Weekly preview - New European politics, new Euro low

May 7th 2012: Weekly preview - New European politics, new Euro low

The new Euro-zone politics will dominate the first part of the week and, in all probability, the week as a whole. The Euro-zone is heading for catastrophe if policies are unchanged and electorates are relentless in demanding change as governments are ousted across Europe. Increased political risk will result in a weaker Euro. Any shift in strategy will, initially at least, mean a weaker Euro. The critical EUR/USD 1.30 support zone could provide a stern test for bears, but the Euro is likely to break lower and threaten 2012 lows.

Confirmation of Hollande’s victory in France marks the end of the Merkel-Sarkozy dominance at the political heart of Europe. In reality, Germany was dominating the agenda, certainly in the key crisis period at the end of 2011, but the illusion of a key alliance with France enhanced political credibility to a point way beyond what was justified by reality.

This will certainly not be the case with Hollande as there will be objections to the social compact and demands for a much more aggressive pro-growth strategy within Europe. Chancellor Merkel will pay a heavy price for supporting Sarkozy. Crucially, the new President has also been much more open in demands for more action by the ECB and this will be a key area of debate over the next few weeks and months. The German government, ECB and especially the Bundesbank will put up very heavy resistance to any significant economic changes with the clash destabilising market confidence.

More immediately, attention will return to Greece where the pro-austerity parties have suffered a battering at the polls and appear unable to form a majority government. If a new government can be formed, the clear upshot is that there will be demands for an easing in austerity. Markets will again have to price-in the possibility of Euro withdrawal while the troika will yet again face the choice of providing extra support and easing economic conditions or effectively push Greece out of the Euro area.

Following the weaker than expected US employment data on Friday, Federal Reserve comments will inevitably be an important focus during this week. The general pattern of recent US releases has been for data to disappointing enough to keep the possibility of further quantitative easing alive, but by no means weak enough to make further action the most likely outcome. In all probability, the payroll data has not changed this trend and should not be a game-changer. Markets will still want to assess whether Fed thinking has changed. Chairman Bernanke is due to speak on Thursday and markets will quickly seize on any policy hints.

The Bank of England will announce its latest monetary policy decision on Thursday and this is a particularly important meeting given that the existing quantitative easing £325bn bond-buying programme is scheduled to be completed early this month. The Monetary Policy Committee (MPC) will therefore have to decide whether t o keep policy on hold for now or whether to provide additional stimulus.

No doubt, the MPC members are as confused about the economic situation as the markets with major uncertainties over the outlook. The most recent PMI surveys have recorded a slowdown, but are still firmly in the area of modest economic expansion. There will inevitably be nerves ahead of the decision, but there seems little reason to stray from a wait and see attitude at this time.

One of the most important data series of the week is likely to be from Australia where the latest building approvals and retail sales data on Monday will be followed by trade data on Tuesday and employment numbers on Tuesday. The Reserve Bank of Australia cut interest rates by a larger than expected 0.5% last week and a disappointing batch of domestic releases would certainly increase fears over the economy as the Australian dollar threatens to dip below parity.

The trade data will also be monitored very closely for evidence on Asian and particularly Chinese demand. If China’s economy really is faltering, then the evidence will clearly show in the form of reduced important demand which will show up in Australia’s exports. The monthly batch of Chinese data on Friday, including the inflation data, together with the trade data which should be released on Thursday, will also have an important impact on Asian sentiment. Trade weakness would have an important negative impact on risk appetite.

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