The EUR has recovered through Q1 helped by the ratification of the second Greek bailout and by the ECB’s addition of liquidity via the two 3 year LTROs, which has reduced the stress on the banking system and brought down sovereign yields in the periphery. All of this has reduced the perceived tail risk associated with the euro area debt crisis and reduced talk of euro break-up. Additional liquidity has, however, helped put downward pressure on yields in the euro core and in the swap market, and has led to a modest move in yield spreads against the euro. In the longer run this should not be persistent, as the increased liquidity should if anything increase the chances of ECB tightening further out, but is limiting the EUR upside in the short term.
In the euro area, the political leaders’ handling of the debt crisis is likely to attract attention, with euro group and ECOFIN meetings in Copenhagen at the end of the week. Central themes are set to include whether the combined firewalls (EFSF and ESM) will be increased above the current EUR500bn. The self-imposed deadline for this decision is March. Note, however, that the decision has been postponed before. Another theme will be who should succeed Luxembourg’s Jean-Claude Juncker as President of the euro group when his term ends. Several names from both the core and the periphery have been discussed but there does not seem to be any consensus.
Following the release of the disappointing PMI figures this week, we will follow ifo Figures closely. Ifo expectations have continued to improve but the decline in German manufacturing PMI and fall in Chinese PMIs suggest we should see a fall in the March figures. Danske expect the decrease to be more pronounced in the current situation component and expect only a minor fall in expectations. Danske do not expect this to be the beginning of downward trend but rather a one-off. Nevertheless, the recent deterioration puts downside risk on our euro area GDP forecast of 0.3% in 2012.
Euro area inflation data for March is due to be released in the coming week. Danske expect a substantial fall to 2.3% in March, from 2.7% in February, as base effects kick in. Euro area M3 growth data could also attract attention. It seems likely the LTROs have halted the decreasing trend in the growth rate and that we could see a rebound. In addition, German CPI and unemployment data are likely to attract attention. ECB President Mario Draghi is due to speak in Berlin on Monday. Recently, speculation on whether the covered bond purchase programme will be stopped prematurely has circulated in the market. The effect of LTRO has been impressive, something Mr Draghi underlined at the last ECB-meeting. Exit strategy is already a theme, so it will be interesting to hear whether Draghi elaborates on this on Monday.
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