What can the ECB and Christine Lagarde do next?

Today is a policy meeting day for the European Central Bank and it has a lot to think about. One way of reflecting on this is just to simply note where it presently stands in terms of policy.

First, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00 per cent, 0.25 per cent and -0.50 per cent respectively.

The operative rate for the banks was in fact not mentioned last time around,perhaps it is considered too embarrassing at -1%. But it looks increasingly permanent.

Third, the Governing Council decided to further recalibrate the conditions of the third series of targeted longer-term refinancing operations (TLTRO III). Specifically, it decided to extend the period over which considerably more favourable terms will apply by twelve months, to June 2022. Three additional operations will also be conducted between June and December 2021.

So rather than further interest-rate cuts the mood music has shifted towards keeping them where they are for longer. It is a relief that they do not seem to be looking at the “Micro-Cuts” hinted at yesterday by the Bank of Canada. After all the interest-rate cuts we have seen does anyone sensible actually believe another 0.1% would make any difference?

Next comes the issue of bond buying or the manipulation of longer-term interest-rates or bond yields. Here we have a rather extraordinary situation where the ECB is running two programmes at the same time! The main one was extended in both size and time at the last meeting.

Second, the Governing Council decided to increase the envelope of the pandemic emergency purchase programme (PEPP) by €500 billion to a total of €1,850 billion. It also extended the horizon for net purchases under the PEPP to at least the end of March 2022.

There was a time when 500 billion Euros seemed a lot but no longer in this context. Also the previous programme appears as something of an after thought these days which is revealing.

Sixth, net purchases under the asset purchase programme (APP) will continue at a monthly pace of €20 billion

The other part that is revealing is the way it now fits with our “Too Infinity! And Beyond!” theme.

The Governing Council continues to expect monthly net asset purchases under the APP to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates.

The Euro

There has been a little relief here for the ECB as the Euro has weakened a little recently. It is a bit over 1.21 versus the US Dollar and the UK Pound £ has rallied above 1.13 this morning. However the ECB started its open mouth operations versus the Euro some months ago at 1.18 versus the US Dollar so it has lost ground.

The real issue here is a more conceptual one as the ability of a central bank to influence its currency has changed in the credit crunch era. It is hard for an interest-rate cut to have much of an impact when interest-rates are so low in so many places. The issue of QE is the same except it is hard for more of it to have an impact. There was a time when the extra 500 billion Euros announced last time would depress the currency but in fact it was expected and over that period the Euro rose. That leaves intervention against a strong currency but as the Swiss have discovered although in theory it should work, in practice even promising unlimited intervention has achieved nothing much. At best it has stopped the Swiss Franc going even higher, but that is almost impossible to quantify.

The other tactic is open mouth operations and there the ECB does have a strength in Christine Lagarde as she can be relied upon to say something stupid. Who can forget the claim that the ECB was not their to “close bond spreads” last year which torpedoed the Italian bond market? Also there was her claim that the Greek bailout was “shock and awe” although to be fair that was partly true as the economy collapsed and went into a depression from which it has never recovered. Maybe they could add something to the script she reads from at the press conference.

The Economy

The problem here is that we were supposed to be in the recovery now whereas economies will contract again this quarter. The central banking response is simply to push the recovery back in time.

Nevertheless, real GDP will recover only gradually, reaching the 2019 pre-crisis level by mid-2022 and exceeding it by 2½% in 2023.

Essentially they took 1% off growth this year as reality forced them too but rather than learn from that they simply added it to 2022! But there is a catch because we will be weaker for longer with the implication for debt and people’s incomes as well as business survival.

I would say the forecasts are a random number generator but I think that is unfair on random number generators. Once the restrictions ease we know the economy will bounce back and in the third quarter of last year it did so more strongly than people thought. But we do not yet know when they will be over and we do not know how the economy will then grow? We came into the pandemic with a Euro area that already was struggling for economic growth. This has been a credit crunch era issue.

Comment

We can take that forwards and give ourselves some perspective by simply asking when the ECB will raise interest-rates. On growth grounds that looks awkward to say the least as the economy is still shrinking and the ground that will hopefully eventually be regained merely takes the ECB back to a place where it felt things were bad enough to ease policy. Inflation could rise towards and indeed above target as we note the way the oil price has risen with Brent Crude Oil around US $56 per barrel and other factors such as shipping costs rising.

