Europe: Still Fluid, Still Uncertain, Still A Big Worry

Financial markets ended their best week in more than two months on Friday as the relief rally continued.

Share markets did very well, especially in most of Europe, gold fell last week (but rose on Friday) and US bond yields rose as investors retreated from safe havens and back into riskier investments.

The euro settled at just under $US1.38 on Friday and ended the week with its first gain in three after the move by major central banks to pump more US dollars into euro banks.

Underpinning the rally last week was new confidence that Europe and Greece are not going to implode.

But right now the rebound has the look of a sucker's rally because nothing much has changed in Europe, especially with Greece, remaining the flashpoint.

Until that is resolved, investors should understand that nothing can save the eurozone from further financial pain and the IMF's global stability report on Wednesday will bring it all back into focus by highlighting the continuing weakness in European banks, especially those in Germany, France and Italy.

Ratings group Moody's said at the weekend it would reveal Italy's new rating sometime in October, which means another major source of tension has been re-injected back into the mix after being put to one side by the central bank dollar auctions and support for euro banks last week.

At best, Moody's new rating could be no change in the negative outlook; at worst one or two notches off the current Aa 2 level.

European finance ministers did nothing for confidence at their two-day meeting in Poland on Friday and Saturday when they put off paying the next installment of financial aid to Greece until October (instead of agreeing to it at the meeting, which would have further clamed nerves).

Ministers and central bank governors from the 17 countries using the euro and the broader 27-nation European Union met on Friday and Saturday to discuss Europe's slowing economic growth and progress in beefing up eurozone defenses against the sovereign debt crisis.

Now two major sources of pressure on the eurozone and the euro are back in the forefront of minds in the markets and all it will take is another surprise (such as another ratings group cutting the ratings of a country or some leading banks) and we will get a return to the volatile trading and wild market swings from a couple of weeks ago.

Adding to the pressures on the markets in Europe was the surprise news that Greek Prime Minister George Papandreou had cancelled a planned visit to the US this week to deal with the deepening budget crisis at home.

He was due to address the IMF on Tuesday, and the cancellation came only days before EU and IMF inspectors return to examine the Greek government's latest budget proposals, spending cuts and revenue raising measures.

The inspectors' reports will determine if the next round of funding, some eight billion euros, can be paid next month. This is a payment from the first Greek bailout package from 2010.

There's speculation that Greece is having problems drafting a new budget for 2011 and 2012 that will be approved by the IMF, ECB and EU.

If it's not then the eurozone will be heading for some sort of bust up, with Greek defaulting.

Reuters said Greece's Finance Minister Evangelos Venizelos sought to allay fears the cancelled trip signalled imminent default, saying such talk was "ridiculous".

"The comments and analyses about an imminent default or bankruptcy are not only irresponsible but also ridiculous," Venizelos said in a statement issued in Athens late Saturday and quoted by Reuters.

Mr Papandreou was in London, on his way to the US and IMF and World Bank meetings when he decided to turn back after discussing developments with Venizelos and other ministers.

Greece has said it has cash until next month.

This news will make markets increasingly nervy, despite the market rally.

The inspectors from the European Central Bank, EU and IMF would report back on progress in early October, meaning the next disbursement of aid to Greece could be paid by mid-October, as the euro finance ministers agreed on Friday night.

The second 109 billion euro bailout agreed in July, after it became clear Greece would not be able to return to bond markets, has also hit snags.

Eurozone countries (such as Finland) are asking for collateral before giving Athens more cash and banks are slow to participate in a bond swap scheme key to the deal.

The results of that swap was supposed to have been revealed last week, but market reports suggest only 75% of the debt covered in the swap has been tendered for swapping instead of the 90% that Greece had wanted.

Papandreou was to meet United Nations Secretary-General Ban Ki-Moon in New York on Sunday and IMF head Christine Lagarde on Tuesday.

Reuters says Finance Minister Venizelos is still due to attend the IMF autumn meetings in Washington later in the week.