Following the turbulent river of news which has flowed unrelentingly through the principal European media outlets since Sunday night, today we seem to be swimming in a relative ocean of calm. This is very deceptive. Today the Netherlands is voting and tomorrow the ECB will have a closely watched meeting which may potentially have significant consequences for the EU economy.
If at this stage there seems little doubt about the outcome of the Dutch vote (more worthy of interest will be the level of participation and the size of the ‘no’ majority), we are also unlikely to see anything earth shattering happening over at the ECB. It is unlikely that there will be any change in the Central Bank’s two per cent interest rate policy (or twirp, as some wit at Morgan Stanley has christened it, after the rather better known zero rate (or zirp) policy at the Bank of Japan). All the watching eyes inevitably be focussed on the press conference, and on Trichet’s handling of the inevitable questions (worth a look at the 2:30pm webcast).
So if today we are enjoying a ‘day of reflection’, tomorrow we will undoubtedly see battle rejoined. In particular, it will be ‘D’ – or decision – day for Barroso and the EU Commission.
Assuming the Dutch vote no, the level of the ‘no’ will undoubtedly give an indication of the extent of the French ‘contagion’ element. Really the major short term decision is whether the vote in Luxembourg should go ahead. This is not in the hands of the Commission, but clearly ‘behind the scenes diplomacy’ can become fast and furious. If the Dutch majority is a really big one, then letting Luxembourg go ahead, really risks letting retreat turn into rout. So tomorrow morning will be interesting.
On the euro, it seems you could treat yesterday’s decline as a factoring-in of the coming Dutch no. Today may in fact be quite calm. But this doesn’t mean that the pressure is off. It is most likely now that during the coming months the euro/USD rate will experience what is termed ‘downside risk’ on the euro side. What this means is that good news from the US (on jobs, growth, balance of payments etc) will send the value of the dollar up by more than any bad news will drive it down. Conversly bad news on the euro side will see it slide, whilst good news may only serve to maintain stability. The bad news to watch for: well wrong-footing by politicians in their handling of the constitution process would be the first issue, then the Stability and Growth pact and how it is enforced, then growth and unemplyment in the eurozone, then the evolution of the de Villepin govt in France and the reform process in Germany. As you can see, there are plenty of potential risk elements around.
On the ECB meeting, what people will be looking at is ‘guidance’, what is the ECB thinking and where is policy moving. Yesterday the ten year German bund bond hit a further record interest yield low. This suggests that the markets are expecting a lowering of rates later in the year: if Trichet fails to face up to this reality, and ditto for Barroso, then tant pis pour nous.