But there is a rub as Shakespeare would put it. That is that all the extra debt taken on by the weaker countries has been oiled by the low bond yields we see. Indeed as a result of the ECB’s policy many are negative even in places you might not expect. As countries borrow ever more due to the longer lasting nature of the pandemic the amount of debt taken on will make it ever harder to raise interest-rates and bond yields. We got some news on this front from Eurostat earlier.

Compared with the third quarter of 2019, the government debt to GDP ratio rose in both the euro area
(from 85.8% to 97.3%) and the EU (from 79.2% to 89.8%): the increases are due to two factors – government debt
increasing considerably, and GDP decreasing.

If we look ahead to the bounceback then we can (hopefully) omit the “GDP decreasing” impact but the Euro area had in the year to then added approximately I trillion Euros of extra debt. That will be continuing last quarter and this. As an aside Greece was just on the edge of 200% relative to GDP (199.9%).

Another way of looking at this is that once you deploy monetary policy on this scale you become a subsidiary of fiscal policy and QE becomes something sung about by Queen.

I’m a shooting star leaping through the sky
Like a tiger defying the laws of gravity
I’m a racing car passing by like Lady Godiva
I’m gonna go, go, go
There’s no stopping me

It is also going to get ever harder to explain another consequence of all this to first-time buyers.

In the third quarter of 2020, house prices, as measured by the House Price Index, rose by 4.9% in the euro area
and by 5.2% in the EU compared with the same quarter of the previous year

 

What happens when mortgage interest-rates fall to 0%?

A feature of the credit crunch era has been the way that in the end monetary policy has come down to two things. Pumping up the housing market and house prices in particular ( The Wealth Effects! The Wealth Effects!) and more recently financing government borrowing. Both conveniently support The Precious via the way that asset prices are driven higher in this instance house and bond prices. There has been news on that front this week from Denmark.

The country with the longest history of negative central bank rates is offering homeowners 20-year loans at a fixed interest rate of zero.

Customers at the Danish home-finance unit of Nordea Bank Abp can, as of Tuesday, get the mortgages, which will carry a lower coupon than benchmark U.S. 10-year Treasuries. ( Bloomberg)

For newer readers who may be wondering why Denmark? Well Bloomberg gets to that as well.

Denmark stands out in a global context as the country to have lived with negative central bank rates longer than any other. Back in 2012, policy makers drove their main rate below zero to defend the krone’s peg to the euro. Since then, Danish homeowners have enjoyed continuous slides in borrowing costs.

So in the round we return to part of yesterday’s theme as the monetary push from the European Central Bank is the same as a super massive black hole which via the pegged exchange rate sucks Denmark along with it. This led it down an odd road back last March.

Effective from 20 March 2020, Danmarks Nationalbank’s interest rate on certificates of deposit is increased by 0.15 percentage point. The monetary policy spread to the euro area is thereby narrowed from -0.25 to -0.10 percentage points, remaining lower than the rate in the euro area. In the context of Denmark’s fixed exchange rate policy, the interest rate increase follows Danmarks Nationalbank’s sale of foreign exchange in the market. ( Nationalbanken)

The increase to -0.6% came about because of pressure on the Kroner.

 it was caused by Danish institutional investors selling kroner in response to a decline in the value of their foreign
assets.

There is now something of a swerve because in the past an increase in the official interest-rate would raise mortgage rates but as central banks learnt early in the credit crunch the world was spun on its axis a bit.

Homeowners have increased their fixed-rate mortgage loans significantly in recent years. During the
last 12 months, new fixed-rate mortgage loans of kr.
134.7 billion have been disbursed.

That was from the Nationalbanken at the end of last September and there is more below.

More than half of the Danish homeowners’ total
mortgage loans of kr. 1,712 billion is now again with
a fixed interest rate, more precisely kr. 856.6 billion.
The last time fixed-rate loans accounted for more
than half of the loans, was in 2009. The lowest level
was in 2012 with just 31.5 per cent.

So we see that the interest-rate cut into the icy world of negative rates back in 2012 probably had an impact because of the predominance of variable rates back then, but now for the reason below fixed-rates have become more popular.

The appetite for fixed-rate loans has increased in line
with the declining interest rate, differentiated administration fees, and the narrowed gap to the variable
interest rate.

