Why are we told some inflation is good for us?

A major topic in the world of economics is the subject of inflation which has been brought into focus by the events of the past 2/3 years or so. First we had the phase where a fall in the price of crude oil filtered through the system such that official consumer inflation across many countries fell to zero per cent on an annual basis and in some cases below that. If you recall that led to the deflation scare or it you will excuse the capitals what much of the media presented as a DEFLATION scare. We were presented with a four horsemen of the apocalypse style scenario where lower and especially negative inflation would take us to a downwards spiral where wages and economic activity fell as well along the line of this from R.E.M.

It’s the end of the world as we know it.
It’s the end of the world as we know it.

I coined the phrase “deflation nutter” to cover this because as I pointed out, Greece the subject of yesterday suffered from quite a few policy errors pushing it into depression and that on the other side of the coin for all its problems Japan had survived years and indeed decades of 0% inflation. Indeed on the 29th of January 2015 I wrote an article on here explaining how lower consumer inflation was boosting consumption across a range of countries via the positive effect it was having on real wages.

 if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly. If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.

 

Relative prices

The comfortable cosy world of central bankers and theoretical economists told us and indeed continues to tell us that we need positive inflation so that relative prices can change. That leads us to the era of inflation targets which are mostly set at 2% per annum although of course there is a regular cry for inflation targets to be raised. However 2015/16 torpedoed their ship as if we just look at the basic change we saw a large relative price adjustment for crude oil leading to adjustments directly to other energy costs and a lot of other changes. Ooops! Even worse for the theory we saw two large sectors of the economy respond in opposite fashion. A clear example of this was provided by my own country the UK where services inflation barely changed and ironically for a period of deflation paranoia was quite often above the inflation target. But the goods sector saw substantial disinflation as it was it that pulled the overall measure down to around 0%.

We can bring this up to date by looking at the latest data from the Statistics Bureau in Japan.

  The consumer price index for Ku-area of Tokyo in October 2017 (preliminary) was 100.1 (2015=100), down 0.2% over the year before seasonal adjustment, and down 0.1% from the previous month on a seasonally adjusted basis.

So not only is there no inflation here there has not been any for some time. Yet the latest monthly update tells us that food prices fell by 2.4% on an annual basis and the sector including energy fuel and lighting rose by 7.1%. Please remember that the next time the Ivory Towers start to chant their “we need inflation so relative prices can adjust” mantra.

Reality

This is that central banks are in the main failing to reach their inflation targets. For example if we look at the US economy the Federal Reserve targets the PCE ( Personal Consumption Expenditure) inflation measure which was running at an annual rate of 1.6% in September and even that level required an 11.1% increase in energy prices.

So we see central banks and establishments responding to this of which the extreme is often to be found in Japan. From @lemasabachthani yesterday.

JAPAN PM AIDE HONDA: INAPPROPRIATE TO REAPPOINT BOJ GOV KURODA, BOJ NEEDS NEW LEADERSHIP TO ACHIEVE 2 PCT INFLATION TARGET

Poor old Governor Kuroda whose turning of the Bank of Japan into the Tokyo Whale was proving in his terms at least to be quite a success. From the Financial Times.

Trading was at its most eye-catching in Japan. Tokyo’s Topix index touched its highest level since November 1991, only to end down on the day after a volatile session. At its peak, the index reached the fresh high of 1,844.05 with gains across almost all major segments, taking it more than 20 per cent higher for the year to date. But it faded back in late trade to close at 1,817.75.

It makes me wonder what any proposed new Governor would be expected to do?! QE for what else?

Whereas in this morning’s monthly bulletin the ECB ( European Central Bank) has told us this.

Following the decision made on 26 October 2017 the monthly pace will be further reduced to €30 billion from January 2018 and net purchases will be carried out until September 2018. The recalibration of the APP reflects growing confidence in the gradual convergence of inflation rates towards the ECB’s inflation aim, on account of
the increasingly robust and broad-based economic expansion, an uptick in measures of underlying inflation and the continued effective pass-through of the Governing
Council’s policy measures to the financing conditions of the real economy.

So we see proposals for central banking policy lost in  a land of confusion as the US tightens, the Euro area eases a little less and yet again the establishment in Japan cries for more, more, more.

Comment

There is a lot to consider here as we mull a world of easy and in some cases extraordinarily easy monetary policy with what is in general below target inflation. Of course there are exceptions like Venezuela which as far as you can measure it seems to have an inflation rate of the order of 2000% + . But in general such places are importing inflation via a lower currency exchange rate which means that someone else’s is reduced. Also we need to note that 2017 is looking like a good year for economic growth as this morning’s forecasts from the European Commission indicate.

The euro area economy is on track to grow at its fastest pace in a decade this year, with real GDP growth forecast at 2.2%. This is substantially higher than expected in spring (1.7%)……..at 2.1% in 2018 and at 1.9% in 2019.

So then of course you need an excuse for easy monetary policy which is below target inflation! Of course this ignores two technical problems. The first is that at the moment if we get inflation it is mostly from a higher oil price as we mull the likely effects of Brent Crude Oil which has moved into the US $60s. The second is that there is inflation to be found if you look at asset prices as whilst some of the equity market highs we keep seeing is genuine some of it is simply where all the QE has gone. Also there is the issue of house prices where even in the Euro area they are growing at an annual rate of 3.8% so if they were in an inflation index even more questions would be asked about monetary policy.

