European Economic Update – 26 January 2015

ECB fires up the printing presses as Greeks vote for change in landmark election

Financial markets threw open their arms last week and provided a warm embrace to the ECB’s belated donning of the funny money hat, with stock markets posting strong gains for the period while the euro fell to an 11 year low against the US dollar.

While markets initially reacted with disappointment to leaked reports of a program that would see the bank purchase 50 billion of bonds per month, soured sentiment soon dissipated when Mario Draghi announced a much larger program with the added potential for it to become open ended.

In detail, the ECB will purchase a total of 60 billion euros worth of bonds on a monthly basis beginning in March. What is not clear at the current time is exactly how much of this will be sovereign debt, how much will be corporate debt and how much will be other types of security such as ABS. In the aftermath of the announcement Bloomberg reported that the ECB is likely to announce the finer details surrounding composition of the purchases at its next meeting in March.

Although it is worth noting that, as it stands, the program currently excludes Greece as the ECB holds too much of the nation’s debt for further purchases to be in keeping with the rules of the newly devised program.

However, from July it will be possible for the bank to include Greek sovereign paper in its purchases so long as the nation makes a number of bond payments which are scheduled to take place between now and June.

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Greek elections and implications for European assets going forward

While many people had quietly anticipated the outcome, 17:00 on Sunday afternoon marked the moment that most European politicians and policy makers have been dreading ever the dying hours of 2014.

This was as voting in a snap Greek national election came to a close and early exit polls began to indicate that the far left SYRIZA party had swept to a landmark victory that now threatens to provide the anti-austerity party with an absolute majority in the Greek parliament.

Although the initial reaction from currency markets was muted at the open on Sunday night it remains unclear just how long the calm will last for.

This is mostly because although the tone of Syriza party politicians has moderated in recent months, as their election to parliament became ever more probable, concerns still exist about the new Greek government’s likely fiscal policies; as well as their pledge to attempt a renegotiation of the nation’s bailout agreement.

The crux of investor concerns is that with a number of European governments refusing to budge on further negotiations over the Greek bailout package and given that the SYRIZA party has swept to power on pledges of radical change; there appears a genuine danger that the troubled Euro member could sleepwalk towards an exit from the monetary bloc.

While an outright exit appears to be a rather low probability threat, in light of statements by the SYRIZA’s leadership indicating a preference for a future inside of the EU, it is still a risk that cannot be completely ignored.

On the flip side, some European policy makers have shown themselves to be open to negotiations with Syriza during recent weeks and with this in mind, it appears possible that continental governments may be able to reach some form of compromise.

After all, it is in the interests of all member governments to do so as a Greek exit could be what marks the beginning of a slow disintegration for the bloc as a whole.

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The takeaway

While a compromise may appear unlikely to some given statements made by Angela Merkel in the run up to the Greek election, it is not entirely outside the realm of possibility.

This would be particularly so if Greece is able to successfully leverage, as it has attempted to do previously, past forms of debt forgiveness that were granted to Germany in the aftermath of World War II during the 1950’s.

However, any eventual deal or compromise is unlikely to be reached in a straight line and for this reason there is scope for volatility to increase across European financial assets during the coming weeks.

European Indices

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FTSE 100 / 10 Minute Intervals

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Dow Jones / 10 Minute Intervals

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