Where next for the Euro, the ECB and the Euro area economy?

In our new financial world where pretty much everything depends on the whims and moods of central bankers one of the main leaders is the ECB or European Central Bank. Yesterday we got one version of its future from the Governor of the Bank of Finland Ollie Rehn. So let me hand you over to his interview with the Wall Street Journal.

“It’s important that we come up with a significant and impactful policy package in September,” said Mr. Rehn, who sits on the ECB’s rate-setting committee as governor of Finland’s central bank.

“When you’re working with financial markets, it’s often better to overshoot than undershoot, and better to have a very strong package of policy measures than to tinker,” Mr. Rehn said.

That is pretty cleat although there is are two self-fulfilling problems in trying to overshoot financial markets. The first is that you are devolving monetary policy to financial markets. The second is that markets will now adjust ( they did so yesterday as I will discuss later) so do you overshoot that as well?

According to the WSJ these are the expectations Ollie was trying to overshoot.

Analysts expect the ECB will announce next month a 0.1 percentage-point cut to its key interest rate, currently set at minus 0.4%, as well as around €50 billion ($56 billion) a month of fresh bond purchases under its quantitative easing program. The program had previously been phased out at the end of last year.

There is already an example of the “slip-sliding away” as Paul Simon would put it that I mentioned earlier as the monthly bond purchases were expected to be 30 billion Euros a month. So which one would Ollie be overshooting?

Even worse for hapless Ollie others seem to have a different set of expectations.

Investors currently expect the ECB to cut its key interest rate to minus 0.7% and to hold rates below their current level through 2024, according to futures markets. Mr. Rehn said those market expectations showed that investors had understood the ECB’s guidance.

So will he now be overshooting -0.5% or -0.7%? Actually it gets better as -0.6% is in there now as well.

The comments suggest the ECB might cut interest rates by more than expected in September, perhaps by 0.2 percentage points, and could start to purchase new types of assets, Mr. Ducrozet said.

So roll up! Roll up! Place your bets on what Ollie will be trying to overshoot. Also as no doubt you have spotted whilst he may be in Finland he wants to start turning Japanese.

Mr. Rehn said he didn’t rule out a move to purchase equities under the QE program, but that would depend on the assessment of ECB staff.

That is a pretty shocking as the ECB staff assessment will be exactly what the Governing Council wants in the manner explained by The Jam.

You want more money – of course, I don’t mind
To buy nuclear textbooks for atomic crimes
And the public gets what the public wants

As I have acquired quite a few extra followers in the last week or two let me explain the Japan reference which is that the Bank of Japan has for a while now been purchasing Japanese equities. According to its latest accounts it now holds 26.6 trillion Yen of them.

The Problem

It is highlighted by this.

To provide space for fresh bond purchases, the ECB could adjust the rules of its bond-buying program, which currently prohibit the bank from buying more than 33% of the debt of any individual eurozone government, he added.

This is an example of what ECB President Mario Draghi calls it being a “rules-based organisation”. It is until they are inconvenient and then it changes them! One of the ways it got support for the previous QE programme was the limit above bit now it will be redacted from history. How high can it go? Well one example is from my own country the UK where the Bank of England does not have country limits ( for obvious reasons) but it does have a limit of 70% for each individual Gilt-Edged bond.

The Euro

Part of the plan behind Ollie’s interview was to talk down the Euro. After all the new “currency war” style consensus is to try a grab a comparative advantage in a zero-sum game. In a small way he succeeded as the Euro fell against most currencies. But there is a catch as highlighted by this release from Eurostat today.

As a result, the euro area recorded a €20.6 bn surplus in trade in goods with the rest of the world in June 2019…….In January to June 2019, euro area exports of goods to the rest of the world rose to €1 163.3 bn (an increase of
3.2% compared with January-June 2018), and imports rose to €1 061.2 bn (an increase of 3.7% compared with
January-June 2018). As a result the euro area recorded a surplus of €102.2 bn, compared with +€103.6 bn in
January-June 2018.

As you can see in the first half of the year trade created a demand for the Euro of around 102 billion Euros which is a barrier against any sustained fall. Actually this is a German thing because if you look at the national breakdown it accounts for 112 billion of this. Other nations such as the Netherlands run large surpluses assuming we look away from the “Rotterdam Effect” but as a collective in a broad sweep they contribute very little. So we get something very awkward which is that the main exchange rate fall came when Germany switched the Dm to the Euro. Since then there has been a lot of hot air on the subject but in terms of the effective exchange rate the Euro is at 98.3 or a mere 1.7% from where it started.

In a purist form I should look at the full current account but hopefully you have the idea from the trade figures. Partly I am doing that because I have very little faith in the other numbers.

Even more awkward for the ECB would be a situation where President Trump actually goes forward with his plan to buy Greenland. He would pay Denmark in its Kroner but as it is pegged to the Euro this would raise the Euro versus the US Dollar which is presumably part of the plan.

Comment

There is a lot to consider here but let me open with looking at the real economy. It is struggling with some but not much growth. So far in 2019 economic growth has gone 0.4% and then 0.2% on a quarterly basis. The fear is that it will slow further based on what was a strength above ( Germany’s trade surplus) which right now looks a weakness or as Frances Coppola out it.

Thread. Germany has been importing demand from China for a long time.

I am not saying it is the only perspective but it is one. On this road we have found little economic growth because even if we take the view of Mario Draghi this created a mere 1.5% of extra GDP growth. On the other side of the ledger is the destruction wreaked on all long-term contracts such as pensions and bond markets by the world of negative interest-rates. Oh and the fact if it had worked we would not be here.

As to the real economy well if we return to Ollie we see that in fact his main concern is “The Precious! The Precious!”