In a world where wages growth is not only subdued but has clearly shifted onto a lower plane the obsession with raising inflation will simply make the ordinary person worse off via its effect on real wages. Sadly this impact is usually hardest on the poorest.

Me on Core Finance TV

http://www.corelondon.tv/uk-housing-market-house-party-keeps-going/

 

 

 

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Let us continue to remember what has been inflicted on Greece

Yesterday the Financial Times revealed the results of an intriguing poll in Greece,

More than half of all Greeks agreed it was a mistake to have joined the euro. Barely a third of Greeks thought the euro wasn’t a mistake. Even among those who wanted to remain in the euro area at the end of 2015, fewer than half would have chosen to join again if given the chance to go back in time and warn their fellow citizens.

That survey took place almost two years ago. Since then, Walter finds that support for the euro has dropped by 10 percentage points.

Frankly I find it a bit of a surprise that even more Greeks do not think that joining the Euro was a mistake! But in life we see so often that some support the status quo again and again almost regardless of what it is. After all so many in the media and in my profession have sung along to Blur about Euro area membership for Greece.

There’s no other way
There’s no other way
All that you can do is watch them play

Regular readers will be aware that I have been arguing there was and indeed is another way since 2011. One of the saddest parts of this sorry saga has been the way that those who have plunged Greece into a severe economic depression accused those suggesting alternatives of heading for economic catastrophe.

If we look at the current state of play we see this.

The available seasonally adjusted data indicate that in the 2nd quarter of 2017 the Gross Domestic Product (GDP) in volume terms increased by 0.5% in comparison with the 1 st quarter of 2017, while in comparison with the 2nd quarter of 2016, it increased by 0.8%.

So economic growth but not very much especially if we note that this is a good year for the Euro area in total. So far not much of that has fed through to Greece although any signs of growth are welcome. To put this in economic terms this is an L-shaped recovery as opposed to the V-shaped one in my scenario. The horizontal part of the L is the fact that growth after the drop has been weak. The vertical drop in the L is illustrated by the fact that twice during its crisis the Greek economy shrank at an annual rate of 10% leaving an economy which had quarterly GDP of 63 billion Euros as 2008 opened now has one of 46.4 billion Euros. By anyone’s standards that is quite an economic depression.

Some good news

Here I would like to switch to what used to be the objective of the International Monetary Fund or IMF which is trade. In essence it helped countries with trade deficits by suggesting programme’s involving reform, austerity and devaluation/depreciation. The French managing directors of the IMF were never going to be keen on devaluation for Greece for obvious reasons and as to reform well you hear Mario Draghi call for that at every single European Central Bank press conference which only left austerity.

This was a shame as you see there was quite a problem. From the Bank of Greece.

In 2010, the current account deficit fell by €1.8 billion or 6.9% in comparison with 2009 and came to €24.0 billion or 10.5% of GDP (2009: 11.0% of GDP).

Even the improvement back then was bad as it was caused by this.

Specifically, the import bill for goods excluding oil and ships fell by €3.9 billion or 12.6%,

The deficit improvement was caused by the economic collapse. Now let us take the TARDIS of Dr. Who and leap forwards in time to the present.

In the January-August 2017 period, the current account improved year-on-year, as the €211 million deficit turned into a €123 million surplus.

This was driven by a welcome rise in tourism to Greece.

In August 2017, the current account showed a surplus of €1.8 billion, up by €163 million year-on-year………The rise in the surplus of the services balance is due to an improvement mostly in the travel balance, since non-residents’ arrivals and the corresponding receipts increased by 14.3% and 16.4%, respectively.

The Bank of Greece is so pleased with the new state of play that it did some in-depth research to discover that it is essentially a European thing.

In January-August 2017, travel receipts increased by 9.1%, relative to the same period of 2016, to €10,524 million. This development is attributed to a 14.5% rise in receipts from within the EU28 to €7,117 million,

I am pleased to note that my country is doing its bit to help Greece which with the weaker Pound £ might not have been expected and that Germans seem both welcome and willing to go.

as did receipts from Germany, by 29.0% to €1,638 million. Receipts from the United Kingdom also increased, by 17.7% to €1,512 million.

So finally we have some better news but there are two catches sadly. The first is that it has taken so long and the second is that Greek should have a solid surplus in terms of scale after such a depression.

Money Money Money

A sign of what Taylor Swift would call “trouble,trouble,trouble” can be found in the monetary system. The media world may have moved onto pastures new but Greece is still suffering from the capital flight of 2015.

On 26 October 2017 the Governing Council of the ECB did not object to an ELA-ceiling for Greek banks of €28.6 billion, up to and including Wednesday, 8 November 2017, following a request by the Bank of Greece.

The amount of Emergency Liquidity Assistance is shrinking but it remains a presence indicating that the banking system still cannot stand on its own two feet. This means that the flow of credit is still not what it should be.

In September 2017, the annual growth rate of total credit extended to the economy stood at -1.5%, unchanged from the previous month and the monthly net flow was negative at €552 million, compared with a negative net flow of €241 million in the previous month.

Also in a country where the central bank has official interest-rates of 0% and -0.4% we see that banks remain afraid to spread the word to ordinary depositors.

