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Europe: Has Greece blinked first?

Market sentiment has shifted today as hopes grow that Greece and the Eurogroup will reach a deal to avoid Greece being left without a source of external finance when its bailout expires on 28th February. This has helped stocks to stage a recovery rally and at the time of writing the Eurostoxx index is up 1.5%. EURUSD is also back above 1.13 on the news.

Hopes were raised when news hit the wires on Tuesday that the new Greek Syriza government had put together a moderate 4-point plan to present to the Eurogroup meeting on Wednesday. The European Commission is also expected to propose a 6-month extension to the current bailout, and EU President Juncker will hold a tele-conference with the Greek Prime Minister later this afternoon.

Greece’s 4-point plan: more bark than bite

The new Greek government appears to have scaled back its demands as we lead up to this week’s crucial European meetings. After pledging to boost public sector worker numbers and end austerity in the run up to last month’s elections, the reality of Greece’s weak financial position has led to a scaled back version of its plan, which includes:

  • A cut to Greece’s primary surplus target to 1.5% of GDP from the original 3% of GDP, which could free up some cash to spend on public services.
  • To reduce Greece’s debt burden.
  • 30% of Troika reforms to be scrapped, but Greece will match this by cutting 10% of its most recent reforms.

If Greek politicians can play their cards right then the Eurogroup may actually accept this plan, and Athens may be able to buy itself some much needed time to sort out its financing needs over the coming months, rather than days. We think that this plan looks more realistic as it concentrates on the structural side of Greece’s debt dynamics and not on public spending.  This is important as we think that European finance ministers will be more willing to negotiate on primary surplus targets rather than whether to scrap planned privatisations and boost public sector spending.

If the EU President and Greece’s Tsiparis can agree on a 6-month bailout extension later today that doesn’t mean that Greece is out of the woods. It would still have to get ratification from all of Europe’s leaders; however they may view a deal proposed by the Commission more favourably than one that comes direct from Athens, so we will be watching the outcome of this call closely.

What should we expect from the Eurogroup meeting?

From 4.30 pm on Wednesday Eurozone finance ministers will hold their much anticipated meeting on Greece. They will decide on what to propose to Europe’s leaders who meet the following day. The Eurogroup have given themselves a deadline of Monday 16th Feb to come up with a solution.

We think there are three potential outcomes from tomorrow’s meeting:

1, Eurogroup enforces Greece’s bailout, albeit with some changes: Syriza agrees to this but only if it can push through some of its proposals listed above. This would secure Greek financing in the short term and avoid a potential Grexit and the ensuing market turmoil. This outcome could be favourable for risky assets, however, we doubt that it would go down too well in Athens if the new government comes back still saddled with the old bailout, which could cause problems down the line.

2, Greece secures a bridging loan: this is Greece’s preferred solution, as it would secure Greek financing in the short term, whilst also laying out a plan to negotiate a new bailout without the austerity that is so unpopular across Greece. The Eurogroup has sounded cool on this idea, and we doubt they would agree to any bridging loan unless Greece was on the precipice of bankruptcy, which, for now, it is not.

3, Negotiations break down: this is still a possibility as both sides have political capital to preserve. If this happens then the prospect of Greek default, a run on its banks and an eventual Grexit would come back into focus. But there would still be a chance of a salvage operation as a breakdown in talks on Wednesday would kick the can down the road to Monday, which is the Eurogroup’s deadline to come up with a solution to Greece. This is the least favourable outcome for risky assets, and could encourage a flight to safe havens like the yen and US Treasuries.

 

Overall, the latest development is good news, it suggests that both sides are working hard on these negotiations and are willing to make compromises. This gives risky assets hope that a neat solution can be found during Wednesday’s Eurogroup meeting. However, Greece still has plenty of hoops to jump through, not least trying to butter up Germany, who only yesterday sounded resolute in enforcing Greece to adhere to the terms of its current bailout. Thus, the market could be under estimating the prospect of a volatile outcome from these talks.

It’s also worth noting that these negotiations are focusing on Greece’s short term financing problems and not on the long term issue of how Greece will ever pay back all of its EUR 245 bn bailout funds when it is essentially a bankrupt nation.

Follow us at @FOREXCOM on Wednesday for all of the latest on the Eurogroup meeting.



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