Finally the European Central Bank implicitly admits its losses and inflation expectations rise well except for Adam Posen!

In most years when one finds that Christmas is only a week away then the amount of financial news is usually correspondingly thinner than usual but not in 2010! In fact this year there has been a flurry of action to match the equally unusual flurries of snow over the UK. If we start with America then it looks as though Congress has passed Mr. Obama’s tax cuts/stimulus programme so the comment I was asked yesterday about the size of borrowing around the world in 2011 looks sure to be somewhat higher than one might have thought only a month ago. In Europe we have European Union ministers at what would be a crisis conference if the term had not suffered from the same problem as the boy who cried wolf leaving everyone with at least a soupcon of ennui. The usual pattern has been for great plans to be discussed which then are either shown to be flawed or not actually agreed upon. However a point I have been making for some time (the poor creditworthiness of the European Central Bank) has been answered. By their actions rather than their words as to admit to the situation would lead to embarrassing questions about what was said previously!

The Euro zone increases the capital of the European Central Bank

Back on the 6th December I continued a theme of questioning the financial status of the ECB

the balance sheet of Europe’s central bank looks ever riskier to me and it is quite conceivable that we could be in an era where central banks as well as private-sector banks need bailing out.

And on the 14th of December I pointed out that some of the capital of the ECB which theoretically is 5.76 billion Euros has not in fact been paid and only 4.142 billion has actually been paid. As an aside it is sad to report that we live in a world where such things happen but let’s face it such events are hardly rare. By my maths only a 3% loss on its asset purchases would have left it without capital and by my maths it probably had more than that.

So it was no great surprise to me to read this yesterday on the ECB website.

The European Central Bank (ECB) has decided to increase its subscribed capital by €5 billion, from €5.76 billion to €10.76 billion, with effect from 29 December 2010…………From a longer-term perspective, the increase in capital – the first general one in 12 years – is also motivated by the need to provide an adequate capital base in a financial system that has grown considerably.

Throughout this crisis I have spotted some changes in the use of language for example “temporary” now seems to define a time period as long as you like and now 12 days away is the “longer-term”! We also have some interesting accountancy methods as some of this announced increase will not actually be paid at all and the part which is will be paid in three installments of which only one of 1,163,191,667 Euros is actually due on the date mentioned with the others due in 2011 or 2012. In case you are wondering why I have counted this to the last Euro it is because I think that the ECB might need it. So desperate might it be I will even mention the 84,220 Euros that central banks not in the Euro including the Bank of England will have to supply.


The first point is that the ECB badly needed some money to shore up its finances. Unfortunately in the way of things these days it will actually have less real capital on December 29th than it claims it has right now!But in a proper calculation it will be stronger. It claimed before the change it had 5.76 billion Euros and after the 29th of this month its paid-up capital will be 5.39 billion Euros with promises of further tranches of 1,163,191,667 Euros in 2011 and 2012. So overall a good move.

The next obvious question is will it be enough? This depends on the future scale of its asset purchases as if it continues with bond-buying on the recent scale it has established with its Securities Markets Programme then the answer in my view is likely to be no. I hope that the capital increase has come with a real plan which will mean that the SMP can be reduced in scale and better still stopped.

Just A Thought

One of the problems that led to the credit crunch was that private-sector banks did not have enough capital and furthermore that they turned out not to have the capital they claimed. As the ECB is in effect at times operating as a policeman, judge and jury you might think that these lessons might make it operate now in an ethically higher plain. Yet it has insufficient capital and claims it has more than it has repeating so quickly the errors of the last decade. When the next bank hits trouble and the ECB points out the error of its ways I wonder if the directors will have the chutzpah to say but you don’t have enough capital either……

Moodys has been busy

This particular ratings agency seems to be involving itself in a plan to either downgrade or threaten to downgrade as many nations in Europe as it can before christmas. We had Spain earlier in the week well now with dizzying speed we have a downgrade of Ireland and threats of downgrades for Greece and some German banks. Does Moodys map of the world only cover Europe?


