Euro zone finance ministers agreed in principle on Friday

Daniel Lenz, Lead Market Strategist Eurozone at DZ Bank AG, on Euro zone economy and EUR

At the height of the Euro zone debt crisis in 2012, ECB President Mario Draghi's challenge was to convince investors to hold on to European bonds. Now he faces a struggle to make them sell. That may complicate the implementation of the QE programme, aimed at reviving growth and inflation in the Euro zone. The ECB might have to pay way above the market prices, or take additional measures to encourage investors to sell. How do you think the ECB is going to solve this problem?

It will be a tough challenge for the ECB to accomplish the target they have set. We expect the Central Bank will try to start buying bonds at the short end of the curve, since there is more interest from the owners to sell their assets. The ECB is concerned itself, since they are especiallt interested in buying those assets which will not correspond the QE requirements after a certain period of time. At the long end of the curve it would be much harder to fulfil the target, given the fact that a lot of these bondholders need to keep their bonds.

This happens because they are dependent on the interest revenues, especially insurance companies and such. Moreover, there is still much movement to be expected, given the awaited bullish flattening of the curves in new sovereign bonds. Thus, it would not be the best decision to sell the bonds first, giving prospects of further price rises.

We believe there could also be discussions between the ECB and other central banks, whether the banks would be willing to sell some of their strategic assets of new sovereign bonds, as for FX reserve needs. All over all, it will need time since it may be harder to begin, yet after certain period there may be more interest in selling the bonds, once the price has come down further.

Euro zone finance ministers agreed in principle on Friday to extend Greece's financial rescue by four months, averting a potential cash crunch in March that could have forced the country out of the currency area. The agreement offers a breathing space for the new Greek government to try negotiate longer-term debt relief with its official creditors. Do you believe that was a first step in the process of rebuilding trust between the Greece and Euro area countries?

I suppose it is too early to talk about rebuilding the trust between Greece and Euro area countries. There was only the decision, as the current bailout programme will not develop at the end of February, but there will be an extension until the end of June, which may only help prevent the exit scenario for Greece. Whether a new agreement will be negotiated until the end of June is far from clear.

There might be some points the lenders could offer Greece to reduce the requirements of the new programme. However, I doubt that lenders would accept a much lower obligation and that Greece would fulfil this even more moderate claim. There is a risk that the overall indebtedness of Greece will stay very high or rise even further. Moreover, in the middle and long term run there is hardly any chance for returning to capital markets. Therefore, concern that in the long run Greece might suffer in new default also appears. However, whether it would be within the Euro zone or whether it occurs in Grexit – is a good question. In case it is two or three years from now, it would be too hard to call.

In spite of the fact that Greece and Euro area counterparts established common ground again to reach agreement, a lot of economists believe that Greece may exit from the monetary union. In that case, what consequences may the Euro zone face and how big will be the damage?

The risk for Grexit by the end of this month and beginning of the next month has certainly decreased strongly. However, the overall Grexit concern has not abated to a certain degree. There still is a measurable risk for Greece to exit monetary union either this year or in the coming years. If Grexit scenario unfolds, it will have especially harsh consequences for the nation itself. Such economic consequence as unemployment would rise in a very short run. Moreover, prices would fall, given the fact that the new Drachma would undoubtedly depreciate against the Euro, and there would be hardly any investments in Greece. Thus, a lot of suffering for Greece may arise in a short run. In a longer term there also might be positive economic effects, for example, unit labour costs coming down and more incentives for tourism to increase in Greece.

For the Euro zone, there probably is a risk for a short term harsh market impact, but it would be very much well covered by the ECB measures and by other instruments implemented by the EU, given the fact that more investors expect that Greece is an isolated case, and that there will be no spill-over effect to other countries. We doubt there would be a lasting sell-off in asset prices outside of Greece. From just a purely economic point of view, regarding trading and etc., Greece is a very small economy, so it would not harm the Euro zone economies if trade with Greece abated strongly. However, there is a risk for some banks that have outstanding loans to Greece to face a negative impact.