The German way…

French president delivered on his Friday’s promise to communicate with the markets after yesterday’s meeting with German chancellor and… basically backed all German proposals. The key statements from yesterday include:

• -New treaty that will include much tighter fiscal integration and might be voluntary for non-euro EU members
  -Fiscal criteria written in national constitutions and automatic procedures for dealing with countries that breach them
  -Euro bonds are rejected and the ECB is independent

This is a good change for numerous reasons. Germany realized that only restoring fiscal credibility will solve the crisis and convinced France there are no shortcuts out of the crisis. However, there are still hurdles to be faced. Those include convincing other members of the euro zone and setting criteria that will have a chance to work. Thus the German way – while it might be the only way out – will be long and rough.

…no sweeteners…

A reaction on the markets were moderate at most, partly because there were no sweeteners offered by Germany. Some on the market hoped the Germany will offer some flexibility towards unorthodox solutions as a prize for accepting tighter integration but those “quick fixes” were decisively rejected. Since markets were rising for few days on hopes, that was a good profit-taking opportunity.

…and the S&P

Market sentiment was further undermined by the S&P that said in the evening that ratings of virtually all euro zone countries might be cut – some by one notch (including Germany) and some by as many as two notches (including France). Investors are aware that the agency is capable of doing that (after lowering the US rating) and that means the EU summit will be even more important.

The EURUSD retreated yesterday in the evening and is now testing a lower limit of the upward (corrective) channel. It is still possible that moods improve towards the end of the week and the euro will gain, especially as the correction has been short and very moderate thus far. Should the ECB cut rates (removing the drag from the euro) and should other countries be as  affable as France, the pair may regain grip and move towards the upper limit of the correction (currently ca. 1,36). Breaking the lower limit would mean at least a retest of 1,3210 and possibly even a return to a downtrend but we think a strong impulse would be needed (at least at the moment) for this to happen (for instance a cut to the French rating).

Przemysław Kwiecień PhD, Chief Economist

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