To offset the impact on eurozone banks of a longer period of negative interest rates, the ECB could introduce a tiered-deposit system, under which only a portion of bank deposits might be subject to negative rates, Mr. Rehn said.

The ECB could also alleviate the stress on banks by sweetening the terms of new long-term loans, known as targeted longer-term refinancing operations, he said.

If the real economy merits a mention I will let you know….

As a final point this version of economic management combining “open mouth operations” with reading a Bloomberg or Reuters screen to see where markets are often involves what have become called “sauces” saying something different, so be on your guard.

Meanwhile liuk on twitter has a suggestion which we can file under QE for millennials.

#ECB STAFF WILL INCLUDE AVOCADO FOR NEW ASSET BUYING PROGRAM

It would be a bit dangerous putting them in the Helicopter Money drop though…..

 

What economic situation faces the new Greek government?

There was a link between the two main news stories on Sunday. Those who feel the main aim of the original Greek bailout was to allow European banks to exit the country will have had a wry smile at the ongoing travails of Deutsche Bank. Also the consequences of that bailout are still being felt in Greece which may vote for political change but finds itself continuing to be in troubled economic times. From Kathimerini.

Crucially, asked to what extent the creditors would be open to a reduction to fiscal targets, Regling said the 3.5 percent of GDP target Greece has committed to is a “cornerstone of the program,” adding that it’s “very hard to see how debt sustainability can be achieved without that.”

This was a reminder that via the fiscal target some 3.5% of economic activity each year will be taken out of the economy to help reduce the size of the national debt. A bit like driving a car with the handbrake on. It also gives us a reminder of the early days of the Greek crisis where a vicious circle was set up as austerity shrank the economy which meant that more austerity was required and repeat. Accordingly Greece was plunged into what can only be described as a great depression. Putting it another way the Greek economy is now 18.8% smaller than it was as 2010 opened.

Another disturbing feature is the weakness of the current recovery. I have written throughout this saga about my fear that what should be a “V-Shaped” recovery has been an “L-Shaped” one. So after a better 2017 ( which was essentially the second quarter) we find ourselves reviewing not much growth.

The available seasonally adjusted data indicate that in the 1st quarter of 2019 the Gross Domestic Product (GDP) in volume terms increased by 0.2% in comparison with the 4th quarter of 2018, while in comparison with the 1st quarter of 2018, it increased by 1.3%

So if there is a recovery impetus it is finding that its energy is being diverted away by the primary surplus target.

Trade Problems

Yesterday we got the latest trade data for Greece and this matters because it is a test of what has become called the internal competitiveness model. This was produced for the Euro area crisis because there was no devaluation option as the official view is that the Euro is irreversible. Thus the wages of the ordinary Greek had to take the whole strain of whipping the economy back into shape. How has that gone?

The total value of imports-arrivals, in May 2019 amounted to 5,230.9 million euros (5,832.8 million dollars) in
comparison with 4,356.6 million euros (5,130.8 million dollars) in May 2018, recording an increase, in euros, of
20.1%…….The total value of exports-dispatches, in May 2019 amounted to 3,044.6 million euros (3,415.5 million dollars) in comparison with 2,955.0 million euros (3,501.2 million dollars) in May 2018, recording an increase, in euros, of 3.0%.

In itself a rise in the import bill may not be bad as it can indicate an economic recovery on its way. Also in these times of trade wars then an increase in exports is welcome. But we need to look further as to the overall position.

The deficit of the Trade Balance, for the 5-month period from January to May 2019 amounted to 9,421.0 million
euros (10,515.9 million dollars) in comparison with 8,086.2 million euros (9,738.3 million dollars) for the
corresponding period of the year 2018, recording an increase, in euros, of 16.5%.

These numbers do not allow for two of the main strengths of the Greek economy so let is put them in.

The rise in the services surplus is attributable to an improvement, primarily in the transport balance and, secondarily, in the travel and other services balances. Transport receipts (mainly sea transports) rose by 9.8%. At the same time, non-residents’ arrivals and the relevant receipts rose by 0.5% and 22.8%, respectively. ( Bank of Greece)

Those numbers are only up to April but we see that even without the grim trade data for May the overall current account was not going well.

In the January-April 2019 period, the current account showed a deficit of €5.1 billion, up by €335 million year-on-year.

Of course the flip side of Euro membership is that the value of the currency is unlikely to take much notice of this as due to Germany’s presence the overall position is of a consistent surplus. But whilst tourism in particular has done well the idea of a net exports surge is just not happening.

Looking Ahead

The Bank of Greece told us this at the beginning of this month.

economic activity is expected to increase by 1.9% in 2019, by 2.1% in 2020 and by 2.2% in 2021, mainly driven by private consumption, business investment and exports.

Those numbers send a chill down my spine because throughout the crisis we have been told that Greece will grow by around 2% per annum. This was supposed to start in 2012 whereas in fact the economy shrank at annual rates of between 4.1% and 8.7%. For now growth via exports seems unlikely to say the least.

The private-sector Markit PMI survey told us this.

Operating conditions in the Greek manufacturing sector
improved moderately in June, with the headline PMI
dipping to its lowest since November 2017. Weighing on
overall growth were slower increases in production and new business.

The reading was 52.4 ( 50 = unchanged)  so slow growth was the order of the day as we note Greece is being affected by a sector that in the Euro area overall is contracting.

Bond Market

There has been a spate of articles pointing out that Greece now has a ten-year yield which is very similar to that of the United States. Actually that is not going quite so well this morning as at 2.17% Greece is 0.1% higher. But it is being used as a way of bathing the situation in a favourable light which has quite a few problems.

