Will Germany leave the Euro or will weaker Euro-zone members leave Germany? This is the key question that needs to be considered and answered as the Euro-zone heads for another summer of misery and Germany refuses to engage ahead of September election. With economic, political and social tensions all increasing, the chances of Germany and the Euro-zone finding harmony continues to deteriorate as recession grinds away inexorably at peripheral cohesion. Doubts over longer-term German commitment to the status quo should strengthen Sterling against the Euro in the short term.
The critical decision is whether global power economy Germany will still be in the Euro after any split as this would have massive implications. Germany and core members could exit from the Euro to form a new hard Deutschemark zone. Alternatively, the weaker Euro-zone countries will have to leave the Euro-zone and devalue to gain competitiveness. The former option would ensure that the Euro containing weaker members weakens sharply. The latter option would eventually entail a sharply stronger Euro as weaker members leave even if the currency is subjected to initial selling. Existing dollar speculative positioning remains an important barrier to US gains. UK fundamentals are weak at best, but there is scope for Sterling gains against the Euro over the next few weeks.
The German Federal Election is due to be held on September 22nd. Chancellor Merkel is facing increased internal divisions, especially with the emergence of a new anti-Euro party. The history of such protest movements suggest that it will be very difficult for the new grouping to gain any traction ahead of the Federal vote. Nevertheless, Merkel will certainly have to take the challenge seriously, especially given the need to maintain CDU unity, and will need to provide vocal reassurance that German interests will be protected. In this context, there is little chance that German government rhetoric will soften.
The underlying economic and political conditions are continuing to deteriorate with a succession of setbacks across the region with most decisions having the unintended (or intended) consequences of increasing underlying tensions. In this context, the Euro area is liable to cross the Rubicon and point of no return before September. The black hole surrounding Cyprus is continuing to widen as estimates of the bailout sum required continue to increase while the Eurogroup has refused to provide any additional support. Cyprus looks to be forced to sell its gold reserves and Germany will inevitably see selling gold as a template for the future.
The Portuguese government will have to find alternative measures to control the budget deficit following the Constitutional Court decision to block certain measures such as cuts to public-sector pensions. Greece, almost forgotten, continues to contract. After six weeks of negotiations, Italy still does not have a government while economic and political confidence in France is liable to deteriorate further. Bond markets have not shown any major stresses so far, but they remain dependent on bond buying by domestic banks. As internal cohesion continues to break down, societies within the peripheral economies are very close to political and economic implosion.
Eurocrats will assume that Germany will ultimately make the ultimate sacrifice required and adopt a much more radical set of policies following the September election. There is a high risk that Germany will disappoint, especially given opposition to banking union. The ECB will be under intense pressure to provide additional support for the Euro-zone. Although the central bank is very sceptical that lower rates will make any meaningful difference, the pressure for some form of action will be intense.
News By Lakforex.com