Greece: referendum reaction

Greek Prime Minister Alexis Tsipras won a resounding mandate to reject the package of austerity measures on the table in Greece’s referendum yesterday. This is but the latest twist in a road that increasingly seems to be leading towards Greece’s departure from the eurozone.

Greek Prime Minister Alexis Tsipras won a resounding mandate to reject the package of austerity measures on the table in Greece’s referendum yesterday. This is but the latest twist in a road that increasingly seems to be leading towards Greece’s departure from the eurozone. Market reaction this morning has been muted, with stock markets down only 1-3%, and Italian government bond yield spreads versus German government bonds only widening by around 10 basis points. Corporate credit spreads have widened only slightly, and the euro is only modestly weaker against the US dollar. We are surprised that the moves have been so modest and continue to believe that market participants are optimistic in their assessment as to the possibility of a favourable resolution of Greece’s travails.

The banking sector holds the key to developments in the short term. Capital controls have been in effect for a week, Greece has defaulted on IMF loans, and there are reports of ATMs running out of banknotes. Now that the referendum has delivered a clear result against the deal that was offered to Greece by its creditors, time is of the essence if de facto ejection from the euro is to be avoided.

Greek banks continue to function because of the existence of Emergency Liquidity Assistance (ELA) from the ECB. The amount of money extended under the ELA has been lifted a number of times until finally being frozen just after the referendum had been called. There is speculation that the ELA will now be cancelled and the banks effectively locked-out of the eurozone, although this appears unlikely as the ECB does not want to enforce such a political decision. However, a large payment is due from Greece to the ECB on 20 July, and it will be hard to maintain ELA if this payment is missed. Without a new programme it does not appear feasible that this payment on 20 July will be made.

Now that the last Greek programme has expired, a new programme would need to be approved by European parliaments before coming into existence – including the German Bundestag which has been dissolved for its summer break. Greek negotiators have insisted that any deal should include debt relief, but this does not at this time appear likely to pass to a variety of eurozone members’ parliaments.

And so, as things stand today, our base case is that the Greek government will be unable to service its ECB debt on 20 July and the ELA will at that time be cut off, requiring the circulation of a secondary currency and reducing exponentially the prospect that Greece will continue to be a full member of the eurozone. Indeed, even ahead of 20 July, there remains a risk that the banks run out of cash under the ECB umbrella, speeding up the process further.

From a market perspective it is a challenge to understand the prospective channels for contagion. Financial market contagion typically spreads when assets that are understood to be risk-free turn out not to be so (for example, when currency pegs previously understood as invulnerable break, when AAA-rated securities are revealed as worthless, when risk-free government debt becomes risky, when systemically-important banks with involvement across the financial system fail). Greek assets are not widely held across the private sector following the efforts in 2011 by European states to transfer privately-held Greek debt into publicly-held Greek debt. In bailing out private sector bondholders in 2011, the original Greek bail-out largely severed the traditional channels of contagion. Those channels of contagion that persist are political, and sentiment-based. Both are harder to analyse.

Political developments in Greece are important to financial markets principally because they will shape how markets will respond to future political situations elsewhere in the eurozone. The markets are watching the impact of recent development on the forthcoming Spanish general election in November, where Podemos – widely understood as SYRIZA’s counterpart in Spain – currently sits in third place in the opinion polls. The markets have been taught that poor Troika relations heighten the risk of capital controls – and potentially exit – and this lesson could be drawn on for a number of years hence across a variety of eurozone polities.

This lesson ultimately heightens the risk of financial Balkanisation of the eurozone. Of less immediate import will be the impact that the treatment of Greece is having on the likelihood of Britons voting against continued membership of the European Union in the upcoming UK referendum, which is today unknown. The willingness of others to offer bailout funds at future dates may also be impeded.

With regard to sentiment, the question we have continually asked ourselves has been to what extent developments in Greece negatively impact business confidence, consumer confidence and credit conditions elsewhere in the eurozone. We continue to forecast a pick-up in European economic growth and see no evidence that these important measures of sentiment that inform economic behaviour have been dented sufficiently to knock our positive expectations off-track. If we see evidence of this, we will need to tread more carefully still with investment positions.

Toby Nangle , July 2015

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