Let is continue the central banking season which allows us to end the week with some good news. As this week has developed there has been good news about economic growth in the Euro area.
The Federal Statistical Office (Destatis) reports that, in the third quarter of 2017, the gross domestic product (GDP) rose 0.8% on the second quarter of 2017 after adjustment for price, seasonal and calendar variations. In the first half of 2017, the GDP had also increased markedly, by 0.6% in the second quarter and 0.9% in the first quarter.
It has been a strong 2017 so far for the German economy but of course whilst analogies about it being the engine of the Euro area economy might be a bitter thinner on the ground due to dieselgate there are still elements of truth about it. But we know that a rising tide does not float all economic boats so ECB President Mario Draghi will have been pleased to see this about a perennial struggler.
In the third quarter of 2017 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.5 per cent with respect to the second quarter of 2017 and by 1.8 per cent in comparison with the third quarter of 2016.
Of course Mario will be especially pleased to see better news from his home country of Italy especially at a time when more issues about the treatment of non-performing loans at its banks are emerging. Also this bank seems to be running its own version of the never-ending story, from the Financial Times.
A group of investors in the world’s oldest bank, Italy’s Monte dei Paschi di Siena, have filed a lawsuit in Luxembourg after it announced bonds would be annulled as part of a state-backed recapitalisation.
But in Mario’s terms he is likely to consider the overall numbers below to be a delivery on his “whatever it takes” speech and promise.
Seasonally adjusted GDP rose by 0.6% in the euro area…….Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.5% in the euro
area.
Inflation
This is a more problematic area for Mario Draghi as this from his speech in this morning indicates.
According to a broad range of measures, underlying inflation has ticked up moderately since the start of this year, but it still lacks clear upward momentum.
This matters because unlike the Bank of England the ECB takes inflation targeting seriously and a past President established a rather precise estimate of it at 1.97% per annum. We seem unlikely now to ever find out how Mario Draghi would deal with above target inflation but he finds himself in what for him maybe a sort of dream. Economic growth has recovered with inflation below target so he can say this.
This recalibration of our asset purchases, supported by the sizeable stock of acquired assets and the forthcoming reinvestments, and by our forward guidance on interest rates, helps to maintain the necessary degree of accommodation and thereby to accompany the economic recovery in an appropriate way.
So we will get negative interest-rates ( -0.4%) for quite a while yet as he has hinted in the past that they may persist past the end of his term. Also of course whilst at a slower rate ( 30 billion Euros a month) the QE ( Quantitative Easing) programme continues. Even that has worked out pretty well for Mario as continuing at the previous pace seemed set to run out of German bonds to buy.
Consequences
However continuing with monetary expansion into a boom is either a new frontier or something which later will have us singing along with Lyndsey Buckingham.
(I think I’m in)(Yes) I think I’m in trouble
(I think I’m in) I think I’m in trouble
Corporate Bonds
When you buy 124 billion Euros of corporate bonds in a year and a few months there are bound to be consequences.
https://twitter.com/creditmacro/status/931440101175029761
“Tequila Tequila” indeed. What could go wrong with this.?
OK, we are officially in la la land. A BBB rated company just borrowed 500 million EUR for 3 years with a negative yield of -0.026 %. A first.. ( h/t @S_Mikhailovich )
You can take your pick whether you think that Veolia is able to issue debt at a negative interest-rate or at only 0.05% above the swaps rate is worse.
Mario Draghi explained this sort of thing earlier in a way that the Alan Parsons Project would have described as psychobabble.
By accumulating a portfolio of long-duration assets, the central bank can compress term premia by extracting duration risk from private investors. Via this “duration extraction” effect, the central bank frees up risk bearing capacity in markets, spurs a rebalancing of private portfolios toward the remaining securities, and thus lowers term premia and yields across a range of financial assets.
Moral hazard anyone?
The dangers of this sort of thing have been highlighted by what has happened to Carillion this morning.
The wages problem
It is sometimes argued in the UK that weak wage growth is a consequence of high employment and low unemployment. But we see that there are issues too in the Euro area where the latter situations whilst improved are still poorer.
A key issue here is wage growth.Since the trough in mid-2016, growth in compensation per employee has risen, recovering around half of the gap towards its historical average. But overall trends remain subdued and are not broad-based.
