The Reserve Bank board meets next week on July 5. It was clear from the tone of the minutes of the June board meeting and the governor’s speech last week that the board sees no immediate need to raise rates, despite holding a strong tightening bias. Therefore we see no reason to expect a hike on July 5.

In the governor’s speech, he clearly linked the next policy event to the June quarter inflation report which will print on July 27. We expect a print of the underlying measure of 0.7 per cent, not sufficient to justify a rate hike at the August meeting. We expect that a print of at least 0.9 per cent will be needed to justify a rate hike in August.

That will also be on the basis that there has been no major deterioration in global financial markets stemming from the European financial crisis.

For the last 10 days I have been travelling in the UK and Europe meeting real money managers, central banks and hedge funds.

Inevitably the discussion came to Europe.

I have to say that no one was optimistic for long-term stability.

It was generally agreed that the European way was to buy time in the hope that, in time, those troubled economies outside Greece would heal such that any eventual necessary restructuring in Greece would not be followed by immediate contagion.

Hence, everything that could be done to hold Greece together in global markets would be. Its total outstanding bonds are €340 billion of which 27 per cent are held by banks, and 43 per cent by real money managers, sovereign wealth funds and central banks. The ECB holds a further 16 per cent; the IMF the remaining 14 per cent. The German bank holdings are thought to be mainly limited to the German Landesbanks, which are not considered to be critical to the German economy. So, in the extreme, an orderly wind down of this sector is possible.

The possibility of the European community guaranteeing the entire volume of outstanding Greek bonds was supported by some arguing that a contagion would be far more expensive for Europe and the global financial system. However, the funding of future deficits – around €30 billion per year – would still be an issue.

The risk is not financial support from the EU, but social unrest in Greece. That could be partially averted by turning a blind eye to the government’s inevitable slow progress in implementing the reforms. The reforms are extreme, including fiscal tightening of 10 per cent of GDP over five years, would still see the debt-to-GDP ratio only stabilise to around 140 per cent of GDP by 2014, and would not stop an eventual default.

However, even if some broad-based but affordable mechanism can be agreed upon to keep Greece out of play for years, it is still questionable as to whether the other problem countries will make sufficient progress to make markets comfortable.

Of course, this approach would carry many risks. Would the social unrest in Greece ease, even if there is some genuine European leadership that can coordinate a soft touch? And if it becomes known to the Portuguese, Irish and Spanish that the EU is not insisting on tough policies, what incentive will the others have to comply? Thus, the risk of social unrest in Greece unwinding the rescue package, despite strong European intentions, looms large.

Elsewhere, economic progress appears to be getting underway slowly in Ireland, and at least they are not rioting in Portugal.

The EU could probably guarantee all of Portugal's debt and confidence might slowly return to Ireland, but what about Spain? Spain's debt, though only around 60 per cent of GDP, would be too large for a blanket EU guarantee.

Spain sits at the centre of the ‘buy time’ strategy. Spain has been subject to the bursting of a massive debt-driven property bubble, yet prices are not reported to have fallen by much. There is a clear anticipation that Spain will have to recapitalise its banking system, which will severely disturb its current benign debt position. The market is alert to distressed investors, who were very successful with distressed banks in Japan, finding it too hard and walking away in Spain.

There is already social unrest in Spain and, with the austerity measures, Spain is suffering from a housing meltdown along US lines. Whereas the US could afford to recapitalise and take the losses, Spain cannot – it is likely that default or hyper-inflation are the only solutions. The market will be watching Spain's attempts to grow out of these problems closely – albeit almost impossible to do so with trading partners that are also weak.

Stress tests are considered to be inadequate and a meltdown in Spain – which could affect Italy – is feared, despite any long-term band-aid jobs for Greece.

Other uncertainties complicate the outlook. One regulator worried about the identities of those banks with exposures to the sovereign CDS market and the magnitude of those positions, despite ISDA executives arguing that net exposures are limited to €5 billion.

European banks are major issuers of US dollar liabilities with a natural buyer being US money market funds. This link was one channel by which financial instability was propagated last time around. The Fed has just announced an extension of US dollar swap lines with European. The US MM funds may be unwinding their European bank exposures. With the exception of Germany, it is assessed that European banks have been slow to deleverage balance sheets.

