Yesterday was a much quieter day in world equity markets and now (only?) 20 of the last 30 days have seen triple digit moves on the Dow Jones Industrial Average. This is still rather extreme particularly considering volumes have hit a summer/World Cup low. However bond markets and particularly the Euro zone peripherals are doing their best to take up the slack. In particular Spain is in the front line and after her surprising ( in case you do not follow football Spain were pre-tournament favourites) defeat to Switzerland yesterday I would imagine that there is much wailing and gnashing of teeth going on today in Spain on both the economic and football front. There is a certain irony in the fact that Germany won her first game 4-0 as it would appear that in football as well as in their economy the Germans are doing well. Although perhaps the economy did not have the advantage of using a new ball before everyone else!
The Greek economy
Having considered Greece’s position again yesterday I thought that it was time to take a look at her economy and where she currently stands. We know that she is beginning a very severe austerity programme but her economic state when she began it is important as it gives us a clue as to what we can expect going forwards. My figures are mostly from Eurostat with one or two additions from the Greek statistical body NSSG.
Growth: Greece’s economy grew by -0.8% in the first quarter of 2010 which made for a year on year growth of -2.3%.
Unemployment: The unemployment rate is at 10.2% and the Bank of Greece expects it to rise to 11% during 2010. These figures are the latest but are for December 2009 and are somewhat out of date and slightly confusingly NSSG has it at 10.3%.
Inflation: The Harmonised Index of Consumer Prices is rising at 5.3% which is very high compared to a euro zone average of 1.6%.
Industrial Production: The figures for April showed a 3.4% fall on the previous month and on a year on year basis fell by 6.4%.
Balance of Payments: The figures for March 2010 showed a current account deficit rising 327 million Euros to 3015 million. For the first quarter as a whole the deficit rose by 2.7 billion Euros to 10 billion. ( The Bank of Greece points out that a Common Agricultural policy payment of 2 billion Euros expected in May was paid earlier last year and has distorted the figures somewhat).
Industrial Producer Prices: These rose by 9.8% in April according to NSSG.
These numbers essentially tell us the state of Greece’s economy as she approached and then began her austerity plan. Her economy was already contracting so she had not fully recovered from the credit crunch yet she was also suffering from the highest inflation in the euro zone. The numbers for industrial production are poor and show no sign at all of a recovery led by increased competitiveness led by the fall in the Euro exchange rate over the last 6 months and the growth in world trade. Just as a comparison Germany’s year on year industrial production rose by 13.9%. Yet the lack of industrial growth was combined with a high producer price index presumably driven by the rise in taxes and the fall in the exchange rate.
To go forwards one needs to add the austerity plan which just as a reminder plans to reduce Greece’s fiscal deficit from the 13.6% of Gross Domestic Product (GDP) in the last fiscal year to 2.6% in 2014. This will lead to a severe contraction in the Greek public sector and I can only see this impacting very severely on economic growth in the Greek economy. I have said before that I feel official forecasts of a fall in economic output of 4% over the next year for Greece are too low. I have written before about Latvia’s experience which was much more severe and I fear that over the year from now Greece’s economy is likely to contract by something more like 6/8%. Her task looks very Herculean (sorry) to me and I am unable to change my previous conclusion that some type of restructuring or default will be required to help Greece through what will be a painful adjustment process.
The figures for balance of payments and in particular what are called “current transfers to general government” which turn out to be transfers from the EU under the Common Agricultural Policy(CAP) stood out from the figures to me at 2 billion Euros. It put a figure on these transfers and I would like to know from my Greek readers as to how dependent you feel Greece has become on the CAP. It has been a topic debated in the UK but from the other side (i.e a contributor).
Having reviewed the situation it is now time to remember the scale of effort the euro zone has put in to help Greece with its 110 billion Euro aid package and the ECB’s Securities Markets Programme which has announced so far purchases of 47 billion Euros of peripheral government and private debt. Yet her ten-year bond yields rose to 9.61% which is +6.93% when compared with the equivalent German bund. In spite of all the help still no-one wants her bonds and accordingly suggestions as to her long-term solvency are deteriorating because at such levels a Greece trying to refinance herself would rapidly become insolvent. I notice that newspaper journalists have quietened down on this subject but in some ways Greece’s position is worse than ever. In other words the euro zone effort is showing signs of failing.