The overall weighted average interest rate on all new deposits stood at 0.29%, unchanged from the previous month.

Also we learn that negative official interest-rates are not destructive to bank profits and how banks plan to recover profits in one go.

The spread* between loan and deposit rates stood at 4.26 percentage points from 4.28 points in the previous month.

Comment

There is a lot to consider here but we can see clearly that the “internal devaluation” economic model or if you prefer the suppression of real wages has been a disaster on an epic scale. Economic output collapsed as wages dropped and unemployment soared. Even now the unemployment rate is 21% and the youth unemployment is 42.8%, how many of the latter will never find employment? As for the outlook well in the positive situation that the Euro area sees overall this from Markit on Greek manufacturing prospects is a disappointment.

“The latest PMI data continue to paint a positive
picture of the Greek manufacturing sector, with the
headline PMI signalling an improvement in
business conditions for the fifth month in
succession……….There was, however, a notable slowdown in output growth, which poses a slight cause for concern
going forward.

A bit more than a slight concern I would say.

Meanwhile I note that the media emphasis has moved on as this from Bloomberg Gadfly indicates.

Greece is taking a step closer to get the respect it deserves from Europe.

It is how?

Yields on the country’s government bonds, which have already taken great strides lower this year, hit a new low last week on news the government is preparing a major debt swap.

I have no idea how the latter means the former but let us analyse the state of play. Lower bond yields for Greece are welcome but are currently irrelevant as it is essentially funded by the institutions and mostly by the European Stability Mechanism. There are in fact so few bonds to trade.

So Greece will have an opportunity to issue debt more expensively than it can fund itself via the ESM now? Why would it do that? We come back to the fact that it would get it out of the austerity programme! Not quite the Respect sung about by Aretha Franklin is it?

 

Can the economic renaissance in France fix its unemployment problem?

Today gives us an opportunity to take a closer look at one of the running themes of this website which is the economy of France. It also gives an opportunity to look at the other side of the coin as its performance in 2017 so far has exceeded that of the UK. Indeed if you believe the media it is Usain Bolt to our Eddie the Eagle. So let us go straight to this morning’s economic growth release.

In Q3 2017, gross domestic product (GDP) in volume terms* kept increasing: +0.5%, after +0.6% in Q2……GDP growth estimate for Q2 2017 is slightly revised upward (+0.1 points), in particular with the update of seasonal adjustment coefficients.

There are two clear changes here for France and the first is simply the higher numbers seen. The next is the stability of them as France did produce quarterly growth at this sort of level but then always fell back sometimes substantially in subsequent quarters. This time around France has gone 0.6%,0.5%,0.6% and now 0.5% which is well within any margins of measurement error. This has led to this.

In comparison with Q3 2016, GDP rose by 2.2%; such a growth rate had not been observed since 2011.

This is good news but it does come with perspective as it reminds us how poorly France performed pre 2017 and in particular how its economic growth was knocked back by the Euro area crisis. It did grow but mostly at a crawl.

The detail

The good news is that investment remains strong.

total gross fixed capital formation (GFCF) remained dynamic (+0.8% after +1.0%).

However the economic dream of investment and net trade rising stalled somewhat.

The foreign trade balance contributed negatively to GDP growth (−0.6 points after +0.6 points): imports accelerated sharply (+2.5% after +0.2%) while exports decelerated significantly (+0.7% after +2.3%).

In fact economic growth relied mostly on consumption and rises in inventories.

Household consumption expenditure slightly accelerated (+0.5% after +0.3%) …….changes in inventories contributed positively to GDP growth (+0.5 points after −0.5 points).

The inventory position can be read two ways. The positive view is that it is in anticipation of further economic expansion and the less positive one is that it signals some slowing.

Another factor we may need to watch is the one below as the UK is far from alone in seeing car registrations dip in recent months.

In particular, it (exports) fell back in transport equipment (−0.5% after +6.2%).

I also note that France is also shifting towards a services based economy.

In August 2017, output increased sharply again in services (+1.0% after +1.3% in July).

Prospects

The official survey is still good ( above 100) albeit not quite as good as previously.

In October 2017, the business climate has weakened slightly after a steady improvement for a year. The composite indicator, compiled from the answers of business managers in the main sectors, has lost one point (109) after eight months of rise.

This leads to welcome hopes for a troubled area of the French economy.

In October 2017, the employment climate has risen for the second consecutive month…….The associated composite indicator has gained two points to 109, clearly above its long-term mean.

The PMI ( Purchasing Managers Index) compiled by Markit could hardly be much more bullish.

Flash France Composite Output Index(1) at 57.5 in October (77-month high) ……According to latest flash data, the resurgence in the French private sector showed no sign of abating at the start of the fourth quarter

They were even more bullish on employment prospects.

Buoyed by strong client demand, private sector firms continued to take on additional staff members in October, extending the latest period of job creation to 12 months. Moreover, the rate of  growth was the most marked in just shy of ten-anda-half years (May 2007).

Unemployment

This has been the Achilles heel of the French economy for some time as its sclerotic rate of economic growth has meant there has been little progress in reducing unemployment.

In Q2 2017, the ILO unemployment rate in metropolitan France decreased slightly, by 0.1 percentage points. The employment rate and the activity rate increased by 0.5 percentage points. The unemployment rate in France stood at 9.5% of active population in Q2 2017.