Here we have seen quite a severe downgrade from Aa2 to Baa1 which is 5 notches. Let me apologise for the confusing litany of numbers and letter that the ratings agencies use I am afraid I have no control over it. There was also a threat of future downgrades. Those who will like this least in the short-term will be the officials at the Securities Markets Programme at the ECB as I guess they will now be busy today buying Irish bonds, no Christmas cheer or shopping for them.

Rather ironically Ireland had posted some positive growth figures yesterday although perhaps not quite as good as some had hoped. Her Gross Domestic Product rose by 0.5% in the third quarter and her more important but less reported Gross National Product rose by 1.1%. It is more important because it represents what she can tax. It at least reversed 9 successive negative quarters for real GNP. A trade surplus was also reported.

Greece and Germany’s banks get threatened

Here Moodys is threatening downgrades on the basis of likely changes. It is afraid of haircuts on Greek debt (hardly new news) but is also worried about the lack of clear plans for the period 2012 to 2014. In the case of Germany’s banks a new law is being introduced in January which makes many of them more risky for debt owners as the German regulator is taking more powers in this area.


I have written many times that we need to find a better system than the current ratings agency one. Unfortunately there is not one in sight apart from one or two plans which might manage the achievement of making things worse! Oh dear. In terms of the logic behind what Moodys has done this week I do not dispute it but I do wonder about the timing. If we take timing literally then after some apparent  economic growth and the IMF releasing funds for Ireland she is in fact  a little stronger just as this hits.

If Moodys was looking for something to occupy itself it could take a look at the Federal Reserve Bank of New York. We have seen the ECB implicitly acknowledge how can I put it some financial issues. However the Fed. hold a lot of US government and mortgage debt the price of which has been doing what recently? When you own nearly a trillion dollars of something and you see the yield rises and price falls we have over the last fortnight…….

UK Inflation Prospects

After generally disappointing across the board inflation figures from the UK,yet again there has been some more news on this front. According to the Automobile Association the price of petrol in the UK has hit an all-time high of 122.14p per litre on average. I discussed on Wednesday my thoughts on the influences of this as they are both inflationary and deflationary. Furthermore I introduced the subject of the fact that those to whom fuel is a cost of business such as driving instructors, taxi drivers and lorry drivers are in effect paying very high marginal tax rates.

Inflation Expectations: The Bank of England survey

Those on the Monetary Policy Committee who have been claiming that inflation expectations have not risen in the UK found a survey they sponsor disagreeing with them this week. Let me quote from it.

Question 1: Asked to give the current rate of inflation, respondents gave a median answer of 3.9%, compared with 3.6% in August.

Question 2a: Median expectations of the rate of inflation over the coming year were 3.9%, compared with 3.4% in August

Question 2b*: Asked about expected inflation in the twelve months after that, respondents gave a median answer of 3.2%, compared with 2.9% in August. 

Question 2c*: Asked about expectations of inflation in the longer term, say in five years time, respondents gave a median answer of 3.3%, compared with 3.2% in August.


Every single answer given above is higher and I think that speaks for itself. However even on results which agree with what I think I would add that this is only a survey and it was one where 51% of respondents thought interest rates had change when in fact they had not. But still a clear message on  inflation emerges.

A Speech By Adam Posen

Mr.Posen has given a speech in Essex explaining his views on UK monetary policy and he has some influence as he is on the Monetary policy Committee. I wrote an article back on the 29th of September explaining what I felt and indeed feel are the problems with his approach. So today I will keep it simple. He feels that inflation is likely to be well below target in two years time and that we need more Quantitative Easing in response. My reply is you felt that two years ago Adam. In an era of digital music and mp3 players younger readers may not know what I mean by sounding like a scratched record but older ones will. One day of course he will probably be right if you persist with anything long enough then eventually you will probably be right.



19 thoughts on “Finally the European Central Bank implicitly admits its losses and inflation expectations rise well except for Adam Posen!

