The challenge for the ECB remains Italy and its banks

This week has seen something of an expected shifting of the sands from the European Central Bank ( ECB) about the economic prospects for the Euro area. On Monday its President Mario Draghi told the European Parliament this.

The data that have become available since my last visit in September have been somewhat weaker than expected. Euro area GDP grew by 0.2% in the third quarter. This follows growth of 0.4% in both the first and second quarter of 2018. The loss in growth momentum mainly reflects weaker trade growth, but also some country and sector-specific factors.

What he did not say was that back in 2017 quarterly growth had risen to 0.7% for a time. Back then the situation was a happy one for Mario and his colleagues as their extraordinary monetary policies looked like they were bearing some fruit. However the challenge was always what happens when they begin to close the tap? Let me illustrate things by looking again at his speech.

The unemployment rate declined to 8.1% in September 2018, which is the lowest level observed since late 2008, and employment continued to increase in the third quarter…….. Wages are rising as labour markets continue to improve and labour supply shortages become increasingly binding in some countries.

There is a ying and yang here because whilst we should all welcome the improvement in the unemployment rate, we would expect the falls to slow and maybe stop in line with the reduced economic growth rate. So is around 8% it for the unemployment rate even after negative interest-rates ( still -0.4%) and a balance sheet now over 4.6 trillion Euros? That seems implied to some extent in talk of “labour supply shortages” when the unemployment rate is around double that of the US and UK and treble that of Japan. This returns us to the fear that the long-term unemployment in some of the Euro area is effectively permanent something we looked at during the crisis. In another form another ECB policymaker has suggested that.

I will focus my remarks today on the economies of central, eastern and south-eastern Europe (CESEE), covering both those that are already part of the European Union (EU) and those that are EU candidate countries or potential candidates………..Clearly, for most countries, convergence towards the EU-28 average has practically stalled since the outbreak of the financial crisis in 2008

Care is needed as only some of these countries are in the Euro but of course some of the others should be converging due to the application process. Even Benoit Coeure admits this.

And if there is no credible prospect of lower-income countries catching up soon, there is a risk that people living in those countries begin questioning the very benefits of membership of the EU or the currency union.

I have a couple of thoughts for you. Firstly Lithuania has done relatively well but the fact I have friends from there highlights how many are in London leading to the thought that how much has that development aided its economy? You may need to probe a little as due to the fact it was part of Russia back in the day some prefer to say they are Russian. Also the data reminds us of how poor that area that was once called Yugoslavia remains. It is hardly going to be helped by the development described below by Balkan Insight.

At the fifth joint meeting of the governments of Albania and Kosovo in Peja, in Kosovo, the Albanian Prime Minister Edi Rama backed the decision of the Kosovo government to raise the tax on imports from Serbia and Bosnia from 10 to 100 per cent.


Here the ECB is conflicted. Like all central banks its priority is “the precious” otherwise known as the banks. Yet it is part of the operation to apply pressure on Italy and take a look at this development.

As this is very significant let us break it down and yes in the world of negative interest-rates and expanded central bank balance sheets Unicredit has just paid an eye-watering 7.83% on some bonds. Just the 6.83% higher than at the opening of 2018 and imagine if you held similar bonds with it. Ouch! Of that there is an element driven by changes in Italy’s situation but the additional part added by Unicredit seems to be around 3.5%.

If we look back I recall describing Unicredit as a zombie bank on Sky News around 7 years ago. The official view in more recent times is that it has been a success story in the way it has dealt with non performing loans and the like. Although of course success is a relative term with a share price of 11.5 Euros as opposed to the previous peak of more like 370 Euros. Now it is paying nearly 8% for its debt we need not only to question even that heavily depreciated share price and it gives a pretty dreadful implied view for the weaker Italian banks such as Monte Paschi which Johannes mentions. Also those non-performing loans which were packaged up and sold at what we were told “great deals” whereas now they look dreadful, well on the long side anyway.

Perhaps this was what the Bank of Italy meant by this.

The fall in prices for Italian government securities has caused a reduction in capital reserves and
liquidity and an increase in the cost of wholesale funding. The sharp decline in bank share prices has resulted
in a marked increase in the cost of equity. Should the tensions on the sovereign debt market be protracted, the
repercussions for banks could be significant, especially for some small and medium-sized banks.


We can bring things right up to date with this morning’s money supply data.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, stood at 6.8% in October, unchanged from previous month.

So we are holding station to some extent although in real terms we are slightly lower as inflation has picked up to 2.2%. Thus the near-term outlook remains weak and we can expect a similar fourth quarter to the third. Actually I would not be surprised if it was slightly better but still weak..

Looking around a couple of years ahead the position is slightly better although we do not know yet how much of this well be inflation as opposed to growth.

