As we await the statement from the Federal Open Markets Committee which is due tomorrow evening two central banks have decided overnight to get their retaliation in early. Both India’s central bank and the Reserve Bank of Australia raised rates by 0.25% and in Australia’s case to 4.75%. I had discussed Australia’s position earlier this year and at that time expected the rise to come sooner than now, however the slowdown in the US economy evident this summer probably delayed the rise which may not be the last. If you look at the RBA’s statement the rise was caused by.
Looking ahead, notwithstanding recent good results on inflation, the risk of inflation rising again over the medium term remains…….most commodity prices have firmed……..the high level of commodity prices………Inflation is likely to rise over the next few years………Looking ahead, notwithstanding recent good results on inflation, the risk of inflation rising again over the medium term remains.
So in spite of the strengthening Australian dollar (which will have an anti-inflationary impact) her central bank fears inflation and has responded. My understanding is that there is something of a bubble in Australian house prices and the RBA is probably trying to take some of the air out of it if it can. It is refreshing to see a central bank at least try. There is one other sentence in its report I would like to draw your attention too.
The global economy grew faster than trend over the year to mid 2010.
You might not get that impression from other central banks this week as they try to justify expansionary measures. Indeed I remember a quote from Ireland’s government which claimed exactly the reverse.
Commodity Prices and the Oil Price
The Commodity Research Bureau spot index has somewhat ironically been taking a breather from its recent rises over the past few days. However its current level of approximately 490 is up some 25.2% over the past year. Of course as a resource based economy many of these moves directly affect Australia but all countries will be indirectly affected.
One commodity which has surged recently has been the price of oil. A barrel of West Texas Intermediate crude oil has risen yesterday and this morning by just under US $2 per barrel to US $83.36. On the 24th of August it closed at a recent low of US $ 71.46 so we have rallied by nearly 17% since then. As this coincides with the call from the US Federal Reserve for a rise in inflation and expectations of it making a move to achieve this it leaves me wondering exactly how this is of any benefit to the US economy? It could of course be a coincidence but QE2 in this instance appears to be inducing a move which is both inflationary and deflationary for the US as paying higher prices for oil leaves US consumers and business with less money for other things.
Problems in the Euro zone continue and indeed get worse
Over the past week the politicians and officials of the Euro zone and other countries in the European Union have been debating several financial issues. I have already discussed the shameful realpolitik that will allow the EU’s bureaucracy to press forward with spending rises at a time of austerity for others who pay their salaries. Well over the past few days the new arrangements for shoring up the Euro with its obvious problems have hit trouble too. For those wishing to look back on what has caused this problems I have a section on the Euro zone crisis.
Their first move which was to make the European Financial Stabilisation Fund permanent was hardly a surprise, indeed it corrected a policy mistake as the idea of it lasting only 3 years was frankly the sort of thing which has observers accusing the EU of being divorced from reality. It did take them a while as I suggested this back on the 25th of June.
I suspect that I will not be alone in finding an answer of maybe somewhat uncomfortable and that the underlying philosophy of “kicking the can down the road” assumes that things improve in the three-year timescale. So to add to my suggestions I would make the facility permanent.
I did notice a UK economist calling recent Euro zone moves somewhat speedy which frankly if you consider what has taken place over this time period is putting it politely somewhat bizarre.
However it is on the issue of conditionality that the Euro zone has hit real trouble, in other words what do you do with miscreant countries in future who do not obey the fiscal guidelines. In essence the European Central Bank wanted fixed conditionality and a mechanism to enforce it whilst politician’s did not. Accordingly we have got a large dose of Euro fudge, the sort of fudge that helped us into the mess that was May 2010. Whilst politician’s and the ECB bicker one piece of news did come out which was that in future private bond-holders would be expected to share with taxpayers the burden of future bail-outs. This has already had unfortunate side-effects in Portugal, Ireland and Greece which I discuss later in this article.
The European Central Bank’s view
Unfortunately the ECB or at least some of its Governing Council have little faith in the new plans. In a speech in Abu Dhabi Executive Board Member Mr Bini Smaghi said the following..
when potential future sinners have to judge current sinners, the tendency for forgiveness prevails………Why should the Eurogroup be expected to behave in the future any differently than in the past? The question remains unanswered. The discussion is not over yet.
So the Euro zone cannot even agree amongst itself.