  1. Rather than a sign of economic recovery it is a sign of a policy ( primary surplus target) which is sucking growth out of the economy.
  2. Pretty much any yield is being bought these days!
  3. Greece does not have that many government bonds in issue as so much of the debt is now owned by the two Euro area bailout vehicles the ESM and EFSF. They disbursed some 204 billion Euros to Greece and now hold more than half its national debt. It is also why if you look back at the first quote in this piece it is Klaus Regling of the ESM who is quoted.

So rather than success what the bond yield now tells us is that Greece is in a program that the so-called bond vigilantes would love, otherwise known as the primary surplus target. It also has seen the ESM debt kicked like a can to the late 2050s. That is really rather different.

Why would you pay investors 2% or so rather than 1% to the ESM? A blind eye keeps being turned to that question.

It is also why I find it frankly somewhat frustrating when people like Yanis Varoufakis call for QE for Greece as via the ESM It got its own form of it on a much larger scale. Their real problem is that it came with conditions.

Comment

This has been a long sad story perhaps best expressed by Elton John.

It’s sad, so sad (so sad)
It’s a sad, sad situation
And it’s getting more and more absurd
It’s sad, so sad (so sad)
Why can’t we talk it over?
Oh it seems to me
That sorry seems to be the hardest word

There have been some improvements but the numbers below also highlight the scale of the problem to be faced.

The seasonally adjusted unemployment rate in March 2019 was 18.1% compared to 20.2% in March 2018 and the downward revised 18.4% in February 2019.

If we look back to the pre credit crunch era then the employment rate was around 10% lower than that. Also a youth unemployment rate of 40.4% is considerably improved but if we look at the past numbers we see that not only must so many young Greek’s not have a job but they must have no hope of one. Also it has gone on so long that some will now be in the next category of 25-34.

So the new Greek government has plenty of challenges so let me finish with the main two as seen by the Bank of Greece.

 This is so because, with a public debt-to-GDP ratio of 180%

and

Banks have made progress in reducing non-performing loans (NPLs). More specifically, at end-March 2019, NPLs amounted to €80 billion, down by about €1.8 billion from end-December 2018 and by around €27.2 billion from their March 2016 peak

 

 

What does a Greek bond yield below 3% tell us?

Sometimes it is good to look at things from another direction so let me start by looking at the current situation through the prism of financial markets rather than the real economy. From @tracyalloway.

Greek government bond yields below 3%

I will return to the why and therefore of this in a moment but let me first move onto the stock market. Here is an article from Forbes from Saturday.

Greece’s stock market rose sharply this week, following a big defeat of the ruling leftist coalition in Regional and Euroelections last Sunday.

The Global Shares X FTSE shares (GREK) have gained 9.10%, as most financial markets around the world lost ground. Banks were particularly strong, leading the rally.

As you can see that was different to many other equity markets and continues stronger performance this year. If we move to the ASE General Index it at 828 is just under its high for the year and is up nearly 9% this year and around 35% on a year ago.

Some Perspective

If we return to the bond market then there are two clear perspectives. The first is that we have yet another day of singing along with the Black-Eyed Peas.

Boom boom boom
That boom boom boom
That boom boom boom
Boom boom boom

We have seen yet another all-time high for the benchmark German bond or bund as the ten-year yield has fallen to -0.21%. That has something of an ominous portent for the world economy if traders are correct. As we note that this time around Greece has joined the party there are nuances.

EFSF financial assistance, part of the second programme, ran from March 2012 through June 2015. In this programme, the EFSF disbursed a total of €141.8 billion, of which €130.9 is outstanding………….Together, the EFSF and ESM disbursed €204 billion to Greece, and now hold more than half of its public debt. ( European Stability Mechanism)

So as you can see there are a lot fewer Greek bonds in circulation than there were, as they have been subsumed into EFSF/ESM system. This has had a consequence for volumes in the market as @Birdyworld points out.

When people are talking about Greek government bond yields it’s worth remembering that it’s basically not a market any more. The average month from 2001-2010 saw 42bn euros in secondary market transactions. The ENTIRE transaction volume 2011-2019 is 29bn euros.

This is a point I remember making back in the early days of the crisis when the ECB was buying Greek bonds to support the market that volumes went off the edge of a cliff. So the bond market does not tell us what it used to.

Also the stock market has improved but when we note it was previously above 5000 we can see that some context is required there too.

Manufacturing

We can continue with something of a positive gloss as we note this from earlier this morning.

The Greek manufacturing sector strengthened further in
May. Production and new order growth remained sharp,
with employment continuing to rise. Domestic and foreign
demand were still resilient as new export orders rose strongly………… Currently, IHS Markit forecasts a 3%
increase in industrial production in 2019, with the rate of
unemployment set to fall to 18.3% by the end of the year.

That was from the Manufacturing PMI release which contrary what you might think was in fact lower at 54.2 as opposed to the previous 56.6. But according to this measure there has been a sustained improvement.

The latest headline PMI figure extended the current sequence of expansion to two years.

However some care is needed because if we look at the official data the numbers have improved so far in 2019 but if we look back the two years to March 2017 we see that output is in fact a little lower than the 104.92 of back then. The current reading of 104.03 is also a fair bit lower than the around 110 of last July.

Trade Problems

This is a crucial area because this was the modus operandi of the IMF (International Monetary Fund). The problem is highlighted by these figures from the Bank of Greece.

In March 2019, the current account deficit came to €1.5 billion, up by €352 million year-on-year, as a result of an increase in the deficit of the balance of goods, and notwithstanding the improved services balance. Additionally, the primary and secondary income accounts deteriorated………..In the first quarter of 2019, the current account deficit came to €3.7 billion, up by €420 million year-on-year, as the improved services balance and primary income account only partly offset a deterioration of the balance of goods and the secondary income account.

