The markets are disappointed again. The reasons for this are Draghi’s refusal to turn the ECB into the lender of last resort, news that the ESM will not be given a banking licence and that the UK will not participate in EU treaty changes meaning that the EU leaders meeting has failed to produce a unanimous accord.  However, none of these events were ever on the cards for this week. 

The ECB’s announcement yesterday regarding liquidity provision was very aggressive.  Liquidity provision has been the ECB’s main tool to tackle  log jam in the interbank system since the global financial crisis and it is continuing to show that it is hugely committed to keeping the wheels of the banking system well oiled within the confines of the law. 

Since peripheral bond yields are trading off their highs, the likelihood that the law would be changed this week to permit the ECB to move gung ho into the area of government financing was very small. In any case there remain significant worries about how such an impact would impact the credibility of the EMU and the EUR going forward. 

Draghi made clear that the two main legs of EMU are fiscal competitiveness and rules on debt levels and Eurozone government did move forward yesterday in agreeing that there would be Treaty changes which would commit them to work towards a fiscal compact.  That the UK has chosen to further isolate itself is not a surprise. 

Since closer fiscal ties for the Eurozone is broadly considered to be part of the solution for the Sovereign Debt crisis progress has been made.  That said there are still huge problems to be overcome.  Next year the market will have to digest a large amount of debt issuance which will be a significant test of investor confidence in EMU. 

This week’s summit has done enough to keep EMU alive for now and to stop the EUR plunging, but the crisis rumbles on and a continuation of nervous range trading looks to be the most likely outlook for EUR/USD near-term.  Nov low in the EUR/USD1.3210 area.  
 

source: Rabobank