  1. I have a vague memory that in order to qualify as eligible collateral with the ECB, bonds must hold an investment grade from at least one of the major three agencies. If we imagine a situation where Irish bonds have been downgraded to junk by all three ratings agencies, do we know, at this stage, where that would leave the ECB? Obviously, ‘nursing a loss’ would be the initial response; but what I’m getting at is: would the ECB be permitted to maintain its holdings? If it had to liquidate its holdings at that point, it would very probably be selling into a falling market with predictable consequences.

  2. Hi Shaun, regarding Mr Posen, he pointed to a below-target CPIY measure as his get-out-of-gaol card whilst admitting to bad forecasting errors. Just wondered what you thought of this?

    • Hi Shireblogger
      I think that there are four types of reply I can immediately think of.
      1. It is not the target he is aiming at and there are plenty of other inflation indices to pick and choose from if the game is voluntary.
      2. CPI is a poor enough measure of inflation in my view without further sub-categorising it.
      3. As I like consistency then I guess I would expect Mr.Posen to have also been emphasing CPIY in late 2008 and most of 2009 when it was not only above ordinary CPI but also above target. Forgive me if I missed that…. His speech looks at the Phillips Curve and uses CPIY for that.
      4. RPIY is 3.4%.

      So in conclusion yes CPIY is 1.6% which is below the 2% and some note should be taken of it but I suspect I am not the only one wondering if he would emphasise any index which is currently below target!

      • Hi Shaun, the excerpt I referred to was
        ” That said, annual inflation in the UK as measured in the CPIY series, which excludes the price effect of indirect taxes, has been below target throughout this calendar year. Thus, if we allow for even just some exchange rate pressure upwards on prices over this period as well, underlying UK inflation has stayed well below target. Recognizing that fact has to be the starting point for our forecast.”

        Only four types of reply?!

        • I was in a bit of a hurry as I was going out to meet a friend and ex-colleague for a chat and coffee!

          Returning to your quote I think the first part of my point 3 is apposite. Did he use CPIY when it was quite a bit above target at times in late 2008 and most of 2009?

      • What worries me, Shaun, is that fiscal authorities have conscoiusly shifted tax raising policy to consumers, away from business. In an economy overly dependent on imports, the UK must be more vulnerable to the twin dangers of exchange rate related price pressures combined with fiscal decisions on indirect taxation. Doesnt this pose a challenge for monetary policy?

  3. Where is the Wikileaks document that will tell us that Moodys are an arm of the Fed with a remit to trash the Euro?

    (I do not go with conspiracy theories!)

  4. Shaun,

    You mention, “In the case of Germany’s banks a new law is being introduced in January which makes many of them more risky for debt owners as the German regulator is taking more powers in this area.”. Can you, or anyone else, elaborate on what the new law is and why it will be risky for new debt owners? Why is it not bad for existing debt owners?

    Thanks very much.


  5. I notice in your article that you voice a wariness about the rating agencies. Me? I’m scared witless by them. They were paid by unscrupulous financial businesses to give favourable reports, luring many unwary people like myself into investing in a business rated as investment grade when they were in fact bankrupt. And scarier still, the rating agencies are still at work. You are reticent to suggest an alternative; what about the government watchdogs in the various countries, at least, in Europe? At least you could claim against any display of negligence, and would give them some real work to do.

    • Hi Robert
      One of the issues of writing a blog like this is I do not know at what point each reader has joined the narrative! Accordingly I try to add updates which cover some of what I have said before and refer from time to time to previous articles. But in the past I have suggested that they turned out to be pretty much useless and in fact rather than informing people up to the credit crunch they in fact gave out disinformation.
      Sometimes their reports in terms of detail are useful.
      As to government watchdogs the potential moral hazard here is even worse than the ratings agencies and would, in my view, turn out to be a step backwards. How would a government watchdog review its own sovereign? I think the Euro zone bank watchdog CEBS showed itself to be clueless with it July stress tests……

