July Round Up

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The month of July was not at all kind to the euro. From start to finish it fell by 3% against the pound and was the month's worst-performing major currency. As usual the euro was shadowed by its alter-ego, the Swiss franc. That poor overall result does, however, conceal a late rush by the euro. In the last week of the month and at the very beginning of August it raised its game, recovering two of the five cents it had at one point been in danger of losing.

Investors' earlier aversion to the euro had been driven by a sense that EU national leaders and the European Central Bank had no collective plan to deal with Spain's financial difficulties. Even the bailout for Spanish banks, agreed in outline a month earlier, had yet to be finalised. Another problem for Spain is its regional governments, some of which are thought to be in need of financial support from Madrid. Taking those factors together with high unemployment and negative growth, investors shunned Spanish debt, forcing the government to pay steadily more for its borrowings.

Then, towards the end of July, the game changed. Mario Draghi, the ECB president, gave a speech to a global investment conference in London. In it, he said he would do "whatever it takes to preserve the euro." It was fighting talk and it sent the euro higher. The assumption was that whatever it took to preserve the euro would amount to more than words. Expectations were high for the ECB council meeting on 2 August.

For some, those expectations were met when Mario Draghi set out a comprehensive plan that would coordinate the efforts of national governments, EU stability funds and the ECB itself. For others, it still amounted to yet more words, more jam tomorrow, the kicking of the can a little further down the road. A particular concern was that any buying of sovereign bonds by the ECB would be "focused on the shorter part of the yield curve". In other words, it would not buy 10- or 30-year bonds, it would support the market for, let's guess, 6- to 24-month treasury bills (he was not specific). When that penny dropped, Spanish and Italian borrowing costs jumped 30 basis points higher, taking the yield on Spanish 10-year bonds back into the danger zone above 7%.

Broadly, analysts liked what they heard from the ECB and investors disliked the lack of action today. The debate will surely rumble on through the European holiday month but disaster is no longer imminent.

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