The danger of contagion from Greece’s referendum rejecting a European aid offer is testing the world’s most-developed nations again, after eight years of rolling financial crises.
With stocks sliding and the dollar rising as a haven, Group of Seven finance chiefs are working on a statement on Greece following Sunday’s referendum, according to an official from a G-7 government. While it makes up less than 0.3 percent of the world economy, Greece has added a potential brake on growth by injecting doubts about the permanent cohesion of the euro zone.
This time, global policy makers are confronting danger with an expanded toolkit, from permanent swap lines to provide dollars to expanded domestic bank-rescue facilities. With a surge in borrowing costs among more highly indebted euro members, such as Spain and Italy, posing a key risk, European officials will be on the front line of any response.
“It’s very important for authorities, via the central banks, to continue to give the market confidence there’s ample liquidity in the financial system given the events in Greece,” said Martin Whetton, an interest-rate strategist at Australia & New Zealand Banking Group Ltd. in Sydney who previously worked for a decade in Europe. “The euro group will seek to assure markets they’ll provide whatever liquidity is needed for banks to fund themselves.”
Monetary policies abroad could also be deployed into any market turmoil. Analysts already anticipate Japan and China to add stimulus in coming months, and a blow to Europe’s growth outlook could encourage the Federal Reserve to put off raising interest rates. For emerging markets, any exodus from riskier assets would put pressure on them to stem currency declines.
The euro was weaker against all 16 major peers by 11:23 a.m. in Tokyo, dropping 0.6 percent versus the dollar and 0.7 percent to the yen. The yield on 10-year Treasuries plunged nine basis points while a benchmark of Asian shares, the MSCI Asia-Pacific Index, was down 1.4 percent.
Economists at JPMorgan Chase & Co. and Barclays Plc were among those concluding the referendum results make it more likely than not that Greece will leave the euro. JPMorgan warned the exit could come “under chaotic circumstances.”
“I don’t think anyone should be in any doubt: the Greek situation has an impact on the European economy, which has an impact on us, and we cannot be immune,” U.K. Chancellor of the Exchequer George Osborne told the BBC’s “Andrew Marr” program on Sunday, ahead of a Monday meeting of U.K. officials to be chaired by Prime Minister David Cameron.
Officials at the European Central Bank last week said that it’s “determined to use all the instruments available within its mandate.” Options to calm markets and curb contagion to other euro-area members include accelerating or boosting the bank’s 1.1 trillion euro bond-buying program or focusing it on the bonds of weaker nations.
The ECB could also deploy its unused Outright Monetary Transactions program, although there could be technical hurdles. The program requires countries to sign up to economic reforms first, and they may balk at doing so for fear of losing control over policy or being seen as tainted in markets. Even so, a legal blessing of the facility by the European Union Court of Justice last month may mean it can be used more broadly.
“The ECB can be relied upon to do ‘whatever it takes’ to support other vulnerable euro area countries,” Huw Pill, chief European economist at Goldman Sachs Group Inc. wrote in a July 2 note to clients. “While the ECB is still likely to be reactive rather than pre-emptive in stepping up sovereign purchases, we expect that reaction to be both prompter and more aggressive than in the past.”
The central banks of the richest nations now have permanent bilateral swap arrangements that can be used to ensure markets have access to major currencies if liquidity begins to dry up as happened in money markets in late-2007. After the Lehman Brothers collapse in September 2008, the key central banks held hand-off calls from one region to the next, briefing on the latest market developments.
Bank of Japan Governor Haruhiko Kuroda said Monday morning that the BOJ was monitoring developments in financial markets, and would keep in close contact with counterparts abroad, along with other domestic agencies.
“Although direct economic and financial linkages between Japan and Greece are limited, the Japanese Government and the Bank of Japan remain fully prepared to deal with possible developments in Greece,” Kuroda said in a statement.
Federal Reserve Bank of New York President William C. Dudley told the Financial Times last week that Greece was a “huge wildcard.” Dudley and his colleagues have been assessing whether the U.S. job market and economic rebound are strong enough to warrant lifting their benchmark lending rate off of zero, where it has been stuck since December 2008.
Any flight to the dollar as a haven could impair American growth, giving reason for the Fed to hold off for longer.
“We’re going to have to wait and see what the fallout is” to determine what Greece means for the Fed, said Jay Bryson, managing director and global economist at Wells Fargo Securities LLC in Charlotte.
For emerging markets, which lack the permanent swap lines with the Fed though have developed their own backstops, the Greek turmoil poses a headwind at a time when they’re already growing at less than half the pace of 2007. Malaysia’s ringgit was among the currencies tumbling in Asian trading, highlighting risks for a country that’s run up borrowing in dollars this year.
That underscores their need for the developed world to head off contagion. The hope will be that Greece amounts to just a little local difficulty for Europe, unlike when its original wobbles starting in 2009 proved toxic and prompted a string of bailouts from Ireland to Spain.
Since then, the world’s banks have cut their exposure to Greece and the euro region now has stronger safety nets in the form of a permanent bailout fund, more aggressive central bank, tougher budget rules and stress-tested banks. The likes of Spain have also made efforts to put their fiscal houses in order.
“We do not see this as a Lehman moment,” Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam, wrote in a note. “There is a risk that peripheral government bond spreads surge to stress levels. In that event, the European authorities will react with force.”