Europe finally takes some positive steps toward tackling its debt crisis, but this week's bond auctions could test it.

So far, so good and at this stage, markets appear to have responded well to the European summit, despite the fact that an agreement between all 27 members of the European Union wasn’t reached. But that’s probably because much of the disagreement wasn’t really about the immediate eurozone crisis at all and indeed all 17 nations of the euro (as well as some others) signed up.

Failure to reach agreement more broadly had more to do with the UK’s desire to obtain some regulatory exemptions – thus the veto – although 26 out of 27 ain’t bad. Otherwise, everything else that was flagged in the press was agreed to. In particular, there are to be automatic sanctions if the new fiscal compact is breached and it looks like the €500 billion bailout fund (the ESM) will commence operation in July next year – the EFSF to ramp up as soon as possible and it taps the market this week. Other actions to be considered at another meeting in March will be increasing the size of the bailout fund again and extending a further €200 billion loan to the IMF.

The only disappointing aspects of the summit, from the market’s perspective, is that it doesn’t look like the ESM will get a banking license and the ECB doesn’t look like it is going to buy unlimited quantities of sovereign bonds (unnamed sources have been quoted as saying the ECB will keep its weekly purchase cap at €20 billion). That said, the fact they are providing unlimited liquidity to banks for three years should encourage private interest, especially as politicians have now dropped any reference to further private sector involvement (read private sector writedowns). That looks to be the intention anyway, but I guess it’s one thing to lead them to water; whether European banks actually buy government bonds with this funding remains to be seen. It did seem to have helped on the secondary market Friday night, as Spanish and Italian bond yields eased further (2-years down 25bps and 28bps respectively to 4.67 per cent and 5.97 per cent, while 10-years fell 6 bps and 9bps to 5.74 per cent and 6.36 per cent).

Market moves elsewhere were fairly volatile in some cases, but in the end we saw the S&P500 up 1.7 per cent (1,255). Currently, Australia’s SPI is up 1.7 per cent (4,262), while our dollar sits just below 102 US cents. In the debt space, US treasuries sold off, with the 2-year yield up 1bp to 0.22 per cent, the 5-year rose 6bps to 0.89 per cent and the 10-year was up 9bps to 2.06 per cent. The Australian 3s were off about 5 ticks to 96.86, while the 10s fell 6 ticks to 96.09.

From what I can tell, it looks like that’ll be it in terms of the major European announcements until March (except for perhaps EFSF news). We’ll see what happens – I mean you can never rule out the odd arbitrary comment from somewhere, whether sourced or not. It’s worth looking out for German, Italian and Spanish debt auctions this week otherwise.

In terms of Australian news flow this week, we get home loans today with the market looking for a flat outcome, although I’m slightly above that at 1 per cent. The trade balance is also out today (1130 AEDT) and the consensus is that we’ll see another surplus of about $2 billion (all October data). Tuesday we see NAB’s business survey for November and then we get Westpac’s consumer confidence number on Wednesday (December). How the RBA’s rate cuts have boosted confidence while the euro crisis raged is the key interest here. Finally, the RBA’s deputy governor gives a speech at 12.30 AEDT on Wednesday.

In the US, it’s a busy one, the key data flow including retail sales on Tuesday night (November data). Then we get the FOMC decision on Wednesday morning (0615 AEDT) although no changes are expected, while industrial production, producer prices, the current account and the Philly Fed are all out Thursday night. US CPI follows up on Friday.

Europe too has some reasonable data flow, the big ones including the German ZEW (Dec) on Tuesday night, industrial production Wednesday and CPI Thursday.

Adam Carr is senior economist at ICAP Australia. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

Follow @AdamCarrEcon on Twitter.


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