The BNP team say the European bond markets are no longer a homogenous entity following the Greek crisis, which has “reduced their attractiveness to foreign investors.”

Having seen the net inflow into the European bond market fall from €285 billion to just €20 billion over the last 12 months, BNP is warning that when money pours out of European equities, as it expects, the euro will fall sharply hitting parity versus the dollar by the end of the first quarter in 2011.

Having played their hand on fiscal transfers to Greece, foreign investors have “been shocked by the mess left by our European politicians" and it “will take some time to repair this damage.”

The ECB Is the Key

Having said this is no time for complacency as the ECB met in Lisbon today, Jean-Claude Trichet will now be the key to further policy responses to the crisis, according to BNP.

“At Thursday’s press conference Trichet confirmed that the ECB had not discussed the outright purchase of sovereign bonds,” said BNP. This suggests to BNP that things will have to get a lot worse before the ECB takes action.

“Europe will change from using fiscal tools, attempting to heal European divergence with monetary instruments, sending the euro massively lower,” conclude the BNP FX team.