Euro Update

The euro’s renaissance continued into last weekend before running out of steam. It reached its highest point against the US dollar since early May and touched a three-month high against the pound. Since then it has staged a tactical withdrawal, leaving it a cent lower on the week against sterling and three quarters of a cent down against the dollar. This has had an impact on money transfer and international payments.

With no news to motivate fresh buying, investors apparently decided to take some profit on long positions that had driven the euro ten cents higher against the dollar and four cents higher against the pound over the previous couple of months. The specific lack of news that concerned them was Spain’s failure to request assistance. Mario Draghi’s plan to support Spanish and Italian government bonds depends on those countries making an official request for a bailout. Neither has done so.

Italy was never going to be first in the queue but it had been supposed that Spain would come to see the necessity for action and Prime Minister Mariano Rajoy would pull the trigger, albeit reluctantly. Instead, the market has been in thrall to the threat of European Central Bank intervention and has, to some extent, done the ECB’s job for it. Spanish borrowing costs have fallen substantially. At an auction this week Spain sold €4.8bn of 10-year treasury bonds at a rate of 5.67%. That is nearly a full percentage point less than Spain had to pay last time it went to the market and two percentage points below the peak two months ago.

That improvement has made urgent action by Sig. Rajoy less urgent. The best guess at the moment is that he will make no move until late October. Regional elections take place in Galicia on 21 October. Galicia is Sig. Rajoy’s home turf. He will not want to go into the elections having backtracked on his pledge to avoid the need for Spain to take a bailout, with all it implies for ignominious examination of the national finances by the ECB/EU/IMF “troika”, austerity and the loss of national prestige.

To an extent investors are ready to accept the logic of the situation but this is not the first time their patience has been tested. If it does take five weeks for Spain to get on board the bailout train it might be too long for them to wait. To some extent the realistic prospect of eventual action will underpin the euro but it is unlikely to send it higher.

In the absence of an official aid request by Spain then, the outlook for the euro has to be mildly bearish. At best it will be able to cling to current levels; at worst it will find itself back where it was prior to the announcement of the still-unratified Draghi Plan. Of course, should Spain make a move to sign up for assistance that picture would almost certainly turn positive for the euro, at least in the short term.

This helpful article was provided by Tariq Ahmed.

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