Indeed some countries have unemployment rates similar to the long-term unemployment rate in France.

The long-term unemployment rate stood at 4.0% of active population in Q2 2017

Youth unemployment disappointingly rose to 22.7% in the quarter.

So there is plenty of work for the improved economic situation to do in this area and the survey results indicate that it is ongoing. However we do have a more up to date number from Eurostat this morning showing the unemployment rate rising from 9.6% in June to 9.7% in July, August and September.

Inflation

The good news is that there is not much of this to be found in France.

Over a year, the Consumer Price Index (CPI) should increase by 1.1% in October 2017, after +1.0% in the previous month, according to the provisional estimate made at the end of the month.

One worrying area is this “an acceleration in food prices ” which were 4.5% higher than a year before. How much of that is due to the issue pointed out by Bloomberg below is not specified.

France’s much-loved croissant au beurre has run up against the forces of global markets.

Finding butter for the breakfast staple has become a challenge across France. Soaring global demand and falling supplies have boosted butter prices, and with French supermarkets unwilling to pay more for the dairy product, producers are taking their wares across the border. That has left the French, the world’s biggest per-capita consumers of butter, short of a key ingredient for their sauces and tarts.

We do know that prices have surged at the wholesale level.

Global butter prices have almost tripled to 7,000 euros ($8,144) a ton from 2,500 euros in 2016, according to Agritel, an Paris-based farming consultancy.

Comment

This year has seen a welcome return to form for the French economy. Let us hope that it can continue it as it has seen a weak run. Todays data release shows us that GDP ( base 2010) was at 511.1 billion Euros in the first quarter of 2012 but only rose by 18.4 billion Euros to the third quarter of 2016 before rising by 11.7 billion in the next year. France did not suffer as directly from the Euro area crisis as some countries but it was affected. One impact of that was the way that its national debt to GDP ratio has risen to 99.2% so it will be hoping that the current growth spurt stops it reaching and then moves it away from 100%.

The European Central Bank has put its shoulder to the wheel in terms of monetary policy which has helped France in various ways. The large purchases of French government bonds which total 345.6 billion Euros have helped the public finances by reducing the cost of debt. Also the advent of an official interest-rate which is negative ( deposit rate -0.4%) indicates a very easy monetary policy. The catch here is how and we should add if the ECB can reverse course as we see that a Euro area which is now doing well ( this morning annual GDP growth has been announced at 2.5%) has a negative official interest-rate and ongoing asset purchases which are only slowly being reduced. After all monetary policy has leads and lags meaning that in general it needs to be set for around 18 months time rather than now.

Moving onto comparing with the UK then the quarterly growth rate is only marginally higher but the annual one is much better for France. Prospects for the immediate future look good and maybe there is an area where we are becoming more similar.

Overall, house prices increased by 3.5% yo-y in Q2 2017, after +2.7% in Q1 2017.

Happy Halloween to you.

 

 

 

 

 

Where next for house prices in Sweden and hence monetary policy?

Today has seen several strands of economic analysis come together so let us stay with yesterday’s topic of housing but move geographically from the UK to Sweden. There is food for thought in the issue that in the UK Sweden is often held up as an example in areas such as education, However there is more food for thought as I note that we are beginning to see denials that “something is going on” in the Swedish housing market as Todd Terry might put it. From the Financial Times.

There is no reason to anticipate a sharp fall in the Swedish housing market despite a housing boom that has seen prices more than double in the past 12 years, according to the chief executive of Stockholm-based Swedbank. The Swedish residential market will slow somewhat, Reuters reported Birgitte Bonnesen saying on a conference call after the bank’s quarterly results on Tuesday, but the chief executive does not see a risk of a sharp fall.

As Swedbank is the largest provider of mortgage credit in Sweden that is pretty close to an official denial that house prices are going to fall and we have learnt what to do with them! Even it had to admit that it does appear that ch-ch-changes are afoot.

Although she acknowledged the Swedish housing market “showed signs of further slowdown” in the latest quarter and the rise in house prices had “dampened”, Ms Bonnesen said the softening — accompanied by a slowdown in the build-up of household debt — was “positive, as it contributes to more sustainable economic development”.

Ah so a bank claiming that lower lending is “positive” so it would have presented its own higher lending in the boom as negative then would it? Of course as you can see below the Financial Times seems to be more concerned about “The Precious” than the effect on the real economy.

Concerns have grown that house prices — which have reached record levels — and mounting household debts somewhat echo the 1990s Swedish banking crisis. If there is a housing market slump and loan losses rise, that could damage the Scandinavian banking sector.

What is going on?

Sweden Statistics tells us that the credit taps seem pretty fully open for housing purposes.

In August, households’ housing loans amounted to SEK 3 035 billion, which is an increase of SEK 17 billion compared with the previous month and SEK 203 billion compared with the corresponding month last year. This means that the annual growth rate of housing loans was 7.2 percent in August, an increase of 0.1 percentage point compared with July.

In addition to the quantity or flow of loans the price or if you prefer mortgage rate is very low.

The average housing loan rate for households for new agreements was 1.58 percent in August, which is unchanged compared with July. The floating interest rate for housing loans was also unchanged compared with the previous month.

