The euro gained steadily on Friday as markets corrected on reflection of the US dollars overbought status. The safe-haven currency has been widely in demand this week as bond yields of several European countries remain high and, specifically, the Italian political situation has been adjusting to the transition of power. Even the comments from German Christian Democrat chairman Volker Kauder advising Spain to engage in the new European bail out fund, the European Financial Stability Facility, rather than the European Central Bank was seemingly factored into the market already. The broad expectation seems to be that, once Angela Merkel has ironed out the last ‘technical details’ of the fund it will become available with the likelihood that Spain and Italy may be its first beneficiaries.
The Spanish general election on Sunday will not be seen in the same light as the removal of Berlusconi in terms of its impact on the financial prospects of the country. Whereas Berlusconi was replaced as a result of his inability to stabilise government debt dating back to the 70’s and 80’s, Spain does not have such a simplistic cause of its current situation. In fact, having not borrowed anything between joining the Euro in 1999 and the financial crisis of 2008 Spain had lowered its debts to below 36% of GDP and has been a model EU nation relative to the Italian experience. The largest contribution to Spain’s current situation was its overindulgence during the boom of the past ten years. High wages and an housing boom which are impossible to sustain during an economic downturn has led to unemployment, an uncompetitive workforce, falling tax revenues and mortgage defaults which are the major drivers of Spain’s problems.
Financial markets seem to have factored this Spanish dilemma into the current Euro price range and technical traders took control, at least on Friday, to force a corrective increase in the Euro value. The bond markets also reacted to intervention by the ECB in buying both Italian and Spanish bonds, pushing the higher Italian yield down to around 6.67% away from the critical 7% level. This intervention comes after yesterdays Spanish bonds almost hit this point and prompted the ECB to attempt to balance the situation whilst the bail-out fund details are apparently being finalised. Whilst investors are reassured by the actions of the ECB intervention, the ideal situation would be to utilise the proposed bail-out facility. The ECB should only really be considered a last resort and the fact that it is currently limiting its intervention suggests that this would require it to commit to buying unlimited bonds of struggling nations and instil substantially more confidence in international investors.
The future role of the ECB in the sovereign debt crisis has become a sticking point between Germany and France who are divided as to the degree of intervention it should be allowed to exercise. Mario Draghi, governor of the ECB, has entered the dispute and called for urgent and swift action in activating the proposed bail-out fund. The Germans are calling for a scaled back ECB role whilst the French are demanding that the ECB should be used as ultimate underwriter to the fund. The fact that this is perhaps the fourth rewriting of the ‘comprehensive strategy’ to save Europe’s finances goes a long way to explaining investor confidence.