The actual market

If we go to Finance Denmark we see that whilst interest-rates have been trending lower there is still quite a gap between short and long ones. For example the short bond mortgage rate is -0.55% and the long bond mortgage rate is 0.94%. But the gap has been narrowing as the long bond rate was over 3% in 2015 whereas the short one went negative then.

What about mortgage borrowing?

This has done this according to the Nationalbanken.

The Danes’ total mortgage debt has grown by 4.0
per cent in the past year, and the debt has increased
in 91 of 98 municipalities. The largest lending growth
is in Glostrup with 7.3 per cent.

The borrowing rise in new terms will be higher because some have chosen to repay more.

In the last four quarters, households have increased
the repayments on their mortgage loans by kr. 998
on average per borrowed million……..The Danes have repaid kr. 6.0 billion on fixed-rate loans in 3rd quarter 2020, while the repayments on variable-rate loans were kr. 4.4 billion……… They have so far repaid kr. 30.8 billion in
2020.

So as so often we see two different behaviours. Some are borrowing more but others are using this as an opportunity to repay. So greed and fear are co-existing.

House Prices

The official data gives us a clue but not a lot more. The latest reading is for the second quarter of last year and it was rising ever since it was set at 100 in 2015 to 120.4.We can set another benchmark I guess as the index had fallen to 85.7 as 2012 began and Denmark prepared for negative interest-rates.

There is a monthly price index for single family houses which showed at annual rate of increase of 4.6% in September which is quite a rise from the -0.2% of March as the pandemic hit.

As to the overall situation prices are now much higher than September 2016 when the central bank announced this.

COPENHAGEN (Reuters) – A housing bubble is looming in Copenhagen, inflated by Denmark’s record-low interest rates, the central bank said on Wednesday.

Comment

There are other issues here and those of you with a sense of deja vu may be thinking of June 14th 2016.

Hans Peter Christensen got some unusual news when he opened his most recent mortgage statement. His quarterly interest payment was negative 249 Danish kroner…. Realkrdit Denmark, one of the nation’s largest home lenders, provided 758 borrowers with negative interest-rates last year.

That is when we on here first covered negative mortgage rates in Denmark. Or maybe you are thinking of August 2019 and this?

In the world’s biggest covered-bond market, a Danish bank says it’s now ready to sell 10-year mortgage-backed notes at a negative coupon for the first time

Actually I noted this back then.

Since then things have taken a further step as Nordea has started offering some mortgage bonds for twenty years at 0%,

So we can say that whilst we need care as there are often admin fees on mortgages which mean the headlines are misleading that 0% mortgage rates lead to higher house prices. They are also associated with more debt.

However, over the past four decades,
debt has increased significantly faster than incomes
and today accounts for 260 per cent of the disposable
income of Danish households ( Nationalbanken)

Whilst some are repaying as we observed earlier others seem much less keen.

At the end of 3rd
quarter of 2020, 59.8 per cent of the variable-rate
loans are, however, interests-only.

Also they borrow for a long time in the mortgage market.

Long remaining maturity is a particular characteristic
on Danes’ mortgage debt. At the end of the 3rd
quarter of 2020, the remaining maturity of 59.9 per
cent of all Danes’ mortgage debt was between 25
and 30 years. Approximately half of the outstanding
debt is in the form of 30-year loans disbursed within
the past year, either as new loans or as refinancing
of existing loans to new loans with 30-year maturities. ( Nationalbankem)

I remember another country which went down that road as we mull whether Denmark is catching the vapors.

I’m turning Japanese
I think I’m turning Japanese
I really think so

 

How can the ECB help the economy of France?

Tomorrow the ECB starts its policy meeting and it is a live meeting with ch-ch-changes expected. At the last meeting we were told all options were on the table but there has been something of a retreat from that position as the latest speech on its website tells us.

We have always said we will consider all instruments, and we will do a cost-benefit analysis of all the available instruments and possibly new ones. We are looking at the effectiveness of the instruments, potential side effects, complementarities between instruments and so on. So far in the pandemic, the combination of the PEPP and TLTROs has worked very well. In the past we decided against further interest rate cuts. ( Isabel Schnabel)

So they have moved away from an interest-rate cut and the hype about the PEPP and TLTROs gives us a clue as to what she at least plans.

France

The last couple of days have brought us more up to date on the state of play in La Belle France. Its statistical office Insee has concluded that one area was hit as badly by the recent lockdown as the original one.

