What to do with a problem like Germany? Cut interest-rates further….

Over the past year there has been something of a sea change for the economy of Germany. After a period of what in these times was strong economic growth the engine of the Euro area has stuttered and coughed. If we look at it in annual terms economic growth went from the 2.2% of 2016 and 2017 to 1.4% last year and the latter was the story of two halves as the second half saw the economic contract in the third quarter and flat line in the fourth. This fits with our subject of yesterday Deutsche Bank which has seen its share price fall by 36% over the past year as both it and its home economy have struggled. Oh and that new bad bank plan rallied the share price for a day and a bit as it is back to 6.03 Euros. So it looks like another new plan is singing along with Queen.

Another one bites the dust
Another one bites the dust
And another one gone, and another one gone
Another one bites the dust.

What Next?

The opening quarter of this year offered some relief as Germany saw the economy grow by 0.4%. However yesterday in its June report the Bundesbank pointed out that it was not convinced that this represented a genuine turn for the better. 

Special effects that contributed to a noticeable rise in gross domestic product in the first quarter are either expiring or being reversed.

Google Translate is a little clunky here but we see that it feels that the construction industry will not have boosted the economy.

So is the construction industry on a quarterly average with certain Rebound effects. Due to weather conditions, construction activity had widened considerably in the winter months.

Also it feels that the ongoing problems with sales of diesel engined cars which we see pretty much everywhere we look will impact again after flattering things as 2019 opened.

Furthermore, due to delivery difficulties as a result of the introduction of the new emissions test procedure WLTP (Worldwide Harmonized Light Vehicles Test Procedure) last fall. Deferred car purchases have been made up for the most part.

It notes that the industrial production sector had a rough April.

Industrial production decreased in the April 2019 strongly. In seasonally adjusted account it fell below the previous month’s level by 2½%. As a result, industrial production also fell sharply compared to the mean of the winter months (- 2%).

Do the business surveys back this up?

If we start with construction then here is the latest from Markit.

After a solid performance in early-spring, the German
construction sector continued to lose momentum during May, recording its weakest rise in total activity for four months……It’s been a largely positive start to the year for the sector, but a first fall in new orders in nine months points to some downside risks to the short-term outlook.

So broadly yes and maybe further slowing is ahead. 

However as we look wider Markit is more optimistic than the Bundesbank.

The Composite Output Index continued to point to a modest
pace of growth across Germany’s private sector. At 52.6, the latest reading was up from 52.2 in April and the highest in three months, but still below the long-run series average of 53.4 (since 1998).

That is interesting as central banks love to peruse PMI numbers. Mind you perhaps they had advance warning of this released this morning from the ZEW Institute.

The German ZEW headline numbers for June showed that the economic sentiment index arrived at -21.1 versus -5.9 expectations and -2.1 last. While the sub-index current conditions figure jumped to 7.8 versus 6.0 expected and 8.2 booked previously, bettering market expectations. ( FXSTREET )

There is a little irony in the present being better than expected but it is rather swamped by the collapse in expectations. The ZEW is an arcane index that is hard to get a handle on so we should not overstate its significance but the change is eye-catching.

A policy response

I was going to point out that this was going to be an influence on the policy of the European Central Bank or ECB. This comes in two forms as firstly Germany is such a bell weather for the Euro area and according to recently updated ECB capital key is 26.4% of it. Also of course there is the thought that overall ECB policy is basically set for Germany. Thus I was expecting some news or what have become called “sauces” from the ECB summer camp at Sintra which opened last night. This morning we have already learned that President Draghi packed more than his shorts, sun cream and sunglasses.

In this environment, what matters is that monetary policy remains committed to its objective and does not resign itself to too-low inflation.

Here he is setting out his stall and the emphasis is his. There is a clear hint in the way that he is pointing at “too-low inflation” as in the coded language of central bankers it leads to this.

Looking forward, the risk outlook remains tilted to the downside, and indicators for the coming quarters point to lingering softness.