When we consider the extent of the economic depression that Greece has been through this is a pretty shocking result. All that pain to still be in deficit. Even worse any sort of stabilisation and maybe improvement seems to come with more imports of goods.

 Imports of goods grew by 6.0% at current prices and 4.1% at constant prices. ( first quarter 2019).

The Greek shipping industry seems to be booming against the world trend but was unable to offset the higher imports.

Sea transport receipts rose by 18.9%.

Money Supply

The good news is that narrow money growth or M1 has been picking up in 2019. However at 6.3% in April it remains below that of the wider Euro area so that is not entirely heartening. The numbers were especially weak around the turn of the year so we cross our fingers for tomorrow’s economic growth release for the first quarter.

Also we need to be cautious as Greece does not have its own money supply so these are numbers which make more assumptions than usual. Central bankers will find something to cheer in this however.

According to data collected from credit institutions,(1) nominal apartment prices are estimated to have increased on average by 2.5% year-on-year in the fourth quarter of 2018, whilst in 2018 the average annual increase in apartment prices was 1.5%, compared with an average decrease of 1.0% in 2017.

If you want to see a bear market though this has provided it with the overall index being at 60.5 at the end of 2018 where 2007 =100.

Comment

There have been some changes in the Greek situation but some things look awfully familiar. From Kathimerini.

There will be no service on the Athens metro and tram from 9 p.m. on Monday as workers walk off the job to protest understaffing, cutbacks and the privatization of public transport.

Also considering its share price you might think Deutsche Bank would have better things to do than troll Greece.

Greece should not sacrifice the credibility and discipline it has earned with such sacrifice in the past few years to short-term measures, warns Ashok Aram, Deutsche Bank’s regional CEO for Europe.

The Greek economy was sacrificed on the altar of turning the public finances into a sustained surplus. It is hard to believe that it was supposed to return Greece to economic growth ( 2.1% was forecast for 2012) whereas the contraction approached 10% at times. Sometimes I have to pinch myself when I see the media proclaiming the views of those responsible for this as being of any use, but that is the world we live in. But the reality is that after a depression which contracted the economy by around a quarter we still have to look hard for clear signs of a recovery or if you prefer the shape of it is an L rather than a V.

The world can be so upside down at times that we cannot rule out we might see a Greek bond with a negative yield.

Weekly Podcast

I look at why bond yields have dropped so sharply in the past few weeks.

 

The economic depression in Greece looks set to continue

A feature of the economic crisis that enfolded in Greece was the fantasy that economic growth would quickly recover. It seems hard to believe now that anyone could have expected the economy to grow at 2% ot so per annum from 2012 onwards but the fans of what Christine Lagarde amongst others called “shock and awe” did. I was reminded of that when I read this from the International Monetary Fund on Tuesday.

Greece has now entered a period of economic growth that puts it among the top performers in the eurozone.

That is to say the least somewhat economical with the truth as this from the Greek statistics office highlights.

The available seasonally adjusted data
indicate that in the 4th quarter of 2018 the Gross Domestic
Product (GDP) in volume terms decreased by 0.1% in comparison with the 3rd quarter of 2018.

So actually it may well have left rather than entered a period of economic growth which is rather different. Over the past year it has done this.

in comparison with the 4th quarter of 2017, it increased by 1.6%.

What this showed was another signal of a slowing economy as 2018 overall was stronger.

GDP for 2018 in volume terms amounted to 190.8 billion euro compared with 187.2 billion euro for 2017 recording an increase of 1.9%.

There is a particular disappointment here as the Greek economy had expanded by 1% in the autumn of last year leading to hopes that it might be about the regain at least some of the ground lost in its depression. Now we find an annual rate of growth that is below the one that was supposed to start an up,up and away recovery in 2012. Nonetheless the IMF is playing what for it is the same old song.

We expect growth to accelerate to nearly 2½ percent this year from around 2 percent in 2018. This puts Greece in the upper tier of the eurozone growth table.

Money Supply

This has proved to be a good guide of economic trends in the Euro area so let us switch to the Bank of Greece data set so we can apply it to Greece alone. The recent peak for the narrow money measure M1 was an annual rate of growth of 7.3% in December 2017 and then mostly grew between 5% and 6% last year. But then the rate of growth slowed to 3.8% last December and further to 2.7% in January.

I am sorry to say that a measure which has worked well is now predicting an economic slow down in Greece and perhaps more contractions in the first half of this year. Looking further ahead broad money growth has slowed from above 6% in general in 2018 to 4.2% in December and 3.3% in January. This gives us a hint towards what economic growth and inflation will be in a couple of years time and the only good thing currently I can say is that Greece tends to have low inflation.

The numbers have been distorted to some extent by the developments mentioned by the IMF below but they are much smaller influences now.

 For example, customers are now free to move their cash to any bank in Greece, and the banks themselves have almost fully repaid emergency liquidity assistance provided by the European Central Bank.

The Greek banks

Even in the ouzo hazed world of the IMF these remain quite a problem.

Third, we are urging the government to do more to fix banks, which remain crippled by past-due loans. This will help households and businesses to once again be able to borrow at reasonable interest rates.

They have another go later.

Directors encouraged the authorities to take a more comprehensive, well-coordinated approach to strengthening bank balance sheets and reviving growth-enhancing lending.

There are two issues with this and let me start with how many times can the Greek banks be saved? Money has been poured again and again into what increasingly looks like a bottomless pit. Also considering they think bank lending is weak – hardly a surprise in the circumstances – on what grounds do they forecast a pick-up in economic growth?

Back on the 29th of January I pointed out that the Bank of Greece was already on the case.