The shock to household consumption would appear to have been of a fairly similar order of magnitude (–14% estimated in November, compared to the pre-crisis level), but was undoubtedly a little harsher than the shock to GDP.

Their explanation for this is below.

 In fact, although we witnessed a growth in distance sales and other home delivery services, the purpose behind the health restrictions was to reduce the numbers of people mixing together and thus they mainly affected specific areas of household demand (closure of restaurants and bars, closure of certain “non-essential” leisure activities and businesses, limited transport).

However other areas were not affected as much and this means that the overall pycture in their opinion is below.

The business tendency surveys collected from companies and households, along with high-frequency data, give the same diagnosis for economic activity in November in France. Overall, activity losses appear to be lower than in the spring, although considerable nonetheless: in November, activity within the meaning of GDP would seem to be around 12% below its pre-crisis level – a slightly lower estimate than that given in the previous Economic Outlook,

This means that 2020 looks like turning out to be quite a shocker in terms of economic output.

All in all, taking into account these hypotheses for the end of the year, GDP in Q4 2020 is likely to shrink by 4½% as a quarterly variation (after a rebound of +18.7% in Q3, as a result of the lifting of the first lockdown). Across the whole of 2020, GDP is expected to decline by about 9% compared to 2019.

It turns out that they may end up being right via the route of being consistently wrong!

On the one hand, coming out of lockdown for the first time resulted in a more vigorous economic rebound than expected. On the other hand and conversely, the resurgence of the epidemic put a strain on economic activity in Q4.

That in itself gives us a warning for 2021 which we hope will be the year of the rebound.

Looking Ahead

We can start with the view on the month we are now in.

We estimate that in December economic activity within the meaning of GDP could be at 8% below its pre-crisis level. Household consumption should rebound a little more sharply than GDP, to be 6% below its pre-crisis level.

Then there is the recovery in China.

The Chinese economy in particular is continuing its recovery, after a shock that was certainly very severe but limited to Q1.

Next if we go back to the October forecasts there is hope for next year from what took place this summer.

As a result, bank card spending by residents
on accommodation and catering rose during July and August to levels that were at least comparable
to those of the summer 2019 season.

Whilst that is only domestic tourism it does offer hope that tourism in general will return relatively quickly to past levels. We started the pandemic by noting the importance of tourism to the French economy and I have been a little surprised it has not been reflected more in the figures.

Employment

This morning’s release give us an idea of the broad trends.

Between the end of June and the end of September 2020, payroll employment rebounded by 1.6%, that is 401,100 net job creations after –2,7% (–697,100 jobs) in the first semester. At the end of Septembre 2020, it thus remained below its pre-crisis level at the end of 2019 (–295,900, or –1.2%), but returned to a level comparable to the end of 2018

As to absolute levels we have the issue that the furlough schemes count as employed.

Debt and Bonds

I thought I would link to the issue that the ECB is most engaged in and we see that the Financial Times has been looking at something we have been following.

Senior Italian officials have recently stirred up the idea once more, suggesting the ECB could forgive debt bought through its asset purchase programme or swap it for perpetual bonds, which are never repaid.

France does get a mention in deficit terms.

Many countries are running budget deficits above 10 per cent of gross domestic product, including Italy, France and Spain.

The issue of France’s debt gets skipped by the FT but below is the Governor of the Bank of France writing to the President of the Republic.

Domestic fiscal policy has been deployed massively, and in
France is close to its limits with public debt set to reach 120% of GDP at the end of 2020 – a twofold increase in only twenty years.

It is hard not to have a wry smile at that. Firstly because that is the level which the Euro area identified as a crisis one for Greece so another one bites the dust to quote Queen. Also France has only ever paid lip service to this although it has applied it to others.

While the EU’s fiscal rules — requiring governments to keep deficits below 3 per cent of GDP and overall debt under 60 per cent of GDP — have been suspended since the pandemic hit, they are likely to be reactivated in some form once the crisis is over, piling pressure on governments to deleverage. ( FT)

Comment

The ECB has been performing the one role it can in the crisis which the FT describes below.

So far investors have not added to the clamour — the cost of new debt remains low as the ECB buys most of the extra bonds sold, so many countries are able to borrow for up to 10 years at yields of close to or below zero.