So now not only do we have too-low inflation we have a weak economy too. So if we were a pot on the stove we are now gently simmering. Then Mario turns up the gas.

In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.

First though we have to wait as he continues with the dead duck that is Forward Guidance.

We remain able to enhance our forward guidance by adjusting its bias and its conditionality to account for variations in the adjustment path of inflation.

After all if it worked we would not be here would we? But then we get to boiling point.

This applies to all instruments of our monetary policy stance.

Further cuts in policy interest rates and mitigating measures to contain any side effects remain part of our tools.

And the APP still has considerable headroom.

For newer readers the APP is the Asset Purchase Programme or how it has operated what has become called Quantitative Easing or QE. This is significant because if there is a country which lacks headroom it is our subject of today Germany. This is because it has been running a fiscal surplus and reducing its national debt which combined with the existing ECB purchases means there are not so many to buy these days. Not Italy though as there are plenty of its bonds around.

Finally we get a reinforcement of the theoretical framework with this.

What matters for our policy calibration is our medium-term policy aim: an inflation rate below, but close to, 2%. That aim is symmetric, which means that, if we are to deliver that value of inflation in the medium term, inflation has to be above that level at some time in the future.


We may have seen the central banking equivalent of what is called a “one-two” in boxing. Yesterday the German Bundesbank talks of an economic contraction and today Mario Draghi is hinting that more easing  is on its way.  What this may mean is that whilst the Bundesbank is unlikely to be leading the charge for easier policy it will not stand in its way. Also if Mario Draghi is going to do this there is not a lot of time left as he departs in October, does he plan to go with a bang?

This has already impacted German financial markets as they look at the newswires and price German bonds even higher. After all if you expect a large buyer why not make them pay for it? So it is now being paid even more to borrow as the benchmark ten-year yield reaches another threshold at -0.3%. Or if you prefer the futures contract has hit all time highs in the 172s.

Of course if the easing worked we would not be here so there is an element of going through the motions about this. Also let’s face it only central bankers and their cheerleaders think low inflation is a bad idea. Sadly the media so rarely challenge them on how they will make people better off via them being poorer.


14 thoughts on “What to do with a problem like Germany? Cut interest-rates further….

  1. “That aim is symmetric, which means that, if we are to deliver that value of inflation in the medium term, inflation has to be above that level at some time in the future.”

    Those words seem to be coming from both sides of the Atlantic now, so I think there is a co-ordinated policy by central bankers to let inflation rip and when questioned simply say they are compensating for the prior periods when it undershot, of course no media whores will question them further on this.
    Also as Shaun points out, there are virtually no German Bunds left to buy -10 year at -0.3% anyone?
    So I fully expect further buying of southern country bonds to drive yields lower and of course house prices higher, and eventually equities, as will the Fed when they are faced with a falling market and realise they have to overtly support the market instead of covertly as they have for the past thirty years.
    I don’t think they’ll need to tell Carney to loosen inflation, he will be way ahead of the pack without any prompting.
    Stockmarkets are now frontrunning the central banks and buying(when QE is re-introduced – remember it was temporary ten years ago?) before they do, expect the US indices to make new highs soon.

    • Hi Kevin

      Lower interest-rates and indeed negative ones were supposed to be temporary too. I don’t think anybody meant they were going to go even lower.

      As to the inflation issue the ECB has failed in its aim to get inflation to run at 2% per annum. Personally I welcome that but they do not. Also ironically if they had put house prices ( 4.2% higher as of the last quarter of 2018) in the HICP inflation measure they would be much nearer to it. In the end that is the swerve which is that it is asset price friendly but has not so far affected the official inflation measure much considering the 2.6 Trillion Euros used.

  2. Great blog as usual, Shaun. I don’t know how Draghi can say that an inflation rate of just under 2% is his symmetrical target with a straight face. From May 2012, the first May after he took office, to May 2019, the annualized HICP inflation rate for the euro area is 0.99%. In May 2019, it stands at 1.2%. In terms of his defined goal, he has been a miserable failure at his job. The problem isn’t so much that he doesn’t practice what he preaches, but that he doesn’t preach what he practices.

