One of the features of this time of year is that the ECB (European Central Bank) is quiet as its Governing Council gets in some research on holiday hot-spots and does its best to boost the economies of the southern countries. However in their absence there is little sign of a summer lull this year so let us take a look at what is happening. Firstly of course we have the deposit and current account rate set at -0.4% and the 80 billion Euros of QE (Quantitative Easing) per month which now includes corporate bond purchases.
Standard and Poors has produced a report on this issue and it starts badly for the ECB. From the FT.
Almost 500 million people are living under negative central bank interest rates – an unprecedented policy move which is “a clear sign of desperation” with a host of unintended consequences for the world economy, Standard & Poor’s has warned.
Almost enough to make Mario Draghi choke on his lunchtime glass of chianti. There is more.
It warned of the danger of a “feedback loop”, where negative rates encourage irresponsible and excessive risk taking that could spillover into escalating defaults that would require yet more stimulus from central banks.
There are two further problems which will be familiar to readers of my work.
This has led to concerns for pension funds and insurance companies, “reducing the investment returns these institutions rely on to meet their long-term liabilities”. They could then be spurred to search for yield by investing in riskier assets.
Should negative rates spread across the economy, it could lead to a “cash-only economy”: “This means increased transaction costs and rising risks of theft”
Then suddenly there is some better news for the ECB as Standard and Poors decides that it should fall into line with the IMF and tell us that this is working.
Negative rates in the eurozone are “having the desired stimulative effect”, managing to spur bank lending and leading to a sustained fall in the value of the euro.
Let us look at bank lending vis the ECB August Bulletin.
Loan dynamics remained on a path of gradual recovery………While the annual growth rate of loans to non-financial corporations (NFCs) recovered further in May, the annual growth rate of loans to households has remained broadly stable since February 2016.
Not entirely convincing is it? The truth is that the ECB has stopped such lending from falling but the numbers are barely positive.
I was interested in the “sustained fall in the value of the Euro” claim as the Euro has been rising recently. The most obvious rise has been the post Brexit leave vote move against the UK Pound £ which has seen it push forwards to 1.15. However it has also been rising against the US Dollar and has pushed above 1.13 versus it this morning after the US Federal Reserve Minutes showed uncertainty last night. I guess it has absolutely surged against the Mongolian Tugrik which has required a 4.5% increase in interest-rates today to try to shore it up!
If we look at the effective or trade-weighted numbers we see that the Euro has been rising since it fell to just below 89 in early April 2015 and it is now 95.6. Or as Sober Look pointed out.
@DeutscheBank‘s trade–weighted euro index now highest since start of QE; has to be frustrating for the ECB –
If you are wondering why? I suspect that some figures released this morning give us at least a partial guide.
As a result, the euro area recorded a €29.2 bn surplus in trade in goods with the rest of the world in June 2016……In January to June 2016 the euro area recorded a surplus of €134.5 bn, compared with +€111.4 bn in January-June 2015.
As you can see whenever we are not in an ouvert crisis phase then there is steady and regular demand for Euros to pay for goods. Actually there is an elephant in this particular room as two thirds of the trade surplus in goods comes from one country Germany which recorded a 89.2 billion Euro surplus in the first half of 2016. We are back to the view that I expressed some years back that the Euro is a vehicle for Germany to get a lower exchange-rate. The price for the other 18 nations is that they get a higher exchange-rate and this has compromised the economic performance particularly of countries like Italy and Portugal and of course especially Greece.
For all the media rhetoric and talk about Germany being a loser in the various Euro negotiations and bailouts it remains an enormous winner from its original currency devaluation. What it did not know back then was that we would see a post credit crunch era where a German Deutschmark would have soared.
The problem here is duofold. The first has been caused by the ECB itself and the way that negative interest-rates impact on the banking sector. An irony because of course so many policies are aimed at supporting the banks. Benoit Coeure of the Governing Council put it like this at the end of last month.
In the euro area, the potential adverse impact on bank profitability, if it materialises, would be compounded by low growth prospects and a legacy of high non-performing loans.
In fact virtually his whole speech was about the banks revealing his real interests! In essence on this road they are being given not far off “free money” from the QE program to offset losses elsewhere.
While average deposit rates only decreased by around 0.2 percentage point between June 2014 and May 2016, loan rates decreased by around 0.8 percentage point, effectively reducing the interest margin.
If we return to the lending figures I quoted early on you might reasonably have expected them to have done better in response to this.
The next problem is responded to rather euphemistically.
In the euro area, this translates into geographic differences based on national banking structures,
He means the banking travails of Portugal and Italy for example but does not want to say so explicitly. I note that Algarve News has reported this.
Portugal’s government has spent €14 billion of public money on ensuring the banking sector is ‘robust’ – but much of this money will never be seen again……….This overall €14 billion bill, as computed by the Court of Auditors and the National Institute of Statistics, represents nearly 8% of Portuguese GDP, hence Moody’s recent warning that the Portuguese banking system is one of the most fragile in Europe.
Even the traditionally insular US Federal Reserve is on the case.
However, European bank equities, especially those of Italian banks, underperformed, reflecting investor fears that lower interest rates will continue to weigh on profitability.
Not everywhere is on a downwards spiral as the economic growth spurt in Spain has helped improve things for banks there. This morning has seen a fall in non performing loans recorded although I also note that another consequence of the To Big To Fail strategy has also been seen as national debt to GDP which was 36% in 2007 looks like it has passed 100%.
There is much to consider for the ECB as it looks at its policies. It did originally manage a fall in the Euro exchange rate but as I have explained above that has been fading. As I have pointed out before both the main QE players right now ( Euro area and Japan) are seeing stronger not weaker exchange-rates these days. Actually one bit of relief for Mario Draghi and his colleagues has been that the Yen has risen even against the Euro.
Also whilst the economy is growing the rate of growth halved in the second quarter of 2016 to 0.3% from 0.6% previously. Whilst Spain has done well and Ireland has recorded some quite extraordinary numbers Italy and France recorded no growth at all in the latest quarter. I think that the ECB if Benoit Coeure is any guide is starting to think that it is struggling.
Fiscal and structural policies should act more decisively to support aggregate demand and productivity, thereby preventing the economy from falling into a low interest rate trap.
Yes especially in the struggling nations. Oh hang on the ECB as part of the institutions or troika has been enforcing exactly the reverse there!
Should the oil price continue to edge higher some of the gains from its lower phase will start to ebb away as well.