Indeed if we look back to late May Mario gave us a rather similar reason to what we often here in the UK as an explanation of weak wages growth.From the Financial Times.
Mr Draghi also acknowledged concerns that sinking unemployment was not leading to a recovery in well-paid permanent jobs………….Mr Draghi said he agreed. “What you say is true,” he said. “Some of this job creation is not of good quality.”
The Italian Job
As I hinted earlier in this piece there are ever more signs of trouble in the Italian banking sector. There have been many cases of can kicking in the credit crunch era but this has been something of a classic with of course a dash of Italian style and finesse. From the FT.
Mid-sized Genoan bank Carige’s future looked uncertain this week after a banking consortium pulled its support for a €560m capital increase demanded by European regulators. Shares in another mid-sized bank Credito Valtellinese fell 8.5 per cent to a market value of €144m after it announced a larger than anticipated €700m capital raising to shore up its balance sheet.
There are issues with banks elsewhere as investors holding bonds which were wiped out insist on their day in court.
Comment
As you can see there is indeed good news for Mario Draghi to celebrate as not only is the Euro area seeing solid economic growth it is expected to continue.
From the ECB’s perspective, we have increasing confidence that the recovery is robust and that this momentum will continue going forward.
The problem though is where does it go from here? Even Mario himself worries about the consequences of monetary policy which has been so easy for so long and is now pro cyclical rather than anti cyclical before of course dismissing them. But unless you believe that growth will continue forever and recessions have been banished there is the issue of how do you deal with the latter when you already have negative interest-rates and ongoing QE?
Also the inflation target problem is covered up by describing it is price stability when of course it is anything but.
Ensuring price stability is a precondition for the economy to be able to grow along a balanced path that can be sustained in the long run.
Wage growth would be improved in real terms if inflation was lower and not higher.
Also Mario has changed his tune on the fiscal situation which he used to regularly compare favourably to elsewhere.
This means actively putting our fiscal houses in order and building up buffers for the future – not just waiting for growth to gradually reduce debt. It means implementing structural reforms that will allow our economies to converge and grow at higher speeds over the long-term.
Number Crunching
This from Bloomberg seemed way too high to me.
Italy’s failure to qualify for the soccer World Cup finals for the first time in 60 years may cost the country about 1 billion euros ($1.2 billion), the former chairman of the national federation said.
Me on Core Finance
http://www.corelondon.tv/2-uk-growth-cap-unreliable-predictive-bodies-bad/
Notayesmanseconomics's Blog 
Hi Shaun, I will be honest that I do not understand Dragi’s words relating to duration extraction… please can you put in simple words for me? thanks Paul
Hi Paul
In essence the argument is that by buying longer dated bonds the ECB is taking risk away from the private investors who would otherwise hold the bonds. Duration is a measure of time to go on a bond and the interest-rate/yield ( the latter bit matters less this days because of where yields are). So the claim is that by taking duration away investors will want more risk elsewhere.
The term premia bit is an attempt to measure duration but well I will let the Bank of England explain it.
“As it is not possible to observe term premia directly, they need to be estimated using a model of bond yields. But, as with any economic model, there is substantial uncertainty involved”
Is it just me that gets deja vu of the Soviets reporting tractor production whenever the Eurozone reports it’s figures? I can only think of the economic horrors concealed below the macro reporting such as Greece and mass youth unemployment. There is also another question I have that I hope someone can help with.
QE purchases bonds from banks etc. But as the state runs a deficit it issues more bonds in exchange for the cash created by bond purchases. That is simply shifting the burden of payment from our other deficit (excluding banks and financials) to our deficit that we pay with indirect price rises and cuts in services.
Have I got this right? It smacks of state aid to me.
Hi bill40
Narrow money is created as the central bank buys the bonds. The problem is where the money then goes about which we get flickers of knowledge ( for example often some of it gets redeposited at the central bank). Maybe some of the cash created is then spent on new bonds but that does not affect the burden of payment. One thing that reduces it over time is that bond yields have fallen so it is cheaper to issue debt. So the aid goes to the government in power.
There are always consequences –
One Tequila, two Tequila, three Tequila, floor!
🙂
Eurozone only has 5 problems
Spain
Italy
Portugal
RBS
Hi Dutch
RBS?