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European debt crisis live: Reports of Greek debt deal

Greek government and bondholders reportedly reach deal
IMF slashes global growth forecast
UK likely to be best-performing major EU economy in 2012
Today’s agenda
• Blogging now: Julia Kollewe

11.40am: The FTSE nudged into positive territory when rumours of a deal in Greece first surfaced but has slipped back a bit again. It’s now up just 1.6 points at 5742. Germany’s Dax and France’s CAC are still down, by 0.4% and 0.5% respectively.

11.18am: The Greek government and private creditors have reached an initial agreement for a bond swap, the Athens-based newspaper Proto Thema reported on its website.

Both sides have agreed that new bonds to replace existing Greek debt will
be of a 30-year maturity and carry a coupon, or interest payment, between 3.1% and 4.75%, the paper said.

It added the Institute of International Finance’s managing director Charles Dallara is expected to announce the deal at a news conference in Athens today.

10.38am: The European Union has made its “fiscal compact” treaty tougher by adding fines to a draft proposal.

Under the revised proposal, the EU’s highest court will be able to fine a country that does not adopt a balanced budget rule in its constitution – with a penalty equivalent to up to 0.1% of GDP. The money would go to boost the resources of the European Stability Mechanism – the eurozone’s permanent bailout fund – which is expected to go live in July.

Britain won’t have to sign the treaty, but EU countries that do will have to introduce a rule, within one year, stipulating that their budget deficit cannot exceed 0.5% of GDP in structural terms. The new draft treaty is likely to be discussed by EU finance ministers next week and by EU leaders on 30 January.

10.15am: Which banks made use of the European Central Bank’s offer of unlimited three-year loans? Why are banks parking record amounts of cash at the ECB’s deposit facility, which pays a near-zero interest rate? Aren’t the ECB’s liquidity injections inflationary?

Economists at ING have sought to answer these and other questions under the heading “Alice in ECB land – Q&A on the central bank’s crisis policy“.

1. Have the ECB’s liquidity injections helped to ease market tensions?

Yes, strains in the eurozone interbank market have eased, but the effect has not been dramatic. Indeed, while the spread between 6m Euribor and overnight rates has narrowed in recent weeks, it remains at elevated levels. Dollar funding strains have eased more significantly. The extra premium that eurozone banks have to pay to swap euros into dollars has fallen to 77 basis points, the lowest since August of last year.

2. Which banks made use of the ECB’s offer of unlimited three-year loans?
The available data clearly indicate that the take-up of three-year loans was strongly concentrated in peripheral banking systems. The second three-year LTRO [long-term refinancing operation] is scheduled for 29 February. While a broader range of collateral will be eligible as collateral, we would be surprised if demand were to exceed the €489bn take-up seen in the first offer.

3. Why are banks parking record amounts of cash at the ECB’s overnight deposit facility – which pays a near-zero interest rate?
The often-heard claim that eurozone banks are incurring a loss, because they borrow at 1% from the ECB and get paid only 0.25% at the deposit facility, is overwhelmingly incorrect. The banks that are borrowing from the ECB typically are not the same banks that are depositing money at the ECB’s overnight deposit facility. Banks in Finland, for example, borrowed €2bn from the ECB in December, but deposited €50bn at the overnight facility, according to national central bank data. In addition, they held €18bn at the ECB in one-week fixed-term deposits.

4. Are three-year ECB loans used to buy sovereign debt?
We feel some of the money from three-year loans is being used to fund purchases of sovereign debt, judging by the successful Spanish and Italian bond auctions and the recent rally in (shorter-dated) Spanish and Italian bonds. Some of it is also surely being used to compensate for fleeing deposits. But we think banks will use most of it to meet their refinancing needs. In fact, the ECB’s January 2012 Monthly Bulletin confirms that medium-term refinancing needs may have had a significant influence on the bidding behaviour of banks in the three-year LTRO.

We suspect that large, listed European banks will remain very reluctant to buy peripheral debt, given concerns about mark-to-market risks and possible reputation risks. Against this backdrop, we are sceptical as to whether the recent rally in shorter-dated Spanish and Italian sovereign bonds will sustain itself after the second three-year LTRO in February. The fact that bond market liquidity has generally remained low, as signalled by the still-high bid-ask spreads, reinforces our caution.

5. Aren’t the ECB’s liquidity injections inflationary?
No, they are aimed at preventing deflation. The ECB’s generous liquidity provision is predominantly aimed at averting liquidity shortages in the financial system. Such shortages could lead to a full-blown ‘credit
crunch’, which would further darken the eurozone’s economic outlook and might raise the spectre of deflation.
Once the extra liquidity created by the ECB starts to translate into strong credit generation to the non-financial private sector, inflationary risks would indeed rise. But given that eurozone banks are under pressure to increase their capital buffers, this is unlikely to occur in the foreseeable future.