An absolutely indicative example can assess the immediate impact of a transfer of about €40 billion of NPLs, namely all denounced loans and €7.4 billion of DTCs ( Deferred Tax Credits).

So the banks remain heavily impaired in spite of all the bailouts and are no doubt a major factor in this.

vulnerabilities remain significant and downside risks are rising……………. If selected fiscal risks materialize, the sovereign’s repayment capacity could become challenged over the medium term.

That would complete the cycle of disasters as about the only bit of good news for the Institutions in the Greek bailout saga is this.

The government exceeded its 2018 primary fiscal balance target of 3.5 percent of GDP,

Moving out of the specific area of public finances we see that money is being sucked out of the economy to achieve this which acts as a drag on economic growth.

The Eurogroup

It does not seem quite so sure that things are going well as it refrains for putting its money behind it at least for now. From Monday.

The finance ministers of the 19-member Eurozone have decided to postpone disbursing 1 billion euros ($1.12 billion) to Greece.

The reason for postponing the payment is that Greece has not yet changed the provisions of a law protecting debtors’ main housing property from creditors to the EU’s satisfaction. ( Kathimerini).

Euro area

The problem with saying you are doing better than the general Euro area is twofold. If we start with the specific then it was not true in the last quarter of last year and if we move to the general Greece should be doing far, far better as it rebounds from the deep recession/depression it has been in. That is not happening.

Also beating the Euro area average is not what it was as this from earlier highlights. From Howard Archer.

Muted news on as German Economy Ministry says economy likely grew moderately in Q1 & warns on industrial sector. Meanwhile, institute cuts 2019 growth forecast sharply to 0.6% from 1.1%, citing weaker foreign demand for industrial goods.

Some have been pointing out that this matches Italy although that does require you to believe that Italy will grow by 0.6% this year.

Comment

Let me shift tack and now look at this from the point of view of how the IMF used to operate. This was when it dealt with trade issues and problems rather than finding French managing directors shifting its focus to Euro area fiscal problems. If you do that you find that the current account did improve in the period 2011-13 substantially but never even got back to balance and then did this.

The current account (CA) deficit was wider than anticipated, reaching 3.4 percent of GDP (though in part due to methodological revisions). Higher export prices and strong external demand were more than offset
by rising imports due to the private consumption recovery, energy price hikes, and the large import share in exports and investment. The primary income deficit widened due to higher payments on foreign investments.

That is quite a failure for the internal competitiveness model ( lower real wages) especially as we noted on January 29th that times were changing there. So the old measure looks grim in fact so grim that I shall cross my fingers and hope for more of this.

The tourism and travel sector in Greece grew 6.9 percent last year, a rate that was three-and-a-half times higher than the growth rate of the entire Greek economy, a survey by the World Travel and Tourism Council (WTTC) has noted.

The survey illustrated that tourism accounted for 20.6 percent of the country’s gross domestic product, against a global rate of just 10.4 percent.

This means that one in every five euros spent in Greece last year came from the tourism and travel sector, whose turnover amounted to 37.5 billion euros. ( Kathimerini ).

The Investing Channel

 

 

UK GDP growth was strong in January meaning we continue to rebalance towards services

This will be an interesting day on the political front but there is also much to consider on the economic one. We have a stronger UK Pound £ this morning with it above US $1.32 and 1.17 versus the Euro which as usual on such days has been accompanied by the currency ticker on Sky News disappearing. We also heard yesterday from the newest member of the Bank of England Monetary Policy Committee Jonathan Haskel. As it has taken him six months to give one public speech I was hoping for a good one as well as wondering if he might have the cheek to lecture the rest of us on productivity?! So what did we get.

Very early there was an “I agree with Mark (Carney)” as I note this.

see for example speeches by (Carney, 2019) and (Vlieghe, 2019)

The subject was business investment which in the circumstances also had Jonathan tiptoeing around the political world but let us avoid that as much as we can and stick to the economics.

First, as has been widely noted, UK investment has been very weak in the last couple of years, especially
during the last year, see for example speeches by (Carney, 2019) and (Vlieghe, 2019) suggesting that Brexit
uncertainty is weighing on business investment. Second, looking at the assets that make up investment
reveals some interesting patterns: transport equipment has been particularly weak, but intellectual property
products (R&D, software, artistic originals) were somewhat stronger. Third, regarding Brexit, as Sir Ivan
Rogers, the UK’s former representative to the EU, has said (Rogers, 2018), “Brexit is a process not an
event”. That process has the possibility of creating more cliff-edges; the length of the
transitional/implementation period, for example. Since the nature of investment is that it needs payback
over a period of time there is a risk that prolonged uncertainty around the Brexit process might continue to
weigh down on investment.

The issue of business investment is that it has been the one area which has been consistently weak since the EU Leave vote. How big a deal is it?

To fix ideas, Table 1 contains nominal investment
in the UK for 2018. As the top line sets out, it was close
to £360bn. Remembering that nominal GDP is £2.1 trillion, this is around 17% of GDP.

Regular readers will know I am troubled as to how investment is defined and to be fair to Jonathan he does point that out. However this is also classic Ivory Tower thinking which imposes an economic model on a reality which is unknown. Have we see a high degree of uncertainty? Yes and that has clearly impacted on investment but what we do not know is how much will return under the various alternatives ahead. Though from the implications of Jonathan’s thoughts the Forward Guidance of interest-rate increases seems rather inappropriate to say the least.

Raghuram Rajan

There has been a curious intervention today by the former head of the Reserve Bank of India. He has told the BBC this.

“I think capitalism is under serious threat because it’s stopped providing for the many, and when that happens, the many revolt against capitalism,” he told the BBC.