The impact on the Peripheral Euro zone countries: Portugal, Ireland and Greece
As you can imagine private-sector bondholders appear to have been not quite so keen to hold debt from these countries over the past few days and all of their government bond yields have risen. Not perhaps quite the triumph that Euro zone politician’s might have expected.Indeed it is in danger of turning into quite a debacle. For politician’s in Portugal it must have been doubly confusing as they came to some sort of agreement on Portugal’s finances over the weekend which they might have expected to stabilise the situation.
To add to this the ratings agency Moodys suggested Portugal,Ireland and Greece are likely to avoid sovereign bond defaults because of a strong domestic investor base of local banks and pension funds that will buy their government’s debt even in times of stress. Unfortunately the credibility of a ratings agency is about on a par with the Euro zones politicians and it may even have unsettled investors,after all it was making similar noise a few years ago about mortgage debt was it not?
Greece hits political and economic trouble
In the fevered pre-election atmosphere in Greece politician’s are saying things that they should not. For example Greece’s deputy Prime Minister Mr. Panaglos said this in an interview in the To Vima newspaper.
Debts exist to be restructured. We may pursue it ourselves or the option may be offered to us and it could be in our interest to turn it down.
Just to add to the doubts in this area the Greek banks are currently engaged in a round of rights issues leading to further speculation in this area. At this moment Piraeus bank is attempting to raise capital following on from the National Bank of Greece leading the newspaper Kathimerini to suggest this.
Although no Greek banker that we know of would like to admit it in public, boosting a bank’s equity capital is also a precautionary move aimed at shielding it from a haircut on the value of Greek government bonds in the future.
When I do the mathematics involved in this I find it hard to see the capital raising as being enough. But then my own country the UK saw this with the rights issue undertaken by Royal Bank of Scotland only a few months before its collapse. I still feel that the Directors of Royal Bank of Scotland should be on trial for this as there are only two real alternatives, negligence or misrepresentation to my mind.
So with the realpolitik going on both in Europe and in Greece itself it is no great surprise that Greek ten-year government bond yields have continued their recent rise and now stand at 10.8%. The three-year yield has risen more quickly to 11.88% which indicates that short-term default is back on financial markets minds. When this saga started some suggested mid-2011 as a “good” time. Personally I have always felt that it is better to get on with it and I feel that whilst Greece has delayed her position has weakened.
Irish woes worsen
After a poor run Irish government bond yields surged again yesterday. She does have a government bond with a fortnight under ten years to maturity and its closing yield was 7.07%. If you remember such yields in Portugal back in May were part of the reason for the introduction of the shock and awe measures of May 10 th. It goes without saying that this is a new peak for Irish bond yields over this crisis period.
There is talk that this latest move was caused by a report from an Irish economist but he said nothing that was particularly new. However I did notice a poll which said that 64% of Irish people would welcome IMF intervention in Ireland. This is probably because of a growing realisation that the domestic Irish banking sector which as of the latest ECB figures is funding itself to the tune of 83 billion Euros from the ECB has nowhere else to turn. This amount had risen by 23 billion Euros in a month.
I suggested that Ireland should call in the IMF back on the 17th September as her political class ridden with cronyism as it is has no answer to her problems. I have seen nothing since that changes my mind, quite the reverse in fact. Indeed it will stop the politicians ruining her Pension Reserve Fund.
Here we see long-term problems to which the Portuguese government has added a failure of austerity. When government expenditure was supposed to be falling it in fact rose by 4% in the most recent figures. In response her government has proposed a more severe plan and appears to have got some political agreement although the vote is tomorrow.
However what might be considered good news has raised a troubling thought, what will happen to Portugal’s economic growth with these cuts? Forecasts of negative growth for next year are concerning when you look at her history. Indeed let me show you a chart from a Portuguese economist Luis Aguiar-Conraria to illustrate what I mean.
Not exactly the sort of trend line you want is it? However you look at it Portuguese government bond yields rose yesterday and her ten-year rose by 0.2% to 6.17%.
I hope that you find it revealing the way that we see countries in Europe struggling with potential deflation and Australia struggling with the reverse. One of the reasons I have highlighted this issue is that I have seen many economic articles saying the equivalent of Kipling’s “and ne’er the twain shall meet”. Well they are wrong and it is about time they began to realise this as our problems going forwards are deeper than their theoretical models suggest.
My musical playlist to occupy minds in the run-up to “Ben Bernanke’s Bazooka Party” is pretty much ready but there is still time for more suggestions.