The EU will be under intense pressure to deliver at this week's Summit, but the growing and unsustainable gap between rhetoric and reality will quickly reverse any initial euro gains. Spain will find it very difficult to stall much longer on a bailout request and the 'core' Euro-zone countries will also be under pressure not to impose even more conditions on Spain. The familiar pattern of caffeine-fuelled late-night drama is sure to be repeated with officials again determined to present a winning communique to the media which would trigger an initial euro rally.
Underlying political and economic cohesion is, however, continuing to crumble under the weight of recession and completely unsustainable policies. In this environment, any agreement is liable to be found wanting very quickly, especially if Germany, Finland and Holland look to backtrack on any deal and fail to offer any further concessions. The euro is also likely to retreat quickly as markets also find they are unable to ditch the dollar.
The EU will hold a two-day Summit meeting in Brussels on the 18th and 19th with a wide range of issues on the agenda. Spain will inevitably be a critical focus as pressure continues to increase on Madrid for an early bailout request. The Greek government will also be looking to cement a deal with the troika which would allow the next EUR31bn loan tranche to be paid. Talks will also be held on a common euro budget as well as proposals for banking union.
There has already been inevitable slippage on the banking union timetable with the ECB warning that common supervision of the banking sector might not start until 2014 even if the legislation was in place at the start of 2013, an outcome which in itself seems highly unlikely in any case given German determination to slow the whole process down.
A key element which will need to be addressed is the pledge to break the link between sovereign and banking debt. The Euro-zone agreed in June that the ESM should be able to recapitalise the banking sector directly. In this scenario, support for the banking sector would not impinge upon government debt/GDP ratios and would not undermine sovereign ratings.
The so called 'hard' euro countries initially signed up to the deal, but quickly took fright and stated that existing legacy debt was the sole responsibility of debtor nations. This will be the critical focus at the Summit, especially as it will have a vital influence on Spain. As if the economic plight was not desperate enough, the Madrid government's worst fear is that it will make an aid request which is then rejected. This would represent total humiliation for Rajoy's administration as well as triggering a fresh onslaught of market pressure.
This backtracking is at the heart of Spanish fears that Germany and its satellites could block any Spanish aid attempt or look to impose even stricter terms before agreeing that any funds are allocated. This will maintain the threat that Spain will play for more time.
The Spanish bond auction will be watched closely on Thursday, especially with market patience being tested severely by delays in requesting a bailout, but the impact should be limited by the fact that it comes just ahead of the Summit meeting .
The most important Euro-zone economic release is likely to be the German ZEW survey due on Tuesday, although the data is likely to be overshadowed by political considerations.
The Asian economy will inevitably be an important focus during the week with key Chinese data releases due. The latest consumer inflation release is due on Monday with the key quarterly GDP data out on Thursday. Markets have certainly put prices in a weak reading, but any below-expectations reading would reinforce concerns surrounding a hard landing, especially with suspicions surrounding the data quality. If the official data comes in below forecast, there will be huge fears surrounding the actual economic performance.
The latest US retail sales report is due for release on Monday. The latest New York manufacturing PMI survey is also due for release and the Philadelphia Fed index will be released on Thursday. These two regional surveys were again weak for the September readings, but this did not translate into a downturn for the national PMI reading. Markets will, therefore, tend to treat the data with a slightly higher degree of scepticism this month which will tend to dampen the impact.
There are important UK releases during the week which will have a significant impact on the Bank of England and have a pivotal impact on Sterling. The latest consumer inflation data will be released on Tuesday and after falling rapidly early in 2012 the inflation rate has levelled out. MPC members have expressed unease surrounding inflation stickiness and concerns will increase if the rate rises this month.
The most recent unemployment data have not chimed with the downbeat growth estimates and the latest data on Wednesday will shed further light on the issue, especially as it may capture any post-Olympics negative effect. Any sharp rise in the claimant count would have an important negative Sterling impact.
The latest MPC minutes will also be released on Wednesday with the retail sales and government borrowing data on Thursday and Friday respectively also having a pivotal impact on sentiment.
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