The problem is that a fair bit of that has been driven by central bankers with policies which boost asset prices and hence the already wealthy especially the 0.01%.

The UK economy

The opening piece of official data today was very strong.

Monthly gross domestic product (GDP) growth was 0.5% in January 2019, as the economy rebounded from the negative growth seen in December 2018. Services, production, manufacturing and construction all experienced positive month-on-month growth in January 2019 after contracting in December 2018.

Production data has been in the news as it has internationally slowed so let us dip into that report as well.

Production output rose by 0.6% between December 2018 and January 2019; the manufacturing sector provided the largest upward contribution, rising by 0.8%, its first monthly rise since June 2018……In January 2019, the monthly increase in manufacturing output was due to rises in 8 of the 13 subsectors and follows a 0.7% fall in December 2018; the largest upward contribution came from pharmaceuticals, which rose by 5.7%.

We had been wondering when the erratic pharmaceutical sector would give us another boost and it looks like that was in play during January. For newer readers its cycle is clearly not monthly and whilst it has grown and been a strength of the UK economy it is sensible to even out the peaks and troughs. But in the circumstances the overall figure for January was good.

Some Perspective

This is provided by the quarterly data as whilst the January data was nice we need to recall that December was -0.4% in GDP terms. The -0.4% followed by a 0.5% rise is rather eloquent about the issues around monthly GDP so I will leave that there and look at the quarterly data.

Rolling three-month growth was 0.2% in January 2019, the same growth rate as in December 2018.

This seems to be working better and is at least more consistent not only with its own pattern but with evidence we have from elsewhere.Also there is a familiar bass line to it.

Rolling three-month growth in the services sector was 0.5% in January 2019. The main contributor to this was wholesale and retail trade, with growth of 1.1%. This was driven mostly by wholesale trade.

This shows that we continue to pivot towards the services sector as it grows faster than the overall economy and in this instance it grew whilst other parts shrank exacerbating the rebalancing.

Production output fell by 0.8% in the three months to January 2019, compared with the three months to October 2018, due to falls in three main sectors……The three-monthly decrease of 0.7% in manufacturing is due mainly to large falls of 4.0% from basic metals and metal products and 2.0% from transport equipment.

Continuing the rebalancing theme we have seen this throughout the credit crunch era as essentially the growth we have seen has come from the services sector.

Production and manufacturing output have risen since then but remain 6.8% and 2.7% lower respectively for the three months to January 2019 than the pre-downturn gross domestic product (GDP) peak in Quarter 1 (Jan to Mar) 2008.

Overall construction has helped also I think but the redesignation of the official construction data as a National Statistic  after over 4 years is an indication of the problems we have seen here. Accordingly our knowledge is incomplete to say the least.

Returning to the production data this was sadly no surprise.

Within transport equipment, weakness is driven by a 4.0% fall in the motor vehicles, trailers and semi-trailers sub-industry.

Also I will let you decide for yourselves whether this monthly change is good or bad as it has features of both.

 was a 17.4% rise for weapons and ammunition, the strongest rise since March 2017, when it rose by 25.7%.

Comment

We arrive at what may be a political crossroads with the UK economy having slowed but still growing albeit at a slow rate. There is something of an irony in us now growing at a similar rate to the Euro area although if we look back we see that over the past half-year or so we have done better. That was essentially the third quarter of last year when Euro area GDP growth fell to 0.1% whereas the UK saw 0.6%.

If we look back over the last decade or so it is hard not to have a wry smile at the “rebalancing” rhetoric of former Bank of England Governor Baron King of Lothbury who if we look at it through the lens of the film Ghostbusters seems to have crossed the streams. Speaking of such concepts there was a familiar issue today.

The total trade deficit (goods and services) widened £1.3 billion in the three months to January 2019, as the trade in goods deficit widened £2.4 billion, partially offset by a £1.1 billion widening of the trade in services surplus.

Although we got a clue to a major issue here as we note this too.

Revisions resulted in a £0.8 billion narrowing of the total trade deficit in Quarter 4 (Oct to Dec) 2018, due largely to upward revisions to the trade in services surplus.

So in fact we only did a little worse than what we thought we had done at the end of last year. Also one of my main themes about us measuring services trade in a shabby fashion is highlighted yet again as the numbers were revised down and now back up a bit.

In Quarter 4 2018 the trade in services balance contributed £1.1 billion to the upward revision of £0.8 billion in the total trade balance as exports and imports were revised up by £3.3 billion and £2.3 billion respectively.

Pretty much the same ( larger though) happened to the third quarter as regular readers mull something I raised at the (Sir Charlie) Bean Review. This was the lack of detail about services trade. I got some fine words back but note today’s report has a lot of detail about goods trade in 2018 but absolutely none on services.

 

 

A bond issue does little for the problem of plunging investment in Greece

Today brings a development which will no doubt be trumpeted across the media and it is explained by this from Reuters yesterday,

Greece will return to bond markets with a five-year issue “in the near future, subject to market conditions”, authorities said on Monday.

The sovereign has mandated BofA Merrill Lynch, Goldman Sachs International Bank, HSBC, J.P. Morgan, Morgan Stanley and SG CIB as joint lead managers for the transaction, according to a regulatory filing to the stock exchange.

The near future is today as we mull that in spite of its role in the Greek economic crisis Goldman Sachs is like the Barnacles in the writings of Charles Dickens as it is always on the scene where money is involved. As to why this is happening the Wall Street Journal explains.

Greece‘s borrowing costs have dropped to a four-month low, and Athens plans to raise up to $3.4 billion in a bond sale.

Although it is not turning out to be quite as cheap as the 3.5% hoped for.