Ordinarily lots of cheap money would lead to surging house prices but maybe we have already seen that.

That gives us a longer=term perspective for Stockholm and if we look wider I note that Aviva investors have just tweeted a chart on asset bubbles which has Swedish property price growth at the top just pipping Canada and New Zealand. If you want a wry smile the surge in house prices began as the inflation targeting era began! But with thanks to Finwire and Google Translate this emerged earlier this month.

The prices of condominiums were unchanged in September. This has risen marginally last month. The villa prices, which remained unchanged in August, rose by 1 per cent. This is evidenced by figures produced by Statistics Sweden on behalf of Swedish Mäklarstatistik

Compared to three months ago, prices for both condominiums and villas have risen by 1 per cent. At year-end, price development is +6 percent for condominiums and +9 percent for villas.

So there seems to be something of a fading and maybe a lull if we add in the bit below.

Generally, we have a somewhat cautious market where we see that an increased supply is not matched by
same increase in sales volume……. we also see a gradual increase in the average time it takes between that
The ads are being put out and the property is then being sold.

So there is more supply and a longer time is required to sell neither of which look bullish.

Is Stockholm the canary in the coalmine?

It is hard not to think of London and in my case Nine Elms in particular when you see something like this.

There is not much optimism to be seen there to say the least. Also are such share price falls even legal these days? Perhaps the Riksbank of Sweden should take a trip to Tokyo to see how the Bank of Japan would deal with such a matter. Or they could simply assume that the official data series is more accurate.

Real estate prices for one- or two-dwelling buildings rose by almost 3 percent in the third quarter of 2017 compared with the second quarter. Prices rose by nearly 9 percent on an annual basis in the third quarter, compared with the same period last year.

Comment

There is a lot to consider here so let us bring in the policy of the Swedish central bank the Riksbank.

The Executive Board of the Riksbank has therefore decided to hold the repo rate unchanged at −0.50 per cent and is expecting, as before, not to raise it until the middle of 2018. The purchases of government bonds will continue during the second half of 2017,

As you can see it is full steam ahead for monetary policy with it being very rare amongst major central banks at hinting of continuing very easy policies. We will find out more later this week as its hand may be forced by what the European Central Bank decides and in particular how the Euro exchange rate responds. If the Riksbank had a choice I am sure it would rather be voting on Friday after the ECB rather than tomorrow. Perhaps it can watch the film Bad Timing to fill in the gap.

Also there is something to mull about the state of the real economy summarised here a month ago by the Riksbank itself.

Economic activity in Sweden is strong; GDP grew rapidly in the second quarter and the employment rate is at a historically high level. Inflation has continued to rise and in recent months been higher than expected.

Some would regard that as grounds for a tightening of monetary policy. Of course should it decide to prioritise a weakening housing market with obvious implications for the banks then this would make it easier.

Between 2007 and 2015, cash in circulation decreased by nearly 15 per cent. Cash withdrawals have declined by around a half, both in number of withdrawals and volume of cash withdrawn, over the past ten years…..By far the most common way of paying for goods in shops is by debit or credit card. Around 97 per cent of the population has access to a card…..Sweden is one of the countries in the world where the most card payments are made. The average Swedish citizen made 290 card payments in 2015. The average for the European Union is 104 card payments per year. ( Riksbank in June)

The Novo Banco saga has been one of misrepresentation and woe

Yesterday saw an announcement from the Bank of Portugal on a saga which has run and run and run.

Banco de Portugal and the Resolution Fund concluded today the sale of Novo Banco to Lone Star, with an injection by the new shareholder of €750 million, which will be followed by a further injection of €250 million to be delivered by the end of 2017.

Indeed there is an element of triumphalism and back-slapping.

The conclusion of this operation brings to a close a complex negotiation process with the new shareholder, European institutions and other domestic institutions, in close cooperation with the Government.
The completion of the sale announced on 31 March brings about a very significant increase in the share capital of Novo Banco and terminates the bank’s bridge bank status that has applied since its setting up.

The opening issue is why this New Bank which is what Novo Banco, means that was supposed to be clean, needs an increase in capital? Let us look deeper.

As of this date, Novo Banco will be held by Lone Star and the Resolution Fund, which will hold 75% and 25% of the share capital respectively. It will be endowed with the necessary means for the implementation of a plan ensuring that the bank will continue to play its key role in the financing of the Portuguese economy.

The story gets a twist as we see that Lone Star will be walking away with 75% of Novo Banco and in return the Portuguese taxpayer does not get one single Euro. The implication is that the Resolution Fund is keen to get it off its books at almost any price.

Step Back In Time

If we follow the advice of Kylie Minogue we can go back to August 2014 when the Bank of Portugal was dealing with this.

The Board of Directors of Banco de Portugal has decided on 3 August 2014 to apply a resolution measure to Banco Espírito Santo, S.A.. The general activity and assets of Banco Espírito Santo, S.A. are transferred, immediately and definitively, to Novo Banco, which is duly capitalised and clean of problem assets. Deposits are fully preserved, as well as all unsubordinated bonds.

BES had collapsed and I note again that Novo Banco was supposed to be clean of problem assets. However it did not take long for what Taylor Swift would call “trouble, trouble, trouble” to emerge as a rather unpleasant Christmas present arrived a few months later for bondholders. From my article on the 4th of April.