    • Hi Andrew and thank you

      That number makes me smile because it is in fact half of what Jean-Claude Trichet put the inflation target as when he defined close to 2% as the 1.97% it had been in his time. I am sure 1.98% or double 0.99% would have been just fine too.

      In a way he may be happy to fail as he can then keep easing policy and if economic trouble continues to arrive he has an alibi.

  3. shaun,

    “What to do with a problem like Germany? Cut interest-rates further”

    Yes keep cutting them and you know what happens to grass if you keep cutting it in summer?
    Gets burnt !

    But of course cutting interest rates is a tool as we all know and can encourage people to spend their money but even that has problems.

    It can inflate assets as has been discussed on this blog numerous times and all seem to have agreed on here property prices are overvalued on numerous metrics here and most places abroad.

    Price of gold gone up but in reality its been a poor investment over 40 years or so I say that as I used to be interested in numismatics and followed the sovereign price many moons ago but moved on to other things.

    So what does one do with their money?

    Well I could quote scripture which says don’t put your faith in earthly things, “moths will eat your clothes gold will rust ands thieves will steal your money”. Well in truth we know now gold doesn’t rust but it can be stolen!

    History however does teach us many lessons corrections do take place!

    I hope I am not coming over as the grim reaper but I am old enough to have seen most things in economics.

    • Hi Peter

      With London’s recent weather the idea of grass being burnt seems from another world but I take your point. The problem investment wise is that the things which would benefit from the next round of easing and QE are already overvalued.

      Oh what a tangled web and all that…

  4. Hello Shaun,

    the inflation they speak of is of course that Creative Price Index , one made from all the possible things that can be cheaper next month from this.

    so what of non core , measured by RPI ?

    well if they wanted inflation , there it is , large as life!

    whats changed? well the economy has – people have no money

    as you say “Sadly the media so rarely challenge them on how they will make people better off via them being poorer”

    and MSM keep pumping , love island , x factor, and the soaps ……. keep moving folks! nothing to see here…..

    interesting times indeed!

    • Hi Forbin

      The CPI as we call it or HICP as it is in Europe was supposed to have owner occupied housing in it. But somehow they have had amnesia for around 20 years. It was supposed to be on its way at the end of last year but then they listed some problems which were known all along. So it is a Euro version of the delaying tactics of Sir Humphrey Appleby.

      As to your rent point below I note this from @grodaeu on Twitter.

      “Emulating Sweden: To get a rental contract you will have to pay €50000 on the black market.”

  5. Hello Shaun,

    soon as I navigate to Reuters I see this…..

    “Berlin’s city government decided on Tuesday to freeze rents for five years, heeding complaints from residents that their once famously affordable city was pricing them out. ”

    oh inflation , Wherefore art thou ?

    oh I forgot , rent must be non core , ahhah


  6. Hi Sean

    Last time I checked one of the functions of money was a “store of value”. As the overseer of our monetary system one might expect the BoE to put some weight on this fact. The evidence suggests otherwise. For a typical UK saver the choice is simple, invest in equities / property and pray the market doesn’t fall sharply or accept that the real value of your savings will be eroded every year. When interest rates averaged around 4% a 2% inflation target still gave investors a positive, after tax, real return. When interest rates are closer to 1% and possibly heading lower this is no longer the case. In the past, the real threat to the value of our money typically came from inflation, today it also comes from ever lower interest rates and central banks that seem to delude themselves that the low and stable inflation we have typically seen in recent years is unacceptable (when inflation targeting was first introduced Central Banks claimed that the main benefits were that low and stable inflation allowed businesses and consumer to plan for the long term – I assume this is no longer so important!). Talk of wealth taxes are increasingly on the political agenda – they are already here thanks to central bank actions – and look like they are only going to get worse.


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