The ECB will be cutting its balance sheet as it cuts interest-rates under present plans.

We can start our look at the Euro area economy with a reflection via the Dine series of books. For those unaware in Dune it is the future which is known and the past which is uncertain. I thought of this as I read the latest HCOB PMI update last week.

“The eurozone got off to a good start in the second quarter. The Composite HCOB Flash PMI took a significant step into
expansionary territory. This was propelled by the services sector, where activity has gathered further steam. Considering various factors including the HCOB PMIs, our GDP forecast suggests a 0.3% expansion in the second quarter, matching the growth rate seen in the first quarter, both measured against the preceding quarter.”

The estimate for the first quarter caught my eye because we had been told 47.9 in January or a decent rate of contraction, 49.2 in February for a minor contraction and 50.3 in March for an even more minor expansion. Some argue that in range of 48-52 the PMI numbers mostly just say a form of stagnation and you can take that two ways. One is that with economic growth at this rate being a bit more than 1% they have a point. Or for these times 1% actually feels okay. But my main point is that the PMI series has just rather rewritten its own history.

This matters as we know that the ECB follows it with President Lagarde and and Dr.Schnabel in the van of those who regularly mention it. Also in an unusual occurrence it shows President Lagarde as being correct in that the survey would show some better news. Although the most recent ECB statement changed its mind.

The economy remained weak in the first quarter.

Also her most recent speech has a curious reflection on things.

But history tells us that ideas can only drive growth if we first create the right conditions that allow them to reach their full potential – and if we are committed to breaking the bottlenecks that stand in their way.

The issue of “bottlenecks” reminds me that every press conference from her predecessor Mario Draghi called for reform. This type of theme continues here.

Most advanced economies, however, have seen productivity decelerate for some time.

Regular readers will recall us looking at a rather downbeat analysis of this from Dr.Isabel Schnabel which is now apparently morphing into this according to President Lagarde.

Developments in recent years suggest that the case for optimism was stronger.

Eh?

The good news for global productivity growth is that we see these new ideas flourishing across major economies, a direct legacy from the common ties that were crafted during the era of globalisation. And Europe, in contrast to what some may believe, is actually well placed to benefit from these ideas.

Those who see this being driven by the big US tech companies may be wondering how all the European attacks on them leave the European Union well placed? They may well be simply adding most of this to US GDP.

One study finds that generative AI alone has the potential to add up to almost USD 4.5 trillion annually to the global economy, roughly 4% of global GDP.^[10

Maybe it was a bit of a Freudian slip to measure it in US Dollars….

According to President Lagarde Europe is the world leader.

According to one study, Europe draws in more AI talent than the United States, with over 120,000 active AI roles, and last year, Europe accounted for one-third of total early-stage capital invested in AI and machine learning across the two economies.

I have had a look at the source quoted for this and it also refers to the UK so the definition of “Europe” used by President Lagarde seems to be rather flexible.

Money Supply

Friday’s update brought some minor improvements.

• Annual growth rate of broad monetary aggregate M3 increased to 0.9% in March 2024 from 0.4% in February

If you take that literally the rate of inflation looks set to fall further if we look ahead 18/24 months or so. The catch is that these numbers have been suggesting low inflation (good) but also low economic growth for a while now.

• Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, was -6.7% in March, compared with -7.8% in February

There may be more of a change here than it may immediately look because the -113 billion Euros of January were replaced with 10 billion Euros in March. The numbers may not be accurate to 10 billion but there looks to have been quite a change for the better. Although that does rather collide with planned ECB policy.

The Governing Council intends to continue to reinvest, in full, the principal payments from maturing securities purchased under the PEPP during the first half of 2024. Over the second half of the year, it intends to reduce the PEPP portfolio by €7.5 billion per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.

So until the end of June we have a “the spice must flow” type of situation. But then any narrow money growth will face a monthly headwind of 7.5 billion Euros and at the end of the year reinvestments will stop meaning a faster pace of reduction. In monetary terms this will be picked up by the M1 numbers as cash is withdrawn. It will also influence the broader measures. This will be added to the existing contraction.

 In addition to that, given the APP gradual runoff, we also reduce our balance sheet by an average of about EUR 30 billion per month.

This gives us a really awkward situation. We have some hopes of economic improvement via a change in the narrow money supply and the ECB may stamp on it just as it is cutting interest-rates!

 but in June we know that we will get a lot more data and a lot more information and we will also have new projections, which will incorporate and be informed by all that will be published before the projection is completed.

For all the rhetoric about being “data dependent” we are being guided towards a June rate cut which will coincide with a further restriction in the money supply via more QT. Iy would be sensible to reverse course on the latter but President Lagarde was adamant.

That process is ongoing and will continue to happen as anticipated, as predicted and as determined by the maturity of those bonds that come to runoff, and then we will move to the reduction of the PEPP reinvestment, from the 1^st of July until the end of December. That’s the plan, but there is no further discussion on that.

Comment

The possible improvement in Euro area growth will not make much difference to the ECB and no doubt some wags will spot that inflation in terms of the ECB towers remains below target this morning.

Germany Hesse CPI (YoY) (Apr) $EUR Actual: 1.9% Previous: 1.6% ( @PiQSuite)

But if we switch to Quantitative Tightening we see that many central banks have got themselves into quite a mess. The US with the best performing economy as loosened the QT strings although it is not the Federal Reserve’s fault as Treasury Secretary Yellen has issued lots of short-dated debt. Whereas the ECB is trimming its sails and intends to add to it with a much worse economic performance. So I would not be surprised if the ECB abandons some of this. Better to be embarrassed than to actually be a fool.

Although it does beg a question of when the ECB can reduce its QE bond holdings?

Podcast

This week’s podcast has turned out to be rather timely as we see the Yen plunge and now intervention today.