Annual growth rate of broad monetary aggregate M3 increased to 3.9% in October 2018 from 3.6% in September (revised from 3.5%).

On the other side of the coin credit flows to businesses seem to have tightened.

Annual growth rate of adjusted loans to non-financial corporations decreased to 3.9% in October from 4.3% in September

Personally I think that the latter number is a lagging indicator but the ECB has trumpeted it as more of a leading one so let’s see.

The external factor which is currently in play is the lower oil price which will soon begin to give a boost and will reduce inflation if it remains near US $60 for the Brent Crude benchmark. But none the less the midnight oil will be burning at the ECB as it mulls the possibility that all that balance sheet expansion and negative interest-rates gave economic activity such a welcome but relatively small boost. Also it will be on action stations about the Italian banking sector. For myself I fear what this new squeeze on Italian banks will do to the lending to the wider economy which of course had ground to a halt as it is.



20 thoughts on “The challenge for the ECB remains Italy and its banks

  1. I am amazed that anyone would lend money to these banks at even 8% – I certainly would not as, on any reasonable measure, they are bust and even more so if Italy’s own bonds continue to require higher yields. I feel very sorry for the Italians in this trap, although I believe that the Target 2 balances show quite a large capital flight already…
    Btw, I think that the ECB’s balance sheet is a tad bigger than 4.6 billion Euros. A billion isn’t real money any more!

    • Hi Forbin

      Many of the Italian plates must be spinning at a rate of knots now. More than the issue of what Unicredit is paying many of the Italian banks are in even worse shape so would have to pay more. Which means they will not borrow and will therefore only have the route of reducing liabilties ( aka lending) to reinforce their balance sheets.

  2. I did say on your blog two Italy episodes ago that the Italian long shots would kick da bucket it’s banking system has been bankrupt for 10 years. The Italians will have to take their Greek medicine or else their money supply will be cut off.

    The ECB have forgotten everything and learned nothing.

    • I agree about the ECB learning nothing etc, but I think that it was handed a bit of a hospital pass, as:
      1. It must know that the euro could only work effectively if there is central fiscal policy
      2. It must know that the southern states are hopelessly trapped by the euro
      3. It was set up on the basis that, in time, there would be political and financial convergence
      4. 3 hasn’t happened and isn’t going to happen
      5. It still has to pretend that it is going to be ok.
      I expect that Draghi’s office has a large graph showing the Target 2 balances expanding every month and covers it up every time a German walks into the room…

  3. Hello Shaun,

    in other news Mark has opened his mouth fully all ready for the foot of fate , or both feet , over brexit…..

    why anyone pays him any credence I don’t know…..


    • Hi Forbin

      The places that have given credence to his talk of interest-rate rises just look rather silly as last time he cut them. Bad timing as well because he was late ( twice actually as 7:30 am was switched to 4:30 pm and then there were technical problems) which meant his pea shooter collided with a bazooka fired by US Federal Reserve Chair Jerome Powell.

  4. Hi Shaun,

    I think there is a bigger challenge for not only the ECB but the UK as well after reading the latest news on a no deal BREXIT from the BOE.

    Worst case scenario 8% economy could shrink 8% in the immediate aftermath, a possibili8ty of house prices falling a third and £ could fall 25%!

    Is all this scaremongering ?

    We were warned that the economy will falter on a referendum to Brexit and it didn’t happen!

    One cannot predict anything at the moment, the UK government in a mess I get the feeling the BOE is saying what it is to force a way forward no one likes uncertainty.

    All eyes will be on the vote next month and the indications thus far is no one giving way the PM will lose the vote.

    If all this isn’t bad enough many an economist like Danny Blanchfower forecasting a US recession 2020 !

    The world slowing down now batten down the hatches and all that will do is slow down the economy further!

    The world is in a mess at the moment and 10 years is a long time before a recession!

    Sorry if all this sounds doom and gloom some wold prefer a sharp fall in house prices but I bet the worst case scenario wold see a possibility of negative interest rates and or deep cut and that is why Carney suggests the £ could fall 25% !!!

    • Sorry for the typos and mistakes:

      “We were warned that the economy will falter on a referendum to Brexit and it didn’t happen!”

      Should have been they were warning we would be worse off after the last referendum the UK would be hurt if we voted to leave!

      In the meantime BBC live now saying the US also warning on a no deal:

      Posted at 18:32
      Fed piles onto Brexit warnings


      “The Bank of England isn’t the only body out there worried about Brexit.
      The US central bank has also flagged the disruption caused by the UK’s exit from the European Union as a risk to the American economy.
      The topic is mentioned in the Federal Reserve’s new financial stability report and in a speech in New York on Wednesday, Fed Chair Jerome Powell called the event a good example of a potential “trigger” for financial distress in the US.”

