Inflation Figures and Optimism on Greece Settlement Generate Euro Surge

The euro made a 2.5% surge against the dollar yesterday, based on positive Eurozone inflation figures news and hope of a deal to avoid a sovereign default by Greece. The surge comes ahead of this afternoon’s European Central Bank meeting as well a Juncker / Tsipras meeting in Brussels this evening and in the wake of rumours of new Greek debt repayment proposals following an emergency mini-summit hosted by Angela Merkel in Berlin.

At 10.00 GMT on Wednesday the euro was trading at 1.1124 dollars slightly down from Tuesday’s surge peak of 1.1191 dollars, which represented its biggest single session rise in three years.

Yesterday’s better than expected inflations numbers mean a receding risk of Eurozone deflation and its negative effect on profitability. According to the Eurostat news release (2nd June 2015), annual inflation in the euro area is expected to be 0.3% in May, up from 0.0% in April. This represents the first rise in Eurozone consumer prices in 6 months.

One of the primary objectives of the European Central Banks massive 1 trillion euro Quantitative Easing programme launched in March 2015 and initially planned to continue till September 2016, was to push up the rate of inflation to a level just below 2%. One of the consequences of this QE was the immediate fall in the value of the euro at the beginning of March, to just 1.05 dollars, its lowest level in 12 years. This was the result of traders selling euros for dollars because the Federal Reserve had completed its own QE program.

It is likely to be a roller-coaster week for the euro as negotiations and rumours of negotiations ‘progress’ or otherwise in the run-up to Friday’s repayment of 305 million euros to the IMF. Friday is one of a number of upcoming critical days for the euro and Greek debt repayments. In June, 1.6 billion euros is due to be repaid to the IMF and between July and August, 6.7 billion euros to the ECB.

Alexis Tsipras is due to meet Jean-Claude Juncker in Brussels this evening (Wednesday) to present his own 47-page proposals for debt repayment and to hear the ‘final proposal’ from the creditor institutions. ‘There needs to be more effective leadership by the president of the European Commission’ says Barry Eichengreen, economist at the University of California. ‘Mr Juncker needs to press the members of the Eurogroup to compromise and not just pressure the Greek government’.

Whether the basis for discussion is the Greek proposals or those put forward by the creditors is likely to be a source of contention and despite optimism on the markets, a compromise would not appear to be imminent and a longer period of brinkmanship would seem to be inevitable even after Friday’s deadline payment to the IMF passes.

Whilst analysts say that the departure of Greece from the Eurozone is not the most likely option, if no agreement is reached between Greece and the creditor institutions before the end of the month then Greece could default and this could herald a ‘Grexit’. However a sovereign default does not necessarily mean a Grexit; Cyprus technically ‘defaulted’ on its debt in 2013 and remains within the Eurozone. As Huw Pill chief European economist at Goldman Sachs explains, ‘Euro exit is a political decision…the Greek authorities could decide to exit in a unilateral manner but the current Greek government has no mandate to do so: if it announced an intention to leave the Euro area preemptively, in our view the government would likely fall’.

Whilst views diverge on the economic consequences of a Grexit, Barry Eichengreen believes ‘it would be a disaster for Greece. Greek GDP has fallen by 25 per cent since the start of the crisis, but there’s no reason it couldn’t fall by another 25 per cent’. The effects of a Grexit on the Eurozone are unknown, and whilst many predict a doomsday scenario, Florian Schui an economic historian at the University of St Gallen points out, ‘Creditors have had an adequate period of time to prepare for a possible loss, and the bulk of Greece’s debts are in the hands of government institutions anyway. Thus the financial markets might remain calm’.

One option for the Greek government concerning this weeks deadline, is to ‘defer’ payment of Fridays 305 million euros and bundle all four of this months  IMF payments into one lump sum, to be paid at the end of June. Whilst this would be a deviation from common practice, it would be within the rules of the IMF and would not constitute a ‘default’. Such an action would not be without precedent; Zambia was the last country to defer payment back in the mid-1980’s.

Friday will also see the release of U.S. employment market figures for the month of May. Better than expected figures could well boost the value of the dollar to the detriment of the value of the euro.

Graham Waghorn