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Prospects daily: Euro Zone reaches deal on Greece; U.S. GDP growth revised down for Q4

Global Macroeconomics Team's picture

Important developments today:

1. Euro Zone reaches deal over Greek aid plan

2. U.S. GDP growth for Q4 revised down to 5.6%

3. Japanese deflationary pressures strengthen

 

Euro-zone reaches deal over Greek aid plan. Leaders of the 16-nation Euro Area on Thursday night agreed on a last-ditch package for deficit-strapped Greece. European leaders endorsed a Franco-German proposal for a joint contingency plan with the International Monetary Fund, complemented by bilateral loans from fellow euro-member countries at market interest rates.

Under the accord brokered by German Chancellor Angela Merkel and French President Nicolas Sarkozy, Greece would—in the event of “very serious difficulties”—receive non-subsidized loans from each euro-member based on its stake in the European Central Bank, as well as “substantial International Monetary Fund financing” [italics added]. A statement said “the objective of this mechanism will not be to provide financing at average euro-area interest rates, but to set incentives to return to market financing as soon as possible.” However, the size of the loan package and levels of interest rates were not immediately available, and the EU didn’t specify what would force it to get involved.

The agreement by European leaders received a positive reaction in financial markets, with the euro rebounding from a 10-month low against the greenback and Greek bonds and stocks surged. The euro rallied 0.7% to $1.3371 after hitting a 10-month low $1.3270 yesterday. Greek stocks posted their biggest gain in nearly two months, while yields on 2-year Greek bonds headed for their biggest weekly decline since March 5th.  [See “Focus” below: Jamus Jerome Lim, DECPG].

 

U.S. GDP marked down modestly for fourth quarter 2009. Final readings for GDP growth in the fourth quarter of 2009, on the whole, were optimistic, with a modest downgrade to growth performance, but--with release of quite favorable corporate profit figures for the quarter--offering an improved view for developments in labor markets and the broader economy in early 2010.

GDP expanded by a revised 5.6% (saar) in the quarter contrasted with 5.9% in second readings last month. Factors accounting for the mark down were (i) less vigor in business fixed investment (growth of 5% versus 6.2%, earlier), (ii) somewhat slower decline in inventories, now contributing 3.8 points of growth (vs. 3.9 points, earlier), and (iii) consumer spending advancing at a 1.6% pace (vs. 1.7%, earlier) [see ].

On the first report of NIA-based estimates of corporate profits, Commerce stated that these jumped by $108.7 billion from the third quarter to $1.47 trillion, a gain of 8.1% (saar).Profits gained 31% from the final quarter of 2008—the biggest year-on-year increase in 25 years—again favorable in a forward-looking perspective.
 

U.S. consumer sentiment remains flat in March. Consumer sentiment measured by the University of Michigan/Reuters remained unchanged at 73.6 for March, slightly higher than the median market estimate. As the economic recovery continues to gain traction, and the pace of job losses decreases, consumers are likely to make further gains in household spending, leading to broader improvement in the recovery.
 

Japanese deflation pressures still virulent. Japan’s core consumer price index, which excludes the more-volatile food and energy categories, fell for a 12th consecutive month in February, off 1.1% (y/y) after dropping 1.2% (y/y) in the preceding two months. Nationwide headline CPI declined 1.1% (y/y) over February, following sharper falloffs averaging 2% (y/y) over the last six months of 2009. Though the pace of price decline in the headline and core price indices appears to be moderating gradually, the Japanese economy also appears to have a long way to go before the deflationary cycle completes. This is grounded in the fact that consumer spending (at least as measured by retail sales) continues to falter, despite a decline in the unemployment rate from near-record highs to 4.9% most recently.

 

Among emerging markets:

In Latin America and the Caribbean, Uruguay’s economy expanded 4.5% year-on-year in the fourth quarter of 2009, the fastest pace of growth in a year, as agricultural output and energy supply increased sharply. For the year as a whole the economy expanded 2.9%.
 

In Central and Eastern Europe and the CIS, Russia cut its main interest rate by 25 basis points to a record low 8.25%, as economic recovery appears to be losing momentum and the ruble is on an appreciating path. The CBR also cut the repurchase rate charged on one- and seven-day loans to 7.25% from 7.5%.
 

In Sub-Saharan Africa, Mauritius’ unemployment rate dropped to 6.3% in the fourth quarter of 2009, down substantially from 7.4% in the third quarter, as economic recovery firmed. Industrial production increased 11.6% over the same period (y/y) on strong gains in sugar milling, which accounts for about half of the country’s output. A better-than-expected recovery prompted the Bank of Mauritius to revise its GDP forecast for 2010 up to 4.5% growth from 4.3% previously. The economy expanded 3% in 2009.

 

FOCUS: The EU, IMF and Greece come together. After months of negotiations and a roller-coaster ride for Greek bond spreads, Euro-zone leaders have finally endorsed an agreement on aid for Greece. The deal would have Euro-zone member states lead the rescue effort (taking on a two-thirds burden, with each state contributing proportionately to their ECB capital shares), while the IMF would enter as a junior partner (covering the remaining third). IMF involvement had earlier been called into question, with the ECB vice-president-elect Vitor Constancio making it clear that the Fund would "not have a role in dealing with the Greek problem."

In some ways, the episode had evolved---for good or ill---from a question of resolving Greek sovereign debt troubles into a broader question of the credibility of the euro and the durability of the entire EMU project (echoing the infamous prediction by Milton Friedman that the euro would not survive its first economic crisis). European leaders were therefore keenly aware that an orderly resolution of the Greek crisis was not only about Greek woes, since the outcome would also shape the agenda for any future assistance to EU member nations.

The key distinctive feature of the package is that disbursement would only be activated if Greece faces sufficient difficulty in obtaining financing from global capital markets (see above). As such, it was designed to send a strong signal to quell speculative activity, while sidestepping some potential moral hazard issues. The compromise of having the IMF involved as a junior partner also neatly resolves the concern, held by European leaders, over how such involvement could have shaped perceptions of the Euro-zone, while allowing the Greeks to leverage the expertise of the Fund in fiscal issues.

Spreads on two-year Greek bonds shaved 19 basis points (bps) on the announcement (after falling 80bps since the start of the week), to 4.47%, a two-month low. The benchmark Athens Composite index, which had been rising steadily all week, closed at 2,145, an 8.6% gain since lows on Monday. The news also had positive spillover effects for the euro, which is currently trading at $1.339 per euro.

 

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