The large scale purchases mean that the 2-year yield is -0.72% and and 10-year -0.34%. Even if France borrows for 30 years it only has to pay 0.35% at the moment. This means that we have to correct the Governor of the Bank of France as it is nowhere near “close to its limits ” as it costs very little and a fair bit actually gives a return. Of course any rise in yields would change things rather quickly which is part of my “To Infinity! And Beyond!” theme as how can the ECB ever get off the QE horse?

Rather than targeting inflation its role now is to finance government spending as cheaply as it thinks it can get away with.

Moving to the real economy it can do much less as after all things were struggling pre pandemic. That is the real issue looking ahead. As economies regain ground some of the debt to GDP panic will go as the flow in the equation improves. But the stock of debt may yet return to be an issue as for example it will block any rise in bond yields for some time yet so we may well see more of this.

Globally, negative-yielding debt climbed to
$17.5 trillion, on a par with all-time highs. This pushed investors into riskier assets as
they searched for yield, which broadened the range of low- or negative-yielding
assets. ( Bank for International Settlements )

What could go wrong?

 

Can the UK afford all the extra debt?

I thought that it was time to take stick and consider the overall position in terms of the build up of debt. This has come with a type of economic perfect storm where the UK has begun borrowing on a grand scale whilst the economy has substantially shrunk.So an stand alone rise in debt has also got relatively much larger due to the smaller economy. Hopes that the latter would be short and sharp rather faded as we went into Lockdown 2.0. Although as we look to 2021 and beyond there is increasing hope that the pace of vaccine development will give us an economic shot in the arm.

In terms of scale we got some idea of the flow with Friday’s figures.

Public sector net borrowing (PSNB ex) in the first seven months of this financial year (April to October 2020) is estimated to have been £214.9 billion, £169.1 billion more than in the same period last year and the highest public sector borrowing in any April to October period since records began in 1993.

The pattern of our borrowing has changed completely and it is hard not to have a wry smile at the promises of a budget balance and then a surplus. Wasn’t that supposed to start in 2016? Oh Well! As Fleetwood Mac would say. Now we face a year where if we borrow at the rate above then the total will be of the order of £370 billion.

If we switch to debt and use the official net definition we see that we opened the financial year in April with a net debt of 1.8 trillion Pounds if you will indulge me for £500 million and since then this has happened.

Public sector net debt excluding public sector banks (PSND ex) rose by £276.3 billion in the first seven months of the financial year to reach £2,076.8 billion at the end of October 2020, or around 100.8% of gross domestic product (GDP); debt to GDP ratios in recent months have reached levels last seen in the early 1960s.

You nay note that the rise in debt is quite a bit higher than the borrowing and looking back this essentially took place in the numbers for April and May when the pandemic struck. Anyway if we assume they are now in control of the numbers we are looking at around £2.2 trillion at the end of the financial year if we cross our fingers for a surplus in the self assessment collection month of January.

The Bank of England

How does this get involved? Mostly by bad design of its attempts to keep helping the banks. But also via a curious form of accountancy where marked to market profits as its bond holdings are counted as debt.

If we were to remove the temporary debt impact of these schemes along with the other transactions relating to the normal operations of the BoE, public sector net debt excluding public sector banks (PSND ex) at the end of October 2020 would reduce by £232.9 billion (or 11.3 percentage points of GDP) to £1,843.9 billion (or 89.5% of GDP).

So on this road we look set to end the fiscal year with a net debt of the order of £2 trillion.

Quantitative Easing

This is another factor in the equation but requires some care as I note this from the twitter feed of Richard Murphy.

Outside Japan QE was unknown until 2009. Since then the UK has done £845 billion of it. This is a big deal as a consequence. But as about half of that has happened this year it’s appropriate to suggest that there have been two stage of QE, so far. And I suggest we need a third.

Actually so far we have done £707 billion if you just count UK bond or Gilt purchases. That is quite a numerical mistake.As we look ahead the Bank of England plans to continue in this manner.

The Committee voted unanimously for the Bank of England to continue with the existing programme of £100 billion of UK government bond purchases, financed by the issuance of central bank reserves, and also for the Bank of England to increase the target stock of purchased UK government bonds by an additional £150 billion, financed by the issuance of central bank reserves, to take the total stock of government bond purchases to £875 billion.

We see that this changes the numbers quite a lot. There are a lot of consequences here so let me this time agree