The nominal amount of the bonds retransferred to Banco Espírito Santo, S.A. totals 1,941 million euros and corresponds to a balance-sheet amount of 1,985 million euros………This measure has a positive impact, in net terms, on the equity of Novo Banco of approximately 1,985 million euros.

So just under 2 billion Euros was required to steady the ship of our “clean” bank and you can see why no one was in a rush to buy it!

Money Money Money

If we go back to the origination of this there was a bold statement from the Bank of Portugal.

This means that this operation does not involve any costs for public funds.

However there was this.

The State will bear no costs related to this operation. The equity capital of Novo Banco, to the amount of €4.9 billion, is fully underwritten by the Resolution Fund.

Ah good so the banking sector was paying up.

The Resolution Fund’s sources of funding are the contributions paid by its member institutions and the proceeds from the levy over the banking sector, which, according to applicable regulations, are collected without jeopardising the solvency ratios.

Meanwhile if we rejoin the real world that is the same Portuguese banking sector that was in severe disarray so the money had to be found from elsewhere.

the Fund took out a loan from the Portuguese State. The loan granted by the State to the Resolution Fund will be temporary and replaceable by loans granted by credit institutions.

At this point it sounds rather like the Amigo loans advertised in the UK where you can borrow the money but somebody else has to guarantee it, in this case the Portuguese taxpayer. Also if this were an episode of Star Trek the USS Enterprise would be on yellow alert at the use of the word “temporary”. If we step forwards to just over a year ago the Resolution Fund told us this.

the conditions of the
loan of €3 900 million extended to the Fund in August 2014

which are?

Currently, the maturity date of said loan is 31 December 2017. The review that has now been
agreed upon will allow the extension of that maturity date in a way that ensures the capacity of
the Resolution Fund to meet in full its obligations through its regular revenue, and regardless of
the positive or negative contingencies to which the Resolution Fund is exposed.

Ah so it is To Infinity! And Beyond?! Oh and the temerity of the idea that the banks might have to back the er banking sector resolution fund.

without the need to raise any special contributions.

Number Crunching

Here is Reuters from September 2015.

“Once more, I repeat, there is no direct impact (on taxpayers), since the Portuguese state did not nationalise the bank nor take a direct stake in Novo Banco’s capital,” minister and government spokesman Luis Marques Guedes said.

Okay that is clear so let us look at the view from Europe’s statistics agency Eurostat a mere one month later.

 The second most significant impact to the deficit in 2014 was in Portugal (3.0pp of GDP) and it was also mainly due to a bank recapitalisation……. The recapitalization of Novo Banco. In the third quarter of 2014, the Portuguese Resolution Fund injected 4.9 bn euro (2.8% of GDP) into Novo Banco. As the sale of Novo Banco did not occur within one year after the capitalisation, the capital injection has impacted the deficit of Portugal in 2014 for its full amount.

Comment

Let us consider this in terms of the two main variables which are time and money. The time element is that the new clean bank was supposed be sold quickly whereas it took more than three years. The money element is that the Resolution Fund underwrote the bank capital to the tune of 4.9 billion Euros. There was then a swerve to get just under 2 billion Euros off some bondholders as the word clean somehow meant dirty, Now we see that where 100%= 4.9 billion back then now 75% = 1 billion as we note the value destruction leaving the Resolution Fund with its 25% apparently worth 0.333 billion Euros but backed by a loan of 3.9 billion Euros.

So quite a large gamble has been taken by the Portuguese authorities with taxpayers money whereas if things go well Lone Star has been able to get assets very cheaply. It has 75% of the capital after only paying around 20% of the total Of course should it go wrong then we can refer back to my timeline for a banking collapse. We had this back in autumn 2014.

6. The relevant government(s) tell us that the bank needs taxpayer support but through clever use of special purpose vehicles there will be no cost and indeed a profit is virtually certain.

And at some date in the future ( like when Eurostat rules on this for example) we are likely to see this.

It is also announced that nobody could possibly have forseen this and that nobody is to blame apart from some irresponsible rumour mongers who are the equivalent of terrorists. A new law is mooted to help stop such financial terrorism from ever happening again.

Me on Core Finance TV

http://www.corelondon.tv/uk-inflation-understated/

 

Will the Spanish economic boom be derailed by separatism?

There is a truism that political problems invariably follow economic ones. If that is true in Spain at the moment then there has been quite a lag as it was several years ago now that the consequences of the Euro area crisis reached a crescendo. If we look back we see the economy as measured by GDP peaked at 103.7 in 2008 and then fell to 100 in the (benchmark) 2010 as the credit crunch hit. But then the Euro area crisis hit as GDP fell to 96.1 in 2012 and 94.5 in 2013 and the latter year saw the unemployment rate rise above 26%. So that was the nadir in economic terms as a recovery began and saw GDP rise again to 95.8 in 2014 and then 99.1 in 2015 followed by 102.3 in 2016.  So we see that in essence there has been something of a lost decade as earlier this year the output of 2007 was passed as well as a recent strong recovery. If economics was the driver one might have expected political issues to arise in say 2014.

What about now?

At the end of last week the Bank of Spain published its latest projections for the economy. Firstly it is nice to see that they have fallen in line with my argument that the lower oil price provided a boost to the Spanish economy mostly via consumption.

