High chance of further euro weakness from political developments

GREECE'S refusal to engage with the international "troika" of creditors will worsen further one of the chief worries about the European Central Bank's (ECB) asset purchase programme due to start next month - a shortage of prime government paper in the euro area.

As financial markets fret about a potential halt to ECB-approved emergency liquidity for Greece, capital is likely to flow further into the "havens" of top-rated government bonds around Europe. The Bundesbank's undertaking to purchase roughly 15 billion euros (S$23 billion) a month of securities, of which the lion's share would be German sovereign bonds, is looking problematic a month before the programme starts.

Many traditional domestic buyers of German government bonds such as banks and insurance companies are required to hold this paper for regulatory reasons. Furthermore, foreign euro investors from official and private sector institutions around the world are reluctant to exchange their German bond holdings in the light of general worries over the euro's stability following tough talk by the new Greek government over its 320 billion euros of public debt, 85 to 90 per cent of which is held by the troika of European governments, the ECB and the IMF (International Monetary Fund).