Spain remains the key risk in this potential house of cards. A decision to neutralise Greece will buy time, but much more information will need to be revealed about Spain to achieve sustainable stability.

While social unrest in Greece, Portugal or Spain looms as an early circuit breaker, the market's acceptance that Spain will be able to deal with its problems seems optimistic. Debt-laden Italy also represents a risk, as does contagion to the US. A period of unacceptable volatility and uncertainty seems likely until it is accepted by the EU that the carving out of a new smaller homogeneous group of debtors is the only lasting solution.

In the short term, Europe, possibly including the demonstrators, is going on holidays, so prepare for an eerie couple of months.

Offshore fund managers argue that a 25bp rate cut priced in for Australia is a 25 per cent chance of a 100bp cut. In the current environment in Europe, you can see their point.

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This report from Bill only confirms my former most pessimistic thoughts so that now I am somewhat of a believer that there is much to be concerned about in Europe for the businessman like myself (See WEEKEND ECONOMIST: Restless Spain, July 1).
I am concerned about the ability of Italian banks and their offshoots such as Bank of Austria to weather the storms when they start to blow/erupt especially when one considers what the contagion fallout to Italy will be from a Spanish Santander Bank problem – remembering that they are very much exposed to a huge amount of long-term unsold speculatively built holiday apartments in Spain and I think Portugal also.
The writer has hit the nail on the head. The austerity measures are so totally unacceptable that the only solution to avoid social unrest is to go slow on implementing them (See WEEKEND ECONOMIST: Restless Spain, July 1).
However this raises the obvious question that, if this is to be the policy with austerity measures - pass them on paper and then go slow implementing them - what's the point of it all? All you are doing is annoying people, giving them a reason to throw rocks at the police, surround parliament and in Greece's case wreck this year's essential tourist industry.
It seems to me that what needs to be recognised is that what Europe is facing is far less an economic problem than a political and social structure problem. What needs to be recognised quickly is that the latest economic tactic of filling people with despair and telling them that for "deep economic science reasons that they cannot comprehend without a degree" things cannot get better for at least a decade, is not a socially acceptable functioning tactic either.
What it all boils down to is, are we going to seek a social restructuring or are we going to make the same mistake the twentieth century made, retreat into authoritarianism, and express regret when millions of those who may even have supported such measures find themselves on the end of an uncontrollable and uncontainable cycle of repression. Those who do not learn from history always repeat it.
The capitalist system as we know it, grew up in the period of industrial revolution and empire. It built on internal and external repression and on availability of cheap natural resources in the mother countries, and resources exploitable through cheap and slave labour overseas. The world has socially evolved but the economic system seems stuck in the past defending class and elite structures that are arguably irrelevant and indeed detrimental to capitalism's efficient functioning.
A few weeks ago there was an article in the Business Spectator that correctly identified the growing defect in our legal system. This man's experience demonstrates another facet of how it is impossible to obtain justice.
You correctly identify the political dimension of the problem and your work and the information you provide is extremely valued by me. As a member of the LNP however, I despair at not getting the messages you are sending out through the noise and clutter that surrounds our politicians, to them.
Somehow you have to widen your base if these very real wrongs are to be corrected. Robert Gottliebson regularly identifies public service incompetence and in its own way you are doing so too, why do priorities suddenly change, by what arrogant right do they have the option of writing unfair contracts. Locally, look at current position with contractors. Look at how immigration officials hobble our tourist industry. And one can go on and on (See WEEKEND ECONOMIST: Restless Spain, July 1).
This article is great but contradicts earlier assessments by "leading economists", including Bill, that the RBA will hike rates on the back of capital investment in the resources industry. So, which is it? Rate hike or rate cut? Boom or doom? (See WEEKEND ECONOMIST: Restless Spain, July 1.)
Bill, A good article which I enjoyed (See WEEKEND ECONOMIST: Restless Spain, July 1).
However cutting the PIIGS out of the EU seems self defeating. A bit like saying that Newcstle and the Hunter Valley should have been excised from NSW when that region had hard times after the BHP Steel Mill closure.
May I suggest that EU reform is desparately needed namely (1) an independent body with teeth to oversee fiscal discipline and (2) an increase in the EU taxes and budget to provide relief programs (fiscal equalisation) for the desparately depressed PIGS.
In the name of enlightened self-interest surely the Germans and French want to maintain their PIIGS export markets?