There was relief in the markets after the German parliament approved the expansion of the European Union's bailout fund yesterday – but the optimism was tempered by persistent concern about the challenges on the road ahead as the eurozone grapples with its debt woes.
The Bundestag approved the extra powers for the European Financial Stability Fund (EFSF) that were agreed by officials in July. The German Chancellor, Angela Merkel, was able to push through the changes without resorting to support from opposition parties, with 315 legislators from the ruling coalition backing the plans.
The wide margin of approval – 523 votes for to 85 votes against the proposals, with three abstentions – was welcomed by the markets as a sign of Germany's commitment to resolve the debt crisis. Buoyed by the vote, the euro notched up steady gains against the US dollar, climbing as high $1.367 in the afternoon. It was also up against the yen and the Swiss franc.
Stocks were also higher, with the FTSE Eurofirst 300 index of leading European shares rising by 0.6 per cent. Supplementing the German vote came news of an upward revision in US growth figures for the second quarter, which helped to drive the FTSE 100 index as high as 5,350.18 in London.
However, the rally began to fizzle out as investors turned their attention to the road ahead. The FTSE 100 closed 0.4 per cent lower at the end of the day, with weakness in commodity stocks hitting performance. Although European shares ended broadly higher, they were off the session's highs when business came to a close.
Hours ahead of the German vote, the yield on Italy's 10-year bonds climbed to 5.86 per cent, its highest since the euro made its debut, at an auction of the country's debt. Although Rome was able to garner enough interest to issue bonds towards higher end of its targeted range, there was concern about the high interest rate. "[Those are] eye-watering yield levels," said David Schnautz, an analyst at Commerzbank.
After the German vote, the credit markets saw some improvement but again the rally proved unremarkable. The German Bund future, though lower, was little changed as the equity markets closed. "Beyond [the German] vote, nothing has changed and we are awaiting a more comprehensive response from eurozone policymakers," said Lee Hardman, a currency analyst at BTM-UFJ.
Gavan Nolan, a director of credit research at the financial data firm Markit, also highlighted the lack of meaningful gains in the aftermath of the vote. "Did the market embark on a strong rally post-vote announcement? Not really," he said.
He added that there were questions about further changes to the bailout fund, given recent speculation about leveraging the EFSF to expand the EU's ability to deal with the crisis. Once again, Germany was the focus of attention. "After the recent constitutional court ruling, it seems probable that more changes to the EFSF would require another round of parliamentary approval," Mr Nolan added. "This would test Merkel's mettle and create another trigger point for the market."