Rumour Mill Goes Mental Before EU Summit

The financial market rumour mill is currently running overdrive in the lead-up to Friday’s EU summit with the “developments” becoming even more strange and unlikely. Tuesday night’s rumour was of a dual bailout fund effort in the Eurozone which was rebuffed out of hand by an unnamed senior German official yesterday morning. Last night’s cracker was that the IMF was likely to extend $600bn in assistance to pay for a new rescue fund. That 2 days ago we heard that the IMF itself may have to raise more money from its contributing governments was by-the-by apparently. The rumour was quashed in a record 11 minutes and the world went back to waiting for Friday’s summit.

The summit has been given an extra dimension by the Standard & Poor’s rating actions seen on Monday night. Last night they went a step further and downgraded the outlook for several European banks including BNP, Barclays, Commerzbank, Rabobank, Credit Agricole, Deutsche Bank, Intesa Sanpaolo, SocGen, Ulster and UniCredit. Asian shares have traded lower on the news however Europe is expected to open positively on the back of hopes that the ECB may ride to the rescue in some form at its meeting today.

We expect the European Central Bank will cut rates by 0.25% at their meeting although there is a risk that they cut by more. The more important measures will be based around helping banks remain funded. We hope that it extends the timeframe of its loans to banks from 13 months to the maximum of 3 years and this should allow banks to become more confident in lending to each other with investors also becoming more satisfied that the banks’ balance sheets are stronger. While these, once again, do not deal with the fundamental core issues that have hamstrung the Eurozone it does further prevent further panic through bank runs and should keep business credit markets away from completely freezing up. Obviously they are unable to launch full-scale intervention on Eurozone sovereign debt yet, Draghi will keep the nuclear option in his pocket until politicians have finally proved themselves to be incapable of solving this problem.

The Bank of England decision is slightly more clear cut and obviously does not include the prospects of a post-decision press conference. We really want to say that the Bank of England will extend quantitative easing but we think that they will wait for February, depending on the outcome of tomorrow’s summit. A vote to extend today would be seen as a real lack of confidence in the European response to the debt situation and as such, a hold is likely.

There has been some good news from the Eurozone this mornin after LCH Clearnet, the main clearer for bond trade in Europe announced that it was cutting the margin requirement on trading of Italian debt. This is a reversal of an earlier increase when Italian yields were going stratospheric and shows that some confidence is returning.

Good luck

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