In particular, compared with the expansionary fiscal policy stance of the period 2015‑16 and the declines in oil prices observed between mid‑2014 and 2016 Q1

Of course that is a clear contradiction of the official inflation target of 2% per annum being good for the economy but I doubt many will point that out. You may note that they try to cover off the consumption rise as a response to the crunch.

Moreover, the expansionary effect resulting, in recent years, from certain spending (on consumer durables) and investment decisions being taken after their postponement during the most acute phases of the crisis is expected to gradually peter out.

Factoring in everything it expects this.

Indeed it is estimated that, in 2017 Q3, GDP growth could have decelerated somewhat, as anticipated in the June projections. As a result of all the above, it is estimated that, after growing by 3.1% this year, GDP will grow by 2.5% in 2018 and by 2.2% in 2019.

A driver of the economic growth seen so far has been export success.

Accordingly, for example in 2016, GDP growth was more reliant on the external component than had been estimated to date.

Also there are hopes that this will continue.

The data on the Spanish economy’s external markets in the most recent period have been more favourable than was expected a few months ago.

Although there is a worry which will be familiar to readers of my work.

owing to the exchange rate appreciation effect,

Oh and there is a thank you Mario Draghi in there as well!

by the continuing favourable financial conditions.

What could go wrong? Well……

Turning to the risks surrounding these GDP growth projections, on the domestic front, the political tension in Catalonia could potentially affect agents’ confidence and their spending decisions and financing conditions

This issue is currently playing out in the banking sector where some are fearful of no longer being backed by the Bank of Spain and hence ECB. Banco Sabadell has just announced it will have a board meeting this afternoon to consider moving its corporate address to Alicante in response. Of course if you wanted custom in Catalonia this is not the way to go about it as we mull the words of the Alan Parsons Project.

I just can’t seem to get it right
Damned if I do
I’m damned if I don’t

What about the business surveys?

Firstly the Euro area background is the best it has been for some time.

The final September PMI numbers round off an impressive third quarter for which the surveys point to GDP rising 0.7%.
The economy enters the fourth quarter with business energized by inflows of new orders growing at the fastest rate for over six years and expectations of future growth reviving after a summer lull.

However that sort of economic growth has been something of a normal situation for Spain in recent times. Let us look at the detail for it.

New orders rose across the service sector for the fiftieth month running, with the latest expansion the strongest since August 2015. Where an increase in new business was recorded, this was attributed by panellists to improving economic conditions.

From this there was a very welcome side-effect.

Responding to higher workloads, service providers increased their staffing levels solidly in September

If we move to the economy overall then we see this.

Taken alongside faster growth in the manufacturing sector, these figures point to a positive end to the third quarter of the year. Over the quarter as a whole, we look to have seen only a slight slowdown from Q2, suggesting a further robust GDP reading is likely. IHS Markit currently forecasts growth of 0.7% for Q3.”

Today’s Euro area survey on retail sales does not reach Spain but yesterday’s retail sales release shows they are struggling relatively with annual growth in August at 1.7% but retail sales are erratic.

Population and Demographics

There has also been some better news on this front as highlighted by this below.

The resident population in Spain grew in 2016 for the first time since 2011. It stood at 46,528,966 inhabitants on January 1, 2017, with an increase of 88,867 people.

This matters because the decline in population exacerbated a problem highlighted by Edward Hugh back in 2015. One of his worries was the ratio of births to deaths which had been shifting unfavourably and was -259 last year. This led to this and the emphasis is mine.

Furthermore, INE projections suggest the over-65s will make up more than 30% of the population by 2050 (almost 13 million people) and the number of over-eighties will exceed 4 million, thus representing more than 30% of the total 65+ population.
International studies have produced even more pessimistic estimates and the United Nations projects that Spain will be the world’s oldest country in 2050, with 40% of its population aged over 60. At the present time the oldest countries in Europe are Germany and Italy, but Spain is catching up fast.

Comment

Spain is an example of what is called a V shaped economic recovery as it has bounced strongly as opposed to the much sadder state of play in Greece which has seen an L shaped or if you prefer little bounce-back at all. If you were using economics to predict secessionist trouble you would be wrong about 100 times out of 100 using it. However if we move to what caused trouble in Greece when it had its recent political crisis we see that the driving force was the monetary system of which a signal is that the ECB is still providing over 32 billion Euros of Emergency Liquidity Assistance to it.

So as we stand the impact on the Spanish economy is small as businesses may be affected but moves if they physically happen will boost GDP and shift mostly from one region to another. However if there is any large movement of funds then all this changes as eyes will turn to the banking system at a point when people are wondering if and not when the Bank of Spain will step in? After all would it help a bank that is no longer in Spain? There are rumours that UK banks could have gone to the ECB if they had back in the day thought ahead about their locations. But imagine the scenario if a bank in Catalonia tries to go to the ECB when there is doubt over whether it was in the European Union?

Personally I would expect, after a suitable delay, the ECB would step in but the price would be high as Greece has found out from the years of the Troika which have been so bad they change their name to the institutions.

Tomorrow

I have a morning appointment with my knee specialist so I intend to post an article but it could easily be somewhat later than usual.

 

 

 

 

Can QE reductions co-exist with the “To Infinity! And Beyond! Critique?

