STOCK MARKET WATCH -- Monday, 1 October 2012

[Ghost Dog]

16. Forex Preview: Eurozone Political Cliff Forces ECB Hand

The U.S. fiscal cliff is a major media talking point, but the eurozone political cliff is the much more pressing threat as elected governments risk a rapid loss of control. With intense pressure to help fill the political vacuum, the ECB is likely to cut interest rates this week and trigger a renewed flood of defensive funds into the Swiss franc and yen. Any euro rally on a Spanish bailout request would reverse very quickly as October political and economic storms intensify.

The eurozone remains in a binary outlook as it will either survive intact in a weakened form or exist as a smaller currency union based around Germany. The denouement is coming ever closer, illustrated by the fantasy budgets presented by Spain and France last week. The Madrid government in particular is increasingly isolated and distanced from domestic realities, a sure sign that a political end-game is approaching fast with levers of power increasingly ineffective. Developments in Catalonia and within Greece will need to be watched very closely as the scent of rebellion becomes ever stronger.

There must be a growing sense of panic within the ECB with increasing fears that it has been left hanging out to dry. Backsliding by Germany on conditions for the ESM and banking union, allied with severe political stresses within Spain, are threatening to derail the ECB strategy. For now, the bank has no choice but to continue to whatever it can to salvage the euro and keep policy extremely loose.

A key fact for the bank to consider is that the economic environment is continuing to deteriorate. Confidence levels may have been improved initially by the ECB plans, but the PMI indices remain at three-year lows with the latest money-supply and lending data also disappointing. The latest austerity budgets in Spain and France can hardly have improved the overall mood, and the economy is set to contract sharply for the third quarter. In this environment, the ECB is set to cut benchmark interest rates again. The negative euro impact is likely to be intensified by the risk of growing splits within the Governing Council, especially after the higher than expected inflation reading last week...

/... http://seekingalpha.com/article/896431-weekly-forex-preview-eurozone-political-cliff-forces-ecb-hand