Greece Opens Books For New 5 Year Bond, Initial Guidance For Yield 3.75-3.875% – RTRS Source ( @LiveSquawk)

Why are investors buying this?

The obvious objection is the default history of Greece but in these times of ultra low yields ~3.8% is not be sniffed at. This is added to by the Euro area slow down which could provoke more ECB QE and whilst Greece does not currently qualify it might as time passes. In the mean time you collect 3.8% per annum.

Why is Greece offering it?

This is much more awkward for the politicians and media who trumpet the deal because it is a bad deal in terms of financing for Greece. It has been able to borrow off the European Stability Mechanism at not much more than 1% yield for some time now. Actually its website suggests it has been even cheaper than that.

0.9992% Average interest rate charged by ESM on loans (Q1 2018)

Past borrowing was more expensive so the overall ESM average is according to it 1.62%. So Greece is paying a bit more than 2% on the average cost of borrowing from the ESM which is hardly a triumph. Even worse the money will have to be borrowed again in five years time whereas the average ESM maturity is 32 years ( and may yet be an example of To Infinity! And Beyond!).

So there is some grandstanding about this but the real reason is escaping from what used to be called the Troika and is now called the Institutions. The fact the name had to be changed is revealing in itself and I can understand why Greece would want to step away from that episode.
As we move on let me remind you that Greece has borrowed some 203.8 billion Euros from the ESM and its predecessor the EFSF.

The economy

We can see why the Greek government wants to establish its ability to issue debt and stay out of the grasp of the institutions as we note this from Kathimerini.

Greek Prime Minister Alexis Tsipras announced an 11 percent increase in the minimum wage during a cabinet meeting on Monday, the first such wage hike in the country in almost a decade.

Actually the sums are small.

The hike will raise the minimum wage from 586 to 650 euros and is expected to affect 600,000 employees. He also said the government will scrap the so-called subminimum wage of 518 euros paid to young employees.

There are two catches here I think. Firstly in some ways Greece is competing with the Balkan nations which have much lower average wages than we are used to. Also this reverses the so-called internal competitiveness model.

The standard mimimum monthly wage was slashed by 22 percent to 586 euros in 2012, when Greece was struggling to emerge from a recession.

A deeper cut was imposed on workers below 25 years, as part of measures prescribed by international lenders to make the labour market more flexible and the economy more competitive.

Productivity

Here we find something really rather awkward which in some ways justifies the description of economics as the dismal science. Let me start with a welcome development which is the one below.

The seasonally adjusted unemployment rate in October 2018 was 18.6% compared to 21.0% in October 2017 and 18.6% in September 2018 ( Greece Statistics Office)

But the improving labour market has not been matched by developments elsewhere as highlighted by this.

we documented that employment had started to lead output growth in the early days of the SYRIZA government. Since such a policy is unsustainable, we have to include in any consistent outlook that this process reverses and output starts leading employment again – hence restoring positive productivity growth. ( Kathimerini)

That led me to look at his numbers and productivity growth plunged to nearly -5% in 2015 and was still at an annual rate of -3% in early 2016. Whilst he says we “have to include” an improvement the reality is that it has not happened yet as this year has seen two better quarters and one weaker one. We have seen employment indicators be the first sign of a turn in an economy before but they normally take a year or so to be followed by the output indicator not three years plus. This reminds us that Greek economic growth is nothing to write home about.

The available seasonally adjusted data
indicate that in the 3rd quarter of 2018 the Gross Domestic
Product (GDP) in volume terms increased by 1.0% in comparison with the 2nd quarter of 2018, while
in comparison with the 3rd quarter of 2017, it increased by 2.2%.

If it could keep up a quarterly rate of 1% that would be something but the annual rate is in the circumstances disappointing. After all the decline was from a quarterly GDP of 62 billion Euros at the peak in 2009 whereas it is now 51.5 billion. So the depression has been followed by only a weak recovery.

More debt

I looked at the woes of the Greek banks yesterday but in terms of the nation here is the Governor of the central bank from a speech last week pointing to yet another cost on the way to repairing their balance sheets

An absolutely indicative example can assess the immediate impact of a transfer of about €40 billion of NPLs, namely all denounced loans and €7.4 billion of DTCs ( Deferred Tax Credits).

Comment

Whilst I welcome the fact that Greece has finally seen some economic growth the problem now is the outlook. The general Euro area background is not good and Greece has been helped by strong export growth currently running at 7.6%. There have to be questions about this heading forwards then there is the simply woeful investment record as shown by the latest national accounts.

Gross fixed capital formation (GFCF) decreased by 23.2% in comparison with the 3rd quarter of 2017.

The scale of the issue was explained by the Governor of the central bank in the speech I referred to earlier.

However, in order to increase the capital stock and thus the potential output of the Greek economy, positive net capital investment is indispensable. For this to happen, private investment must grow by about 50% within the next few years. In other words, the Greek economy needs an investment shock, with a focus on the most productive and extrovert business investment, to avoid output hysteresis and foster a rebalancing of the growth model in favour of tradeable goods and services.

Yet as we stand with the banks still handicapped how can that happen? Also if we return to the productivity discussion at best it will have one hand tied behind its back by as the lack of investment leads to an ageing capital stock. So whilst the annual rate of economic growth may pick up at the end of 2018 as last year quarterly growth was only 0.2% I am worried about the prospects for 2019.

It should not be this way and those who created this deserve more than a few sleepless nights in my opinion.

The ESM is being made ready to lead the next set of Euro area bailouts

Yesterday saw something of a change in the way that the Euro area would deal with a future crisis. A special purpose vehicle or SPV that was created in response to the post credit crunch crisis is expanding its role. This is the ESM or European Stability Mechanism which was the second effort in this area as the initial effort called the European Financial Stability Fund or EFSF turned out to be anything but that. However that was then and this is now at let me explain the driving force behind all of this which the EFSF highlighted in a press release on the 9th of this month.