Today looks set to take us a step nearer a change from the world’s major central bank. Later we will here from the US Federal Reserve on its plans for a reduction in its balance sheet. If we look back to September 2014 there was a basis for a plan announced.

The Committee intends to reduce the Federal Reserve’s securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA.  ( System Open Market Account).

Okay so what will this mean?

The Committee expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve.

So we learnt that it planned to reduce its balance sheet by not reinvesting bonds as they mature. A sensible plan and indeed one I had suggested for the UK a year before in City AM. Of course back then they were talking about doing it rather than actually doing it. Also there was a warning of what it would not entail.

.The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance

Thus we were already getting the idea that any such process was likely to take a very long time. This was added to by the fact that there is no clear end destination.

The Committee intends that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, and that it will hold primarily Treasury securities.

This was brought more up to date this June when we were told that any moves would be in what are baby steps compared to the US $4.5 trillion size of the balance sheet.

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.

They will do the same for mortgage-backed securities except US $ 4 billion and US $20 billion are the relevant amounts. But as you can see it will take a year to reach an annual amount of US $0.6 trillion. Thus we reach a situation where balance sheet reduction can in fact be combined with another chorus of “To Infinity! And Beyond!” Why? Well unless they have ended recessions then the reduction seems extremely unlikely to be complete until it is presumably being expanded again. Indeed for some members of the Federal Reserve this seems to be the plan. From the Financial Times.

 

Mr Dudley has said he expects the balance sheet to shrink by roughly $1tn to $2tn over the period, from its current $4.5tn. This compares with an increase of about $3.7tn during the era of quantitative easing.

The ECB

There was a reduction in monthly QE purchases from the European Central Bank from 80 billion Euros to 60 billion which started earlier this year. But so far there has been no announcement of more reductions and of course these are so far only reductions in the rate of increase of its balance sheet. Then yesterday there was a flurry of what are called “sauces”.

FRANKFURT (Reuters) – European Central Bank policymakers disagree on whether to set a definitive end-date for their money-printing programme when they meet in October, raising the chance that they will keep open at least the option of prolonging it again, six sources told Reuters.

Of course talk and leaks are cheap but from time to time they are genuine kite flying. Also there is some potential logic behind this as the higher level of the Euro has reduced the likely path of inflation and the ECB is an institution which takes its target seriously. Now the subject gets complicated so let me show you the “Draghi Rule” from March 2014,

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

So the Euro rally will have trimmed say 0.3% off future inflation. However some are claiming much more with HSBC saying it is 0.75% and if so no wonder the ECB is considering a change of tack. Mind you if I was HSBC I would be quiet right now after the embarrassment of how they changed their forecasts for the UK Pound £ ( when it was low they said US $1.20 and after it rallied to US $1.35 they forecast US $1.35!).

This is something of a moveable feast as on the 9th of this month Reuters sources were telling us a monthly reduction was a done deal. But there is some backing from markets with for example the Euro rising above 1.20 versus the US Dollar today and it hitting a post cap removal high ( remember January 2015?) against the Swiss Franc yesterday.

As we stand the ECB QE programme amounts to 2.2 trillion Euros and of course rising.

The Bank of England

We see something of a different tack from the Bank of England as it increased its QE programme last August and that is over. But it is working to maintain its holdings of UK Gilts at £435 billion as highlighted below.

As set out in the MPC’s statement of 3 August 2017, the MPC has agreed to make £10.1bn of gilt purchases, financed by central bank reserves, to reinvest the cash flows associated with the maturities on 25 August and 7 September 2017 of gilts owned by the Asset Purchase Facility (APF).

Today it will purchase some £1.125 billion of medium-dated Gilts as part of that which may not be that easy as only 3 Gilts are now eligible in that maturity range.

However tucked away in the recent purchases are an intriguing detail. You see over the past 2 weeks the Bank of England has purchased some £1.36 billion of our longest dated conventional Gilt which runs to July 2068. So if Gilts only ever “run off” then QE will be with us in the UK for a very long time.

The current Bank of England plan such as it is involves only looking to reduce its stock of bond holdings after it has raised Bank Rate an unspecified number of times. I fear that such a policy will involve losses as whilst the rises in the US have not particularly affected its position there have been more than a few special factors ( inflation, North Korea, Trumpenomics…), also we would be late comers to the party.

The MPC intends to maintain the stock of purchased assets at least until the first rise in Bank Rate.

Will that be like the 7% unemployment rate? Because also rise from what level?

at least until Bank Rate has been raised from its current level of 0.5%.

Comment

As you can see there is a fair bit to consider and that is without looking at the Bank of Japan or the Swiss National Bank which of course has if its share price is any guide has suddenly become very valuable. We find that any reduction moves are usually small and much smaller than the increases we saw! Some of that is related to the so-called Taper Tantrum but it is also true that central banks ploughed ahead with expansions of their balance sheets without thinking through how they would ever exit from them and some no doubt do not intend to exit.

The future is uncertain but not quite as uncertain as central banks efforts at Forward Guidance might indicate. So if we address my initial question there must be real fears that the next recession will strike before the tapering in the case of the ECB or the reductions of the US Federal Reserve have got that far. As to my own country the Bank of England just simply seems lost in its own land of confusion.