News In Charts: ECB’s QE-Lite Unravels As Greece Votes

Escalating tensions between the new coalition government of Greece and the Troika have rippled across the single currency bloc, eroding much of the boost to sovereign bond prices that followed the ECB’s announcement of something close to, but not quite the same as, QE.

Markets still see GREXIT as a distant prospect. And that is our view too. It is surely to the advantage of the whole region for the Troika to agree some form of debt forgiveness with the Greeks – dressed up in whatever way it sees fit – and sooner rather than later. European policy makers must get their house in order before the full consequences of China’s dramatic slowdown hit home. Developments in Greece over the past week remind us that the Expanded Asset Purchase Programme is far from a panacea. Unless and until policy makers agree a permanent solution to the banking crisis, which must necessarily involve a mechanism for fiscal transfers, then any beneficial effects of the programme risk being swamped by the slightest turn of events.

Last week we argued that the Expanded Asset Purchase Programme (EAPP) would probably be enough to lock in the gains – both in equity prices, and in government bond prices – that had followed Mario Draghi’s ‘whatever it takes speech’ of July 2012. The upside risk, from the position 24 hours after the announcement, was limited in our view. This week we find ourselves in danger of being proved right all too quickly. This is in stark contrast to the experience of the US Federal Reserve, the Bank of England and more recently the Bank of Japan, each of whom were rewarded with more sustained gains in asset prices.

The drop in yields that took place in the immediate aftermath of last week’s ECB announcement was both significant and widespread, with the peripheral economies benefitting most. Between close of business the day before the policy meeting, and close of business the day after, the yield on ten-year Bunds fell by almost one third to just 0.37%, while the yield on ten-year Greek government bonds fell more than 100 basis points. However, at the time of writing, both Greek and Portuguese government bonds have given back all of their gains, while yields on Irish and Spanish government debt have moved almost halfway back to where they were on the eve of the announcement. Only the yield on Bunds continues to fall.

A Greek dilemma

That Syriza would become the largest party in the Greek parliament after the elections held on Sunday 25 January was never really in doubt. The surprise was that the Independent Greeks, a right-wing party, but one that shares Syriza’s outright rejection of the conditions attached by the Troika to the bailout programme, would secure enough votes to enter parliament, and thereby displace the more moderate To Potami party as the preferred coalition partner. As a result, Greece now finds itself in an impossible position. It has a government vehemently opposed to austerity. And yet, if opinion polls are to be believed, it has a populace determined to remain within the EU, and to retain the common currency. We took a view before the elections were held that whatever government emerged, it would ultimately play ball with the Troika. To reject out-of-hand its demands would see Greek banks lose access to ECB funds, making them insolvent overnight. Our logic is now being put to the test.

Refresh Chart Edit Chart

By December of last year, Greek banks held deposits of €168 billion. Press reports suggest that up to €1 billion of deposits have been withdrawn each day this week. If true, that would suggest that Greece is facing a run on its banks more severe than that seen at the height of the crisis. Equity markets have responded, with the value of shares in each of the country’s ‘Big 4’ banks down somewhere between 30% and 50% on their close last week. And the cost of insuring against a default by any one of these banks has more than doubled over the past month. The Greek government probably has a matter of weeks, if not days, before it must show its hand. But what will it do?

Refresh Chart Edit Chart

Refresh Chart Edit Chart

No way out for Greece

Although we might have wavered a little at the height of the crisis, we have always felt it more likely than not that Greece would remain within the single currency bloc. ‘GREXIT’ has never been our central case. In the chart below we show, based on our own calculations, how the market-implied probabilities of default, and separately of GREXIT, have varied since 2010. What is striking is that, up until early 2013, the two moved very closely together. Default was seen to imply an exit from the single currency. Through 2011 and into 2012, both were seen as more or less nailed on. But from early 2013 the implied probability of GREXIT fell sharply, even though a further default continued to be seen as almost inevitable. Now, with the new anti-austerity coalition in place, GREXIT risk has edged up a little. In absolute terms, however, it remains unlikely, with an implied probability of around 15%.

Refresh Chart Edit Chart

This makes sense. Simple debt arithmetic suggests that a further default is almost inevitable. GREXIT, by contrast, would not only be against the wishes of the Greek people, as surveyed, it might also be of little economic benefit. If the Greek populace can be persuaded to accept a new, rapidly depreciating currency as a unit of account, then Greece will have an independent monetary policy once again. Its citizens will, however, continue to have debts that are denominated in euros. How will these be repaid? Alternatively, if the country were to undergo a form of ‘euro-isation’, with long-term contracts specifying payments that are fixed in euros, then Greece will see none of the competitiveness gains that many assume would go hand-in-hand with leaving the single currency bloc. As one commentator put it recently:

‘The euro isn’t a glove that you can take on and off, it’s a Chinese finger trap; once in, it’s tricky to get out’.

QE, let alone QE-lite, was never the solution

In a speech that has attracted a degree of press comment, Bank of England Governor Mark Carney this week put pressure on the Troika to give ground in any forthcoming negotiations with Greece. Of course, Governor Carney is not the first to spot the inherent tensions that exist in a monetary union that takes place with no mechanism in place for enacting fiscal transfers. Almost twenty years ago, when the euro was still a distant dream, his predecessor, the late Eddie George, was adamant that the question of whether to join the euro was a political one, and not an economic one. The difficulty of achieving improvements in competiveness through adjustments in nominal wages alone caused him to:

‘…. foresee potential pressures—in the form of unwelcome migration in search of employment or increased demands for fiscal transfers’.

Speech given at the Royal Institute of International Affairs, 13 March 1996.

In continuing to insist that Greece adheres to the conditions laid out in the bailout programme in full, the Troika is flogging a dead horse. Faced with substantial outright deflation – consumer prices fell by 2.5% in the twelve-months to December – monetary policy in Greece is exceptionally tight. As our final chart shows, the real rate of interest charged by Greek banks on loans to non-financial corporates is now in excess of 6.0% – that is hardly a level likely to encourage much investment, or indeed growth. If the core European countries want loans made to Greece to be repaid, they must raise their own domestic consumption, and allow Greece to grow. That means less austerity, for now at least.

Refresh Chart Edit Chart

Developments this week have brought the Greek debt crisis to a head once again. Ripples are being felt across the periphery. Sovereign bond prices are falling again, outside of Germany, as the beneficial effects of the ECB’s announcement of QE-lite begin to unwind. The Expanded Asset Purchase Programme is far from a panacea. Unless and until policy makers agree a permanent solution to the banking crisis, which must necessarily involve a mechanism for fiscal transfers, then any beneficial effects of the programme risk being swamped by the slightest turn of events. It is our hope, and indeed our expectation, that the Greek government will soon reach an agreement with the Troika that sees at least some reduction in the burden of adjustment forced on that country. According to the preliminary estimate, headline inflation across the single currency bloc fell 0.4 percentage points to -0.6% in the twelve-months to January, with core dropping 0.2 percentage points to 0.5%. If the central scenario set out in our latest quarterly forecast comes to pass, and China responds to mounting evidence that it is in a hard landing by letting its currency fall significantly, then worse is to come. Best that Europe get its house in order.

This research note is provided by Fathom Consulting. All of the charts below and many many more, covering a range of topics and countries on both the macroeconomy and financial markets are available in the Chartbook to Datastream users at www.datastream.com. Alternatively you can access Fathom’s Chartbook at www.fathom-consulting.com/TR.

Receive stories like this to your inbox as they are published. Subscribe here and follow us @Alpha_Now on Twitter. If you are looking to access Thomson Reuters data or analytics, register for a free trial.