Spanish government bonds
Today is an important day for the Spanish government bond market as she is auctioning some 3.5 billion Euros of 10 and 30 year government debt. This follows on from the problems for her that I have highlighted recently. The last time she issued such instruments in May and March respectively they yielded 4.05% and 4.75% so markets will be watching to see the difference this time.
Yesterday there were further developments in Spain. The rumour mill was in full force about a potential 250 billion bailout being led by the EU/IMF. The Bank of Spain announced that it will publish the results of a stress test into Spanish banks probably thinking that such results are unlikely to reduce the general consensus view of the Spanish banking sector and in particular its cajas or savings banks. Mr Zapotero’s Spanish government also announced some reforms of its labour market in essence planning to ease firing rules for employers in economic difficulty, while discouraging an over-reliance on temporary hiring to try to help trim a 20 % unemployment rate, which is the euro zone’s highest. Unfortunately even a decree on this subject may take some time to go through Parliament and I notice that in Spain there are suggestions that the reforms do not go far enough.
The net effect of the pressure on Spain is that her ten-year government bond yield rose to 4.97% which is some 2.28% over that of the German equivalent and is much worse than the 4% yield she had on the day after the euro zones “shock and awe” rescue plan. The impact of this is significant as Spain is a much larger economy than Portugal, Ireland or Greece and any support for her will accordingly be much more expensive. It is also significant because of the ECB’s Securities Market Programme means that this is happening whilst it is trying to support the market.
As someone from the UK there has been a fascinating development which goes as follows. If you go back to two months ago then ten-year UK Gilts (government bonds) yielded 3.99% whilst the Spanish equivalent yielded 3.83% so a difference of -0.16% from the Spanish perspective. As of last nights close the difference was +1.43%. This to my mind shows two things. Firstly how the Spanish situation has developed and deteriorated and secondly how favourably (and in many respects surprisingly) debt markets have recently treated the UK.
As I type the results from the ten-year auction have been published and Spain has auctioned 3 billion Euros worth at a yield of 4.86%. So we have a rise since the last auction of 0.81% which is an indicator of the deterioration in the perception of Spain’s financial circumstances. The yield is below last nights close which looks good but please remember that as I have said many times before the full impact of an auction takes several days to come through. There would have been a lot of pressure to buy today I think.
Just as a matter of tactics if I was in charge of the ECB’s Securities Market Programme I would not only be buying today but I would step up my purchases.
Mansion House speeches
Last night Chancellor George Osbourne announced the following.
I can confirm that the Government will abolish the tripartite regime, and the Financial Services Authority will cease to exist in its current form.We will create a new prudential regulator, which will operate as a subsidiary of the Bank of England.
As someone who has worked under the system of financial regulation set by the FSA and has been a critic of its role I would like to say that I support this move. I believe that the FSA has been very expensive (£3.5 billion over the past decade), very bureaucratic and when it came to the test it failed. I know that many vested interests have come out in support of it and that many are afraid of change but the new body will have to go some in my view to do worse than the FSA. My only caveat is that if we look at a football analogy when you sack a manager you need a new (hopefully better!) one ready….
Mervyn King however gave a speech somewhat different in tone which I found to be rather complacent when it came to monetary policy and I would like to illustrate this with a few quotes.
Of late there have been those who doubt our ability or willingness to meet the inflation target.
of which I am one and part of my reason for this is
for much of the past three years (inflation) has been above the 2% target
No one should take this as a sign of complacency……and…..No one should doubt our determination to meet the target
Unfortunately Mr. King then rather embarrassed himself as he defined a central banks role by implication
the role of a central bank in monetary policy is to take the punch bowl away just as the party gets going
You see that is what he and his fellow members on the Monetary Policy Committee failed to do. So to my mind his performance was disappointing to say the least.
Update 12:30 pm
I have the full results for the Spanish bond auctions and the 30 year bond was issued at 5.91% and some 479 million Euros were sold. So Spain auctioned the 3.5 billion Euros she wanted and markets have initially taken it well with her stockmarket improving and the initial move in government bond yields being down.
I notice many cries pretty much saying “victory” on the newswires and believe one should be careful. Bond auctions take a few days to settle down as I have argued before and what happened on some Greek auctions/issues backed my point up I would suggest. Also the 30 year bond was issued at a 1.16% higher yield than her immediate precessor. Or to put it amother way will cost some 111 million Euros extra in interest payments over its lifetime.