6. Is the ECB’s sovereign bond-buying effective?
The ECB has bought €220bn in peripheral government bonds since the launch of its Securities Markets Programme (SMP) in May 2010. This is roughly equivalent to 2.3% of eurozone GDP. Nevertheless, ten-year yields on peripheral sovereign bonds – except for those of Spain – are higher now than when the ECB started its bond purchases. This suggests that the ECB’s purchases have not been very effective. The ECB would probably disagree, arguing that yields would have been even higher if not for its intervention. A fair point, but we would still not be convinced. Why? The ECB has always argued that its interventions are aimed at “restoring the monetary policy transmission mechanism” – the process through which interest rate decisions are transmitted to the real economy. However, bank lending rates (continue to) vary strongly across the eurozone. From that perspective, the ECB’s bond buying programme can hardly be called a success.

7. What further action is the ECB likely to take in 2012?

The signs are that eurozone inflation, boosted last year by higher oil and energy prices, is waning. The ECB will therefore have more leeway to ease policy this year. Consequently, the current ‘wait-and-see’ stance notwithstanding, we still see a possibility of (at least) one further 25bp cut in the main refinancing rate.
In addition to cutting short-term interest rates, we expect the ECB to (again) step up its bond buying, on the back of renewed unrest in European bond markets. A failure on the part of political leaders to successfully engineer a significant increase in the firepower of the rescue fund faculties (EFSF/ESM) – in the wake of the latest rating downgrades – might well prompt the ECB into more forceful action.
In extreme circumstances, we could even see the ECB signalling that it will cap bond yields.

9.54am: Here is some reaction to the strong UK retail sales numbers for December (although November was revised down slightly). James Knightley, UK economist at ING, said:

While today’s number is relatively encouraging, the outlook for the sector remains poor. Unemployment is rising, employment intention surveys are deteriorating, wages are still failing to keep pace with the cost of living and consumer confidence continues to fall. Consequently, we expect consumer spending to make a negative contribution to GDP growth in the first quarter, which will intensify pressure on the Bank of England to step up its stimulus efforts.

And Chris Williamson, chief economist at Markit, said:

The indications are that high street and internet retail sales rose in December only because retailers lured hard-pressed consumers with discounts at the expense of profit margins. This was particularly noticeable for clothing and footwear.

The big question therefore is how big the New Year hangover will be, as households retrench from the Christmas mini-spending spree. Households are still facing high inflation, which continues to run at more than double average employee pay growth, and is squeezing incomes in real terms. Pay is also rising at an annual rate of increase of just 1.9%. With inflation due to ease markedly in 2012, this may alleviate some of this income squeeze, but with unemployment hitting a new 17-year high and due to rise further in coming months, any boost to spending from lower inflation this year may be offset by a reluctance to spend due to rising joblessness and concerns about job security.

The sales figures therefore do little to change our expectations that next week’s gross domestic product data will show the economy flat-lined in the final quarter of last year, and that the Bank of England is likely to announce further stimulus in the form of additional asset purchases of £50-75 billion in February to help avert a slide back into recession. The Monetary Policy Committee may choose to postpone any further quantitative easing, however, if the business surveys show a further pick up in January, building on a tentative improvement seen in December.

9.39am: The Hungarian prime minister Viktor Orban has backed down on one of the key points of conflict with the EU that threatened to block a deal on aid with the EU and IMF. He said Hungary will ditch the planned merger of its central bank and financial markets regulator.

The forint climbed 1% on the news and prices of Hungarian bonds surged.

9.32am: Retail sales in Britain bounced back in December as shops resorted to heavy promotions – some slashing prices by up to 50% – to lure shoppers in the run-up to Christmas. Sales volumes rose 0.6% from November, taking the three-month growth rate to 1.1%.

The figures show shoppers splashed out mainly on clothes and food, and indicate that the economy as a whole may have avoided contraction in the final three months of the year, although strong sales are unlikely to persist into this year.

John Lewis is clearly an exception – it enjoyed a 14.4% jump in sales at its department stores last week on a year ago.

The retailer said:

The last week of clearance (sale) peaked with a fantastic sales performance of plus 14.4% on last year. We continued to make great headway against soft sales last year after the VAT increase and 20 branches were up on last year.

9.05am: Ben Broadbent, who sits on the Bank of England’s monetary policy committee, said the committee is not pre-committed to more quantitative easing in February and it is irrelevant how quickly the Bank buys government bonds, known as gilts.

In an interview with Market News International, Broadbent indicated that the Bank is not trying to stagger its gilt purchases, and would have announced more QE if it had thought it necessary. He rejected the idea that a “speed limit” on QE – the assumption that if the Bank stepped up the pace of gilt purchases, it would create liquidity problems – has had any influence on his policy decisions. He believes the MPC is free to announce as much QE as needed to meet its inflation target without being distracted by concerns over gilt market supply.

Broadbent is scornful of the view the MPC has been simply biding its time until it completes the current round of asset purchases before launching the next round of QE in February.

If we had wanted to vote for more QE, as measured by the stock, and that is how we tend to understand its effects, then I would have done that in October and, indeed, the committee could have done it again in November or December.

