be in a slightly more comfortable position that the Federal Reserve. The Bank already moved to sanction additional easing at the July meeting and the most likely outcome is that the MPC will wait for the current programme to be completed in November before taking additional action. This will give the Bank of England more time to assess the effectiveness of Euro-zone measures, especially as these will have a pivotal impact on the UK economic outlook.
UK PMI surveys will be watched very closely during the week as further deterioration could lead to a political breaking point. The UK parliament returns from the Summer break. The mood will certainly be much more hostile following the succession of weak data with growing pressure for action and demands that the Chancellor should be replaced.
The Australian Reserve Bank will hold its latest policy meeting on Tuesday and the most likely outcome is no change with the bank holding back to assess developments over the next few weeks.
Markets will remain on alert over sovereign rating cuts by credit-rating agencies, although comments from Moody's suggest that the timescale for deciding on Spain's rating has been pushed back. Most likely, the agencies will now wait and assess what if any bailout package is asked for before determining whether to cut to junk status.