Fiscal consolidation = end of Euro?

Fiscal consolidation = end of Euro?

Fiscal consolidation is the flavour of the month both in Europe and the UK at the moment, but yesterday George Soros, billionaire investor, suggested that the deficit reducing measures pursued by Germany may end up causing the demise of the Euro. Mr Soros said that Germany should set out a growth led strategy to help member states regain competitiveness, not push them into a deflation cycle and impose economic stagnation. By raising taxes and cutting spending in an economy already short of domestic demand, the Germans are restricting other Eurozone countries ability to partly export their way out of trouble, and thus eventually having to pull out of the Euro. The comments by Mr Soros come after economist Paul Krugman warned the Germans that any fiscal consolidation before full economic recovery has taken hold would be counterproductive, and that now is not the time to be worry about deficits. Given the German stance on monetary and fiscal policy, Mr Krugman’s comments will have gone down like a lead balloon, but given the prominence his views are received in the US, it shows the beginnings of potential policy differences between the US and Europe. The Euro has traded down against both Sterling and the Dollar as new PMI data scaled back investors optimism of the economic recovery in the Eurozone.

The Federal Reserve held rates again last night and suggested the American recovery is proceeding at a ‘moderate pace’. In a slight change in tone the Fed acknowledged the Eurozone problems are acting as a headwind for the recovery and also pointed to continuing high unemployment and a depressed housing sector as key issues constraining growth. The key phrases ‘exceptionally low’ and ‘extended period’ were once again used to describe policy going forward. The Dollar has lost some ground against Sterling since the announcement as the market digests the first implicit acknowledgement by the Fed that Europe’s fiscal problems are affecting the US economy. The key level in cable is now 1.50, rumours of option interest means it is likely to be heavily defended and we may test around this level throughout today.

Sterling rose sharply overnight, hitting a 6 week high against the dollar, as BoE minutes showed that MPC member Andrew Sentance voted for a 25bps hike in the last meeting. The minutes revealed that the committee voted 7-1 to keep the bank rate unchanged at .5%. In the wake of the UK’s austerity budget, it seems likely that the majority of the MPC will steer away for a calling of policy tightening, at least until further assessments of the impact of the budget has been made. Many analysts said the austerity plans would help the UK to avoid ratings downgrades suffered by some euro zone countries, whereas other analysts are concerned that tightening the country’s purse strings may choke economic growth. The debate as to whether the budget will knock the economy back into recession at the expense of funding the deficit may continue to rage in the UK for some time.

Report by Alistair Cotton

The contents of this report are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. Currencies Direct cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.