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Published: Wednesday June 27, 2012 MYT 5:10:00 PM

Fading hopes for EU summit leave euro flat


LONDON: European shares edged up on Wednesday but the euro was flat, with investors increasingly cautious a day ahead of an EU leaders summit that few expect will do much to resolve the region's debt crisis, now in its third year.

The German Chancellor meets new French President Francois Hollande later to try to hammer out a common line to take to the meeting, but Angela Merkel's reported comments that debt sharing would not happen in her lifetime, dashed hopes of a breakthrough.

"The disillusionment is palpable at the moment because, whatever happens over the next couple of days during this summit, no one is expecting anything concrete to come out the other side," said Richard Hunter, Head of UK Equities at Hargreaves Lansdown.

The disappointment left the dollar slightly firmer against a basket of major currencies, while riskier assets like commodities eased, with all markets reluctant to advance before the June 28-29 summit in Brussels.

The euro was barely changed at $1.2491, recovering from the fall to a two-week low of $1.2441 on Tuesday, which was its lowest level since June 8.

Markets had been hoping this week's summit would deliver at least a high-level agreement on greater fiscal and financial integration across the euro area that could then ultimately lead to the issuance of common euro bonds.

There were also hopes that Europe's bailout funds, the European Financial Stability Facility and the soon to be launched European Stability Mechanism, could use their money to ease the pressure on peripheral debt markets.

But Merkel's rejection of the idea of mutualising the region's debt burden - favoured by France, Italy and Spain -, saying Europe would not share total debt liability "as long as I live", signalled that deep divisions remain, though Germany is expected to offer some flexibility on the use of bailout funds.

"People are waiting for the inevitable - which is that policymakers will probably fail to do what is necessary," said Neil Mellor, currency analyst at Bank of New York Mellon.

EQUITY RECOVERY

Following sharp falls last week and Monday as hopes for a quick solution to Europe's crisis at the summit faded, stock markets around the world have steadily recovered.

Rises in U.S. equities on Tuesday and across Asia earlier lifted the MSCI world equity index by 0.25 percent to 303.70 points, though the index is down around 1 percent for the week so far.

The FTSEurofirst 300 index of top European shares was up 0.3 percent at 989.77 points after ending unchanged on Tuesday following falls in the three preceding sessions as investors positioned for a poor outcome at the summit.

But there were signs in the derivatives market that some market players are expecting a rebound in the coming weeks.

The put/call ratio of Euro STOXX 50 options, a ratio of the trading volume of options to benefit from share price falls versus gains, has fallen to 0.75, a level not seen in nearly two months.

The Euro STOXX 50 volatility index - Europe's main gauge of anxiety, known as the VSTOXX - has also fallen sharply this month, down 27 percent since a peak on June 4, breaking its usually strong negative correlation with stocks.

The last time there was such a drop in the correlation between the volatility index and underlying equities was in mid-December, at the start of a 20 percent rally in euro zone stocks that lasted three months.

EURO DEBT ON HOLD

Debt markets continue to reflect the worsening funding outlook for many euro zone nations and the impact of the crisis on the region's growth prospects, with investors reluctant to increase their exposure, even to safe-haven debt, ahead of the summit.

German 10-year Bund yields rose 4 basis points to 1.536 percent, while 10-year bond yields in Spain, which has already requested EU bailout funds for its troubled banking sector, were steady at 6.86 percent.

The Bank of Spain warned on Wednesday the rate of economic contraction was accelerating, and Prime Minister Mariano Rajoy said his country would be unable to keep financing itself at current yields for long.

Italy's six-month borrowing costs rose sharply on Wednesday to nearly 3 percent at an auction of 9 billion euros of new Treasury bills, which was expected to have been largely bought by its domestic banks.

Ten-year Italian government bond yields were steady at 6.14 percent, with Italy facing a much bigger test of investor sentiment on Thursday when it auctions up to 5.5 billion euros of new five- and 10-year bonds. - Reuters

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