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FX Briefing - German suggestion of creating crisis mechanism triggers fresh crisis on the periphery

FX Briefing 12 November 2010



German suggestion of creating crisis mechanism triggers fresh crisis on the periphery

G20: No agreement in currency skirmish

ECB marching on towards exit

Euro in a crisis maelstrom


The dollar recovered across the board this week. This was not so much due to the data coming from the US, despite the latest labour market figures having helped to ease the economic concerns somewhat, but rather because tensions have escalated again significantly in the rest of the world. This applies particularly to the eurozone, where the fiscal situation in countries on the periphery has become critical again. EUR-USD fell below 1.36 temporarily and is now trading at just under 1.37.


The yen, as one of the main safe-haven currencies, did not benefit from this, however. This was probably largely because, prior to the G20 summit in Seoul, the Chinese government had allowed the yuan to appreciate and raised the minimum reserve requirement ratio by 50 basis points to 17.5%. USD-JPY climbed to over 82. The Chinese currency, on the other hand, soared to its highest level against the dollar since 2005.


Ever since the summit a fortnight ago, when heads of state and government decided to reopen EU treaties and create a crisis mechanism, yields on peripheral eurozone debt have been rising. The initiative, led by Germany and France, wants private bondholders to share the burden when countries are at risk of defaulting. This has given rise to an unprecedented cacophony in the eurozone. While the German finance minister is already making concrete suggestions about extending and restructuring debts, ECB representatives, including the president himself, are more sceptical. The governor of the Irish central bank actually accused Germany of destabilising the bond markets. Luxembourg’s prime minister and president of the Eurogroup, Jean-Claude Juncker, warned that demand for bonds of the heavily indebted peripheral eurozone countries could dry up as a result of the German-French initiative.


It is therefore hardly surprising that pressure to sell or hold off on buying government bonds issued by the problems countries has increased immensely, particularly as the string of bad news about these countries’ fiscal situation seems to be never-ending. Since the end of October, yields on 10-year Irish government bonds have risen by around 2 percentage points to almost 9%, and those on Portuguese bonds by 1 percentage point to over 7%. Yield spreads between Bunds and peripheral sovereign government bonds hit new highs, even though last week, and presumably this week too, the ECB purchased large quantities of troubled eurozone countries’ bonds. If the situation does not ease, it seems to be only a question of time until refuge is sought under the EU umbrella.


Due to the surge in refinancing costs, the banks in these countries are also under great pressure, which could lead to further systemic risks. For instance, the cost of credit default insurance for Irish banks surged to new record highs at the end of the week.


In view of this crisis, discussions on the currency war and global imbalances in the currency markets have taken a back burner. While the US was  widely criticised at the G20 summit for its accommodative monetary policy, the export nations China, Japan and Germany are under pressure because of their high current account surpluses. The discussions would be unlikely to lead to concrete results at the moment anyway.


The divergences in the eurozone are underlined by the economic data. Spain’s economy stagnated in the third quarter, thus thwarting hopes of lowering the budget deficit without curbing growth. On the other hand, Germany posted high growth figures again: after record growth in Q2 of 2.3% compared to the previous quarter, GDP rose again in Q3 by 0.7%. GDP for the eurozone as a whole increased by 0.4% – the fifth successive quarter of growth.


The ECB’s exit seems to be getting nearer. This week liquidity was drained from the money market again via the tender operations, and money market rates continue to be under pressure. No one can really imagine the ECB abandoning its expansionary policy in the current situation.

However, its latest monthly bulletin, in which it assesses the role of monetary policy in asset price bubbles and concludes that its stability-oriented monetary policy contains elements of the leaning against the wind strategy, could raise doubts on this. Given the widely divergent monetary policies on both sides of the Atlantic, the single currency should remain well supported, as soon as the crisis symptoms in the eurozone become less acute.


Uwe Angenendt +49 69 718-3648




Economics Department

+49 69 718-3642

[email protected]

Foreign Exchange Trading

[email protected]

Matthias Klein

+49 69 718-2175

Matthias Grabbe / Klaus Näfken

+49 69 718-2146 / -2683


This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.


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