Slowing growth and higher inflation is a toxic combination for the Euro area

Sometimes life comes at you fast and the last week will have come at the European Central Bank with an element of ground rush. It was only on the 30th of last month we were looking at this development.

Seasonally adjusted GDP rose by 0.2% in the euro area (EA19) and by 0.3% in the EU28 during the third quarter
of 2018,

Which brought to mind this description from the preceding ECB press conference.

Incoming information, while somewhat weaker than expected, remains overall consistent with an ongoing broad-based expansion of the euro area economy and gradually rising inflation pressures. The underlying strength of the economy continues to support our confidence ……..

There was an issue with broad-based as the Italian economy registered no growth at all and the idea of “underlying strength” did not really go with quarterly growth of a mere 0.2%. But of course one should not place too much emphasis on one GDP reading.

Business Surveys

However this morning has brought us to this from the Markit Purchasing Managers Indices.

Eurozone growth weakens to lowest in over two years

The immediate thought is, lower than 0.2% quarterly growth? Let us look deeper.

Both the manufacturing and service sectors
recorded slower rates of growth during October.
Following on from September, manufacturing
registered the weaker increase in output, posting its
lowest growth in nearly four years. Despite
remaining at a solid level, the service sector saw its
slowest expansion since the start of 2017.

There is a certain sense of irony in the reported slow down being broad-based. The issue with manufacturing is no doubt driven by the automotive sector which has the trade issues to add to the ongoing diesel scandal. That slow down has spread to the services sector. Geographically we see that Germany is in a soft patch and I will come to Italy in a moment. This also stuck out.

France and Spain, in contrast, have
seen more resilient business conditions, though both
are registering much slower growth than earlier in
the year.

Fair enough for Spain as we looked at only last Wednesday, but France had a bad start of 2018 so that is something of a confused message.

Italy

The situation continues to deteriorate here.

Italy’s service sector suffered a drop in
performance during October, with business activity
falling for the first time in over two years. This was
partly due to the weakest expansion in new
business in 44 months.

Although I am not so sure about the perspective?

After a period of solid growth in activity

The reality is that fears of a “triple-dip” for Italy will only be raised by this. Also the issue over the proposed Budget has not gone away as this from @LiveSquawk makes clear.

EU’s Moscovici: Sanctions Can Be Applied If There Is No Compromise On Italy Budget $EURUSD -Policy In Italy That Entails Higher Public Debt Is Not Favourable To Growth.

Commissioner Moscovici is however being trolled by people pointing out that France broke the Euro area fiscal rules when he was finance minister. He ran deficits of 4.8% of GDP, followed by 4.1% and 3,9% which were above the 3% limit and in one instance double what Italy plans. This is of course awkward but not probably for Pierre as his other worldly pronouncements on Greece have indicated a somewhat loose relationship with reality.

Actually the Italian situation has thrown up another challenge to the Euro area orthodoxy.

https://twitter.com/LucioMM1/status/1059553782655344641

 

Regular readers will be aware I am no fan of simply projecting the pre credit crunch period forwards but I do think that the Brad Setser point that Italy is nowhere near regaining where it was is relevant. If you think that such a situation is “above potential” then you have a fair bit of explaining to do. Some of this is unfair on the ECB in that it has to look at the whole Euro area as if it was a sovereign nation it would be a situation crying out for some regional policy transfers. Like say from Germany with its fiscal surplus. Anyway I will leave that there and move on.

Ch-ch-changes

This did the rounds on Friday afternoon.

ECB Said To Be Considering Fresh TLTRO – MNI ( @LiveSquawk )

Targeted Long-Term Refinancing Operation in case you were wondering and as to new targets well Reuters gives a nod and a wink.

Euro zone banks took up 739 billion euros at the ECB’s latest round of TLTRO, in March 2017. Of this, so far 14.6 has been repaid, with the rest falling due in 2020 and 2021.

This may prove painful in countries such as Italy, where banks have to repay some 250 billion euros worth of TLTRO money amid rising market rates and an unfavorable political situation.

So the targets of a type of maturity extension would be 2020/1 in terms of time and Italy in terms of geography. More generally we have the issue of oiling the banking wheels. Oh and whilst the Italian amount is rather similar to some measures of how much they have put into Italian bonds there is no direct link in my view.

Housing market

If you give a bank cheap liquidity then this morning’s ECB Publication makes it clear where it tends to go.

The upturn in the euro area housing market is in its fourth year. Measured in terms of annual growth rates, house prices started to pick up at the end of 2013, while the pick-up in residential investment started somewhat later, at the end of 2014. The latest available data (first quarter of 2018) indicate annual growth rates above their long-term averages, for both indicators.

How has this been driven?

 In addition, financing conditions remained favourable, as reflected in composite bank lending rates for house purchase that have declined by more than 130 basis points since 2013 and by easing credit standards. This has given rise to a higher demand for loans for house purchase and a substantial strengthening in new mortgage lending.

Indeed even QE gets a slap on the back.

Private and institutional investors, both domestically and globally based, searching for yield may thus have contributed to additional housing demand.

It is at least something the central planners can influence and watch.

Housing market developments affect investment and consumption decisions and can thus be a major determinant of the broader business cycle. They also have wealth and collateral effects and can thus play a key role in shaping the broader financial cycle. The housing market’s pivotal role in the business and financial cycles makes it a regular subject of monitoring and assessment for monetary policy and financial stability considerations.

 

Comment

The ECB now finds itself between something of a rock and a hard place. If we start with the rock then the question is whether the shift is just a slow down for a bit or something more? The latter would have the ECB shifting very uncomfortably around its board room table as it would be facing it with interest-rates already negative and QE just stopping in flow terms. Let me now bring in the hard place from today’s Markit PMI survey.

Meanwhile, prices data signalled another sharp
increase in company operating expenses. Rising
energy and fuel prices were widely reported to have
underpinned inflation, whilst there was some
evidence of higher labour costs (especially in
Germany).

Whilst there may be some hopeful news for wages tucked in there the main message is of inflationary pressure. Of course central bankers like to ignore energy costs but the ECB will be hoping for further falls in the oil price, otherwise it might find itself in rather a cleft stick. It is easy to forget that its “pumping it up” stage was oiled by falling energy prices.

Yet an alternative would be fiscal policy which hits the problem of it being a bad idea according to the Euro area’s pronouncements on Italy.