      So there we are everyone will probably be in the mire!

    • You wanna read Nouriel’s 2020 forecast for some real doom. Ithis moniker after all. Seems to me that 2020 is beating a path towards us at rate. The BoE messaging is part of Maybot’s sales plan to dumb politician’s and their vote on the 11th.

  5. 25% fall easy, and more if the UK doesn’t toe the line, the UK will be punished until it learns to be a good European, just like all the other countries that have been threatened.

    Carney would love a fall like that, he could then crow that he warned of exactly that happening, and would use the fall in the pound to justify miniscule increases in interest rates, but never enough to arrest the fall or reverse it.

    His role in exacerbating the weakness of sterling due to his refusal to raise rates since the GFC and the fact he actually cut interest rates following the BREXIT referendum will be totally ignored by the mainstream fake news media of course.

    • A cording to latest on Carney worst case scenario 7 UK banks passed a stress test far worse than the worst case scenario:

      “What does it mean for the banking sector?
      The Bank of England has exposed seven major lenders to a stress test which it said was two and half times more severe than the Brexit scenarios.
      All seven lenders – Royal Bank of Scotland, HSBC, Barclays, Lloyds, Standard Chartered, Santander and Nationwide Building Society – passed the test.”

      So interest rates could rise to above 4% and that would not only hit householders with mortgages but many companies who are reliant on borrowings!

      My own predictions would suggest many a business and large retailers would go bust overnight, John Lewis, Debenhams. Marks Spencer all at risk at the moment.

      With higher interest rates re-possessions wold follow bear in mind personal borrowing back to decade ago highs.

      £ plummets imports rise consumers in the shi*

      Unemployment rises more house repossessions more bankruptcies.

      Commercial property prices collapse, more trouble for the banks!

      I could go on but I do not believe the banks are capable of passing any stress test under the worst case scenarios not when assets are way overvalued!

  6. Hi Shaun
    As predicted TPTB are ratcheting up the rhetoric and the total
    imbalance of the Tv media is to me appalling, thank goodness
    that our news editors,like the BofE committee are independent:o)
    Never cared for what they do.
    Never cared for what they know.
    But I know.


      • Whatever the rights and wrongs of the many dire warnings:
        1. It seems to me daft that they pretend to know what the economy will look like in 2030. I would like to see their assumptions on the exchange rate, inflation, unemployment, immigration, Corbyn government etc etc as a starter;
        2. When you see the daily diatribe against no-deal (yesterday the BoE, today the pharma comanies), the obvious coordination undermines the point. Project Fear had the BoE one day, defence the next, the banks the next, the economists the next. You just knew that it was a fix. And now, coincidentally just before the vote in parliament, here they are again, the same lot at the rate of one or two a day for maximum impact.
        We already know that the establishment doesn’t want to leave, but the way they treat the rest of us (even if they are right) is patronising at best, plain dishonest at worst.
        Carney’s figures are plucked out of the air and he knows it. Had he been a Brexiteer, he could and would have produced totally different figures.
        Rant over. Back to bed with a good book.

        • I wonder how many days it will be before they bring out Blair, Brown and
          Major to enlighten us with their platitudes, don’t TPTB realize how much
          disrespect the masses have for their opinions?

          • The answer is clearly “no”, they don’t have any idea of the level of how they are perceived. If you spend your whole life in politics, you talk to the BBC, other politicians, you swan off round the world to Davos etc, you talk to the BoE, senior civil servants, where on earth are you going to meet the masses? On a staged factory tour? A visit to an old woman who you call a bigot as soon as you leave her house? A party congress?
            That is why they are all so shocked when Trump wins or Brexit happens or AfD becomes the official opposition in Germany or when Orban bans Muslims or when Marine le Pen comes second or those ghastly fascists take over Italy and Austria or people riot over fuel duty in France.
            None of them can understand any of this because they never talk to anyone outside the bubble. They have focus groups to tell them what the great unwashed think.
            That is also why, IMHO, the stuff about GDP falling in 2030 isn’t going to cut much ice with Brexit voters. Where I live (a long way from London), people haven’t had a wage rise in years because of Eastern European immigration. It’s no good tellling people about some theoretical number in ten years’ time, when they see right in front of their eyes that every semi and unskilled job is now being done by migrants and they are now driving taxis etc on low wages.
            It’s no good harping on about the benefits of the EU when it clearly has not benefited them in any way.
            There is a large pig processing plant in Norfolk which now employs 50 Brits and 850 Eastern European’s, all on minimum wage. Ten years ago, the same plant employed 900 Brits on £ 12 an hour. Try telling them that the EU is about 2030 GDP levels.

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