EU Leaders Finally Agree on Pandemic Fiscal Package

US markets saw yet another record for the Nasdaq, while the S&P500 closed at its highest level since late February.

For the last few days all eyes have been on the political theatre going on in Brussels as EU leaders strive to cobble together a recovery fund that will somehow create a consensus between the various interests of 27 member states, and its leaders and deliver help to the likes of Spain, Italy and Greece, whose economies have been hit hardest by the coronavirus pandemic.

The latest compromise appears to be in the form of grants of €390bn, down from the initial €500bn, with low interest loans of €360bn, with the total sum of the pandemic recovery fund set to remain at €750bn. The leaders also agreed as a €1trn budget for the period of the next 7 years.

The Netherlands, led by PM Mark Rutte had insisted on certain changes being made, including a much lower grants figure, however it appears a compromise has been found in the form of a larger rebate. This would be bigger than the one they receive now under current EU budget rules.

These larger rebates would also apply to the other hold-outs including Austria, Denmark and Sweden. The Dutch PM also secured an emergency brake that would allow any country that was not satisfied with attempts by other countries to honour reform promises to call a halt to any monies being allocated to these countries. This brake, however would be time limited to approximately three months, however there were no details as to how any sanction would be applied if a breach were discovered.

The talks at the weekend which have spilled over into this week, have also touched upon the upcoming EU budget, which will need to be increased substantially in the coming years, not only to deal with the current pandemic, but for the EU to be able to meet its climate targets. With the UK leaving the bloc that will also mean much higher contributions from the remaining member nations, something that is proving to be somewhat of a sore spot.

While markets have reacted positively to the prospect that some form of deal will be agreed, with the German DAX leading the way in Europe, it will still need to be approved by all other EU member parliaments over the coming weeks.

This will mean any funds are unlikely to be available until the beginning of next year at the earliest, and even if all the funds are made available, the money will be nowhere near enough to compensate for the billions of euros of lost tax revenue, that has pushed southern European countries even deeper into their fiscal black holes.

While markets have been buoyed by the prospect that this deal has been agreed, the money in question is but a fraction of what is required to help the likes of Italy, Spain and Greece get out of their current difficulties. This deal is likely to be yet another sticking plaster on a dysfunctional monetary union, as it lurches from one crisis to another. On a more positive note what this agreement does do is establish the principal of some form of joint debt issuance, and it is this which can be construed as a baby step towards wider fiscal integration.

As a result today’s European session is expected to see a higher open, with the DAX set to open at its highest level in almost 5 months. .

Later this morning we’ll get another look under the hood of the UK economy and the amount of extra borrowing that the UK government undertook in June to keep the economic motor of the UK ticking over in response to the current coronavirus crisis.

The previous two months saw the UK government has borrow over £100bn, an exceptional post war intervention to support an economic shock that will reverberate for years to come. In April we saw £47.8bn, added to the national debt, followed by another £54.5bn in May as the UK treasury paid the wages of over 8m private sector employees.

Since then we’ve since discovered that the UK government shelled out over £15bn in respect of PPE to deal with the crisis, more money than it spends on the Home Office, Treasury and Foreign Office combined, while the number of jobs getting government support has risen to over 10m. Expectations are for another £40bn to be added to the national debt.

At some point the UK government will have to look at how they intend to pay for all of this, but for now with 2- and 5-year yields in negative territory, and 10 year yields below 0.2%, it isn’t something they need to be too concerned about right now.

We’re expecting to see another big number today for the June numbers, as the costs of the furlough scheme continue to rack up, and UK borrowing moves above 100% of GDP for the first time since World War Two.

The US dollar slipped to a one-month low yesterday as optimism over a deal in Brussels pushed the euro close to its best levels this year. The pound also enjoyed some decent gains ahead of the release of more economic data this week which is likely to lay bare the fairly lacklustre nature of the economic rebound as lockdown restrictions continue to be eased.

Bank of England chief economist Andrew Haldane maintained his recent view that the UK economic rebound was likely to be v-shaped in nature despite the announcement of further job cuts, this time from high street retailer Marks and Spencer yesterday. His view does appear to be a minority one on the MPC, with the declines in the pound seen last week driven by market expectations of a further cut in interest rates by the Bank of England at its September meeting.

EURUSD – broke above 1.1370 last week and has continued to edge higher with the highs this year at 1.1495 the next key resistance, after breaking above the 200-week MA, for the first time since June last year. A break above the 1.1500 level opens up a potential move towards 1.1570 and the 2019 highs. Support comes in at the 1.1370 level.

GBPUSD – another solid day yesterday, the pound has support at the 1.2500 area, with resistance currently at the 1.2680 area as well as the 200-day MA at 1. 2720. The larger resistance remains at the 1.2770 area as well as the June highs at 1.2815.

EURGBP – the June peaks at 0.9175/80 remain a key resistance zone, and the failure thus far to move beyond them does keep the bias slightly negative for a return to the 50-day MA at 0.8980, as well as the July lows at 0.8920.

USDJPY – currently has fairly solid support down near the 106.50 area, and resistance up near 107.50, as well as cloud resistance at the 108.00 level.

FTSE100 is expected to open 37 points higher at 6,298

DAX is expected to open 103 points higher at 13,150

CAC40 is expected to open 32 points higher at 5,125

For a look at all of today’s economic events, check out our economic calendar.

By Michael Hewson (Chief Market Analyst at CMC Markets UK)