[In October] I voted for £75[bn of QE] because I thought £75 was right.

If someone had said we can do it in two weeks, or someone had said we can do it in six months, it wouldn’t have had any bearing on what I voted for.

Broadbent, who joined the MPC last year having worked as an economist at Goldman Sachs, also said: “It is clear that the [UK] economy is broadly flat and therefore growing less than its potential rate.” But he also sees some positive trends emerging which make a pick-up in the economy in the second half a “reasonable” forecast. He added that the European Central Bank’s recent actions appear to have lowered downside risks for the UK economy.

The Bank is widely expected to announce more QE next month, after pumping £75bn into the economy in October.

In February the MPC will have a new set of growth and inflation forecasts. The previous predictions in November showed inflation heading back below the Bank’s 2% target, ending up at some 1.3% in two years’ time.

The sizeable projected inflation undershoot, and the belief that the February Inflation Report projections will be similar, have reinforced the view more QE in February is inevitable. Broadbent says the MPC is not in the business of fine-tuning policy and the balance of risks justified the October decision.

We are dealing in coarse, rather than fine-tuning, because it is probably, at the margin, harder to say what the impact of any policy change in the instrument [QE] is, because we are less familiar with the instrument.

8.43am: European stock markets opened higher this morning but are now trading slightly lower after four days of gains, with the FTSE 100 index in London down 11 points at 5730, a 0.2% fall.

The Dax in Frankfurt has lost 21 points, or 0.3% while the CAC in Paris slipped 15 points, or 0.45%.

8.34am: After all the retail doom and gloom, Ikea has provided some cheer, with profits up 10% last year despite the eurozone crisis. The Swedish furniture retailer enjoyed a net profit of €2.97bn (£2.5bn) in the year to the end of August, while revenues grew 6.9% to €25.17bn.

The chief executive, Mikael Ohlsson, said: “Today, when nations and people face economic challenges, Ikea is more relevant than ever.”

Ikea is casting an eye over India, where recent legislation will open up the country to foreign companies and allow large single-brand retailers to own 100% of their stores there.

8.31am: Here is today’s agenda.

• UK retail sales at 9.30am
• Bank of England trends in lending at 9.30am
• Greece locked in crunch talks with bondholders
• Troika officials due to meet Greek finance minister Evangelos Venizelos, then prime minister Lucas Papademos at 4pm
• Nicolas Sarkozy meeting Mario Monti

All times are GMT

8.04am: The troika of EU, IMF and ECB officials return to Athens today to discuss the terms of a second bailout, as talks between the Greek government and private creditors rumble on. The troika got a rough ride from the Irish press pack yesterday, even though they gave Ireland a favourable progress report.

Greece is racing to clinch a deal with bondholders on a bond swap, to secure its next tranche of bailout money before €14.5bn of bonds fall due in March. After a breakdown in talks last week over the coupon, or interest payment offered on new bonds, the two sides appeared to be inching closer to a deal last night.

“The atmosphere was good, progress was made and we will continue tomorrow afternoon,” Greek finance minister Evangelos Venizelos said after Thursday’s round of talks in Athens with Charles Dallara, head of the Institute of International Finance representing bondholders.

The IIF issued a statement echoing the minister’s comments, and described the discussions as “productive.”

According to Reuters, who quoted Venizelos, a large chunk of the bond swap must be agreed by noon today and formalised before Monday’s meeting of eurozone finance ministers.

“Now is the crucial moment in the final battle for the debt swap and the crucial moment in the final and definitive battle for the new bailout,” Venizelos told parliament on Thursday. “Now, now! Now is the time to negotiate for the sake of the country.”

7.43am: David Cameron and George Osborne are likely to seize on the fact that the UK is forecast to outperform all other major economies in Europe with growth of 0.6%, rebounding to 2% next year. Germany, by contrast, is set to grow by just 0.3% and France by 0.2% this year.

China and the US will remain the main growth engines, with the US seen growing at 1.8%, unchanged from the IMF’s previous estimate, while China’s is now forecast to grow by 8.2%, down from 9%.

7.20am: Good morning and welcome back to our live coverage of the world economy and eurozone debt crisis.

The International Monetary Fund’s latest forecasts have been leaked, as usual, ahead of official publication next week.

The IMF has slashed its global growth forecast for this year, blaming the eurozone debt crisis. It reckons the world economy will grow by 3.3% rather than 4% as predicted previously. Italy’s economy is forecast to shrink by 2.2% and Spain’s by 1.7% as tough austerity measures and weak bank lending plunge the countries into at least two years of recession.

“The global recovery is threatened by the growing tensions in the euro area,” the Fund said, according to a leaked draft of its World Economic Outlook.

“The most immediate political challenge is to re-establish confidence and put an end to the euro area crisis, supporting growth,” said the draft, obtained by the Italian news agency Ansa.

The eurozone as a whole will shrink by 0.5% this year, compared with the IMF’s last forecast of 1.1% growth in September.

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