This week's thought-provokers for investors
The European Central Bank cut interest rates by 25 basis points to 1% on Thursday, meeting market expectations. Mario Draghi, the ECB president, announced that the ECB will off er banks liquidity in longer-term (i.e. 36 month) fi nancing operations and that the eligibility of collateral will be loosened by accepting bank loans and reducing the rating of asset- backed securities the central bank accepts. Further, bank reserve requirements will be cut from 2% to 1%. Mr. Draghi made it clear that he will continue to strictly adhere to the EU's founding treaties by sticking to the Bundesbank tradition of not fi nancing governments. The measures were announced just before the European Banking Authority published the results of the latest bank stress tests. The tests revealed that EU banks must raise EUR114.7 billion in fresh capital.
The ECB measures are focussed on avoiding a credit crunch by supporting European banks. But they will do nothing to change the economic fundamentals. It will prove diffi cult for the banks to raise the capital needed according to the stress test if market participants lose further confidence.
S&P warned the eurozone members about a possible mass downgrade on Monday. The top-rated countries like Germany, France, Austria, Finland, the Netherlands and Luxembourg are facing the threat of a possible downgrade after S&P put them on creditwatch negative. The review will be fi nished as soon as possible after this week's EU summit comes to an end. S&P is concerned about the fi nancial impact of the problems aff ecting the European economic and monetary union. It considers the only modest progress of policymakers in dealing with the crisis to be a sign of structural weakness in the decision-making process of the eurozone and the European Union.
Yet again an announcement and potential subsequent reaction by the rating agencies is causing major concern. The reaction of S&P just before the EU summit increases pressure on EU leaders to deliver a credible solution to rebuild investor confi dence. The move also comes ahead of a busy quarter in terms of issuance of government bonds and bank debt at the beginning of 2012. Italy alone is estimated to raise EUR350bn next year.
German industrial production increased by 0.8% in October from the previous month. This was ahead of market expectations of 0.3%, but not enough to off set a sharp 2.8% fall in September. In Italy industrial production declined by 0.9% in October.
The data add evidence of an upcoming economic downturn in the eurozone. Future austerity measures will further accentuate this trend.
Italian government bond yields plunged below 7% after the new government announced numerous austerity measures. All in all, the cabinet approved austerity measures totalling EUR30bn. They include the reintroduction of a local housing tax, a VAT hike and measures to tackle tax evasion. Furthermore, the pension system will be changed radically. The pension reform alone is expected to generate savings of 0.5% of GDP by 2014.
The measures are just the tip of the iceberg and will weigh on Italy's growth. The path to restore competitiveness and stabilise public fi nances will be long. Italy will not be able to address it without help.
The US jobless rate declined from 9.4% in December 2010 to 8.6% in November. Non-farm payroll employment increased by only 120,000, meeting expectations. The strongest confi dence was apparent in retailers' numbers, which showed an increase of 50,000 jobs ahead of the holiday shopping season.
The US continues to surprise with positive economic data. However, this will not be suffi cient to avoid an economic contagion if the situation in Europe spins out of control.
The latest US ISM non-manufacturing survey signalled the slowest pace of expansion for the service industry since January 2010. The ISM non-manufacturing index fell to 52.0 in November, disappointing expectations of a level of 53.9. The employment and supplier deliveries indices declined, but these declines were off set by the rise in the business activity and new orders indices. All indices except the employment index remain above the boom/bust level of 50.
Contrary to the ISM non-manufacturing index, the ISM manufacturing index has proven extremely resilient though it is heavily exposed to Europe. This shows how the once synchronous economic cycles are getting out of sync.
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