    • Hi Mr.K
      There has been a drip drip of news in the UK today that is troubling about Ireland and our banks exposure to it. Then the real news is that the ECB has established a swap line with the Bank of England for ten billion Pounds in case it needs to borrow some sterling to help the Central Bank of Ireland. Which begs the question why? The answer is unlikely to be good otherwise why does it exist?
      If it were me I would never do such a thing unless I was about to immediately use it. I write from time to time saying that central banks should have things ready but keep them a secret such as liquidity support if you feel a bank is in trouble. Accordingly if I were to announce such a thing it would mean I was about to use it or had just used it!
      Of course they are not me and have made presentational mistakes before but if you wished to add an air of uncertainty this is the way to go about it.
      I will be mulling this one over…..

  6. That’d do it. Making public things such as a Central Bank needing a loan is ineptitude at it’s worst. From all I’ve read, I fail to see how the ECB can realistically continue the SMP, especially in light of this, nevermind supporting various Greek, Spanish and Irish banks. ZH has said the ECB’s latest liquidity measure has reduced the ECB’s bank leverage from 331-1 in half.. but, as you point out, did they really ? This just can’t have a happy ending.

  7. Talking of broken clocks being right twice a day, have a look at Roger Bootle in the Telegraph today. Yes, he admits he has been wrong on inflation, but his time will come (in 2012, apparently!).

  8. Hi Shaun,

    Just wanted congratulate you. Some voices of the media have recently asked for the BoE base rate to increase. The recent improvement is people suggesting to should have been increased a long time before. At the time when you first suggested an increase no one would agree with you, now with hindsight there are articles suggesting you were right.

    Also only Posen has talked about the last MPC meeting, this seems quite unusual at the moment. I suspect that Posen felt isolated at the meeting and does not think the minutes will give a fair review. We’ll find out on the 22nd but slowly the MPC seem to be moving towards the rate rise.


  9. Some CBs regularly run at negative capital due to losses on foreign reserves. Your comment that the ‘ECB badly needs to shore up its finances’ would make sense for a bank, but for a central bank? I’m afraid not. They can run at negative capital forever if they so choose. They print the money!

    I believe Hungary, Poland, Jamaica, all neg cap positions temporarily, Czech persistently and PBC did a capital raise recently due to losses on its USTs.

    The ECB could take losses on all its govies holdings in its SMP. It doesn’t matter. It can purchase far more. It hasn’t really these same constraints as does a regular bank.

    It’s rather a subtlety as to whether they need capital or not, but there are a number of papers on the topic of whether a CB’s credibilty or efficacy is hindered by negative capital. (check out link below for some of the papers).

    It’s like splitting hairs but perhaps a large haircut (with negative equity) is a large liquidity add and the ECB wants to dampen this. Then again, going from 5bln to 10bln is a net 5bln liquidity drain, small change in the world awash with liquidity.

    There are some who think the ECB has gotten Govts to sign up for the nonstandard measures by this capital call. In other words, Remember We Come first! The timing itself is kind of funny seeing that it points to the fact that they run at very thin capital and won’t be asking for much for a while.

    End analysis: no easy answer.

    • Hi Nick and welcome to my blog.
      There is a difference between the structure of the ECB and ordinary central banks which does make a difference in my opinion. An ordinary central bank is usually backed by the national treasury be it implicitly or explicitly such as say the Bank Of England’s asset purchases when the UK Treasury indemnified it against losses. But the ECB is backed by the various national banks who are backed by their own treasuries which is not quite the same. In my view it should maintain capital to cover its losses. There is a danger for example of some treasuries not being able to pay.

      Of course a central bank can print although in the case of the ECB it may have to strap down and tranquilise the ex-members of the Bundesbank if it did so! But to my mind that is not quite the same thing in the same way that liquidity and capital are not the same thing. Also I feel that it is the wrong thing to do.

      None of the answers are easy I agree and please feel free to comment in future, as the title of the blog implies agreeing with me is by no means compulsory….. On another topic noticing your email address what is the current state of play of the Bank of Japan in this regard?

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