David Morris
EQUITIES staged a strong rally for most of last week, as European leaders and the European Central Bank (ECB) managed to reach agreement on a second Greek bailout package. At first glance, the proposed measures appeared far bolder than many analysts expected. Previously, policymakers were accused of being too tentative in their response to the European sovereign debt crisis, exacerbating the fear that contagion to the larger Eurozone countries was becoming unavoidable. Yet this time round, the feeling was that the Eurocrats had finally caught up with the markets.

This latest agreement provides an additional €109bn aid programme for Greece, and reduces the interest rate on rescue loans to Greece, Ireland and Portugal to 3.5 per cent, while extending their respective maturities. The European Financial Stability Facility has been made more flexible but hasn’t been beefed up. Private sector bondholders are being asked to take a haircut on their Greek bond holdings (but not on Irish or Portuguese) of around 20 per cent. This is thought to be far smaller than the losses they should realistically be accepting, given Greek 10-years are still around 14.7 per cent. A selective/restricted/transitory Greek default is inevitable, and the ECB has backed down from its previous, strongly held position and will allow defaulted debt to be offered up as collateral.

The main aim was to ring-fence Greece from the rest of Europe. But yesterday, Moody’s warned that this second bailout has increased the risk of downgrades to creditor countries, including Germany and France. This is becoming a worry. The growing burden on Germany’s taxpayers is not only politically problematic, but also economically damaging. Last week saw disappointing economic data from the core of Europe. French and German manufacturing and services PMIs both fell sharply in July from the previous month, and were much lower than expected. Then on Friday, Germany’s Ifo business climate survey showed that business confidence fell sharply.

On top of this, while the second quarter US earnings season has proved to be broadly positive so far, a grimmer picture is emerging from Europe. Bank of America reported last week that of the 49 companies who have reported to date, earnings for 53 per cent have come in below expectations. This doesn’t bode well for the stronger growth necessary for a full European recovery.