The European Financial Stability Facility (EFSF) raised €4 billion today in a new 5-year benchmark bond, completing the EFSF’s funding needs for 2018………..The spread of the 0.20% bond, maturing on 17 January 2024, was fixed at mid swaps minus 13 basis points, for a reoffer yield of 0.258%. The order book was in excess of €5.3 billion.

As you can see it can borrow on extraordinarily cheap terms as it borrows at 0.26% for five years. Back in the day there were questions as to what interest-rate these collective Euro area institutions would be able to borrow at? We now know that they have been able to borrow if not at Germany;s rate ( it was around -0.15% on that day) at what we might consider to be a Germanic rate. Or as Middle of the Road put it.

Chirpy chirpy cheep cheep chirp

In a way it is extraordinary but amidst the turmoil these two vehicles which whilst they still have differences are treated by markets pretty much as they are one have been able to do this. From the 2017 annual report.

The ESM has a strong financial capacity. The EFSF
and the ESM together have disbursed €273 billion in
loans since inception. The ESM has an unused lending
capacity of €380 billion, after taking into account
the maximum possible disbursements to Greece.

As you can see there is still plenty of ammunition in the locker and once the Euro area switched course from punishing nations ( too late for Greece) it allowed it to trumpet things like the one below.

As a result of ESM and EFSF lending terms, our five beneficiary countries saved a total of €16.6 billion in debt service payments in 2017, compared to the assumed market cost of funding. Greece alone saved €12 billion last year, the equivalent of 6.7% of the country’s GDP.

Yet it is in fact a geared SPV which is another of its attractions until of course the day that really matters.

to ensure the preservation of the paid-in capital of €80.4 billion.1 This money was paid in by the 19 euro area countries, and is by far the largest paid-in capital of any IFI.

Okay so what changes are planned?

This was explained on Friday in Les Echos by ESM Chair Klaus Regling.

The ESM will play a more important role in financial crisis management together with the European Commission. At the beginning of the crisis, there was the troika consisting of the Commission, the ECB and the IMF. With the third programme for Greece in 2015, the ESM was added and it became a quartet. In the future, in principle, a tandem composed of the Commission and the ESM will deal with assistance programmes for countries in financial difficulty. The IMF and the ECB will play a less important role than 8 years ago.

The IMF move seems sensible on two counts. Firstly it should never have got itself involved in the Euro area in the first place as it has a balance of payments surplus. Secondly and this is of course interrelated to the first point the Euro area cannot always rely on it having a French managing director. The ECB may be more subtle as we mull whether its (large) balance sheet will be deployed in other roles? As an aside it is hardly a sign of success if you have to keep changing the names.

The banks

As we know “the precious” must always be protected in case anyone tries to throw it into Mount Doom. There are obvious issues in Greece to be dealt with.

Both Piraeus Bank and the National Bank of Greece dropped to all time record lows today. ( h/t @nikoschrysoloras )

Actually Piraeus Bank has dropped another 5% today so he could rinse and repeat his message. It seems that the triumphant last bailout is going the way of the previous triumphant bailout. Also there is my old employer Deutsche Bank which has got near to breaking the 8 Euro barrier today which will help to bring the Germans on board. Adding to the fear about its derivatives book is the allegation that some US $150 billion of the Danske money laundering scandal went through the books of  DB’s US subsidiary. Sometimes this sort of thing gets really mind-boggling as we observe the period when Danske had a bigger market capitalisation than DB partly driven by money laundering that was facilitated by DB. Do I have that right?

Anyway in the future Klaus Regling may well be stepping in. From his interview with Les Echos.

In June, we agreed that the ESM will provide the backstop. Its volume will be the same as the volume of the Single Resolution Fund. This is being built up with bank contributions and it will reach 1% of bank deposits at the end of 2023, in other words €55 to 60 billion. The decision to use this security net in case the resolution fund is insufficient has to be taken very quickly, even if the parliaments of some countries need to be consulted.

They seem to be hurrying along for some reason…..

 This will be in 2024 at the latest and it could be earlier.

Exactly how can the troubled banking sector which in relative terms is not far off as weak as it was when the credit crunch hit pay for all of this?

Italy

Regular readers will be aware that due to their astonishing track record we take careful note of official denials. Well on the 6th of October the ESM wrote to the Editor of Frankfurter Allgemeine Zeitung.

The claim that the ESM is guaranteeing Italy’s state debt is wrong. Italy has never lost access to international financial markets. Therefore, Italy has never had a rescue programme with the ESM or its temporary predecessor institution, the EFSF. For the same reason, the ESM has neither guaranteed Italy’s state debt nor has it granted Italy any emergency loans.

Of course not as Italy would have to do as it is told first and presently there is little or no sign of that. But one day…

Comment

There is a fair bit to consider here and the likely new role of the ESM is at the top. It is convenient for politicians to pass their responsibilities to technocrats as the latter can take the bad news from a country bailout. However whilst it will need to be approved by the 19 Euro area parliaments these things have a powerful tendency to turn out different to the description on the tin. Just look at the Greek bailout for example.

Whereas the banking moves seem more sotto voce in this but as we seem to be in the middle of if not a crisis a phase where we have seen bank share prices tumble we need to be on alert. It is not just the Euro area girding its loins as for example it was only a few short months ago we were noting plans for more capital for the Bank of England. It is quite an indictment of the bank bailout culture that all these years later we seem to be as David Bowie so aptly put it.

Where’s your shame
You’ve left us up to our necks in it
Time may change me
But you can’t trace time