Euro slumps as ‘wolf pack’ hits world’s markets in response to Merkel move

Thursday, May 20, 2010
By Paul Martin

Carl Mortished
TimesOnlineUK

The markets delivered a swift and brutal judgment on Berlin early yesterday, hammering the euro and slamming share values after its decision to ban speculators from German markets.

Even as Angela Merkel, the German Chancellor, sought to draw a line in the sand, declaring to the German parliament that the euro was critical to the survival of the EU, the so-called wolf pack of speculators was attacking the single currency in New York, London and Tokyo.

The euro fell to $1.21, a four-year low against the dollar, and stock markets plummeted across Europe, with the London market losing 2.8 per cent of its value. Shares in Paris also tumbled and Frankfurt’s DAX index of leading shares fell sharply.

The euro recovered some ground in the afternoon but only as rumours surfaced that the European Central Bank was preparing to defend the single currency with market purchases.

The announcement by Bafin, Germany’s market regulator, of a ban on “naked short-selling”, a method of betting that a bond price will fall, was greeted with derision by financial market players. Gary Jenkins, head of fixed income research at Evolution Securities, said that it would have no effect in London, where much of the trading takes place.

“[The ban] will put further pressure on the euro,” he said. “Will this encourage investors to buy eurozone bonds? It is very difficult to invest when you have no idea what they will do from one day to the next.”

Short-selling, or borrowing stock and agreeing to sell it at a future date, is a common technique used by investors to bet on falling values. Germany wants to ban a riskier form in which the short-seller has not even borrowed what he sells.

Germany’s lone war on speculators drew a cool reception in Paris, where Christine Lagarde, the Economy Minister, said there was no plan for a French ban on speculators. Michel Barnier, the European Commissioner for internal markets, delivered a rebuke, suggesting that co-ordinated measures would be more effective, while AMF, the French stock market regulator, criticised Germany’s decision for confusing investors.

Germany’s panicky move to quash speculators is being seen by investors as evidence of weakness and disunity in the eurozone. Stephen Jen, of Bluegold hedge fund, said that Brussels was adopting a “barbarians-at-the-gate” view of the market. “I think this view is close to 100 per cent off the mark. If anything … the biggest sellers of European bonds are European pension funds, not US hedge funds,” he said.

The announcement of the ban came as the eurozone task force on economic governance prepared to meet on Friday. Germany is expected to call for new rules to give the European Commission more power to co-ordinate the budgets of member states to avoid the huge public deficits that have brought Greece to the edge of bankruptcy.

President Sarkozy of France was reported to have told Ms Merkel at their last meeting ten days ago that the fate of the euro lay in her agreement to support the rescue. He is understood to have telephoned her this week to emphasise the urgency. French ministers refuse to entertain any public thought of the currency’s collapse.

Behind the scenes, Mr Sarkozy is pressing Ms Merkel to accept France’s long-standing call for an EU “economic government” to match the Central Bank, but it is still not clear how much sovereignty, if any, Paris is prepared to yield in the name of economic harmony. French officials are privately pessimistic over Germany’s readiness to take part in any pooling of economic and financial policy.

A proposal that all EU states should submit their budgets for scrutiny in Brussels provoked a swift rebuke this week from George Osborne, the Lib-Con Chancellor.

A political backlash against the EU is building in Germany. Popular anger at the use of taxpayers’ euros to rescue Greece has been fuelled by press campaigns against Greek self-indulgence and suggestions by German politicians that Greece should sell its Aegean islands to repay its debts.

Berlin’s attack on speculators comes after a build-up of criticism and warnings by Europe’s leaders that sovereign bond markets were being undermined. The European Commission has promised to prepare legislation to regulate credit default swaps (CDS), a form of insurance contract on the risk that a bond issuer might default on repayment.

George Papandreou, the Greek Prime Minister, blamed speculators in the CDS market for undermining the value of Greek bonds. He described the trading as similar to betting that your neighbour’s house might burn down and then setting fire to it.

Fears that the near-insolvency of Greece will start “fires” in other financially challenged eurozone states, such as Spain and Portugal, has infected the government bond markets in the Mediterranean states. As bond prices fall, interest rates soar, raising the cost of borrowing for cash-strapped governments.

Bond analysts were dubious about the effect of the short-selling ban yesterday. Most of the market is outside Germany, mainly in London where no ban is in place. Mr Jenkins said: “The problem has not been one of evil speculators but of investor concern that government finances are so out of control and the amount of money they have to raise is so large that there is a prospect they will be unable to repay.”

The euro’s rapid descent is causing mounting alarm. Some reckon that it will fall below the dollar and others speak of a break-up of the eurozone.

Barclays Capital believes that the euro may have found a floor at $1.20 and the bank’s head of currency resarch dismissed predictions that the eurozone might fall apart. “Politicians will do all they can to make sure it survives,” Paul Robinson, European head of foreign exchange research at the bank, said. A weaker euro was good for the zone’s exporters, he pointed out, but what governments feared was an uncontrolled fall. “What they don’t want is financial instability. If it falls too quickly, it deters investors because a falling euro reduces the value of your investment,” he said.

The bearish outlook is prompting some forecasters to predict that the euro will fall to parity with the dollar. A leading Germany business confidence survey, ZEW, turned sour on Tuesday after a period of optimism. Capital Economics reckons that economic weakness will push the eurozone to dollar parity by the end of the 2011.

In an effort to stamp out the risk of financial infection, eurozone leaders assembled the world’s largest financial bailout, a €750 billion package of loans and financial guarantees, announced last week. Britain, which would be heavily at risk from a eurozone collapse because of its trade links with Europe, took a small share — €8 billion — but the largest is borne by Germany.

Markets initially reacted favourably to the rescue but doubts quickly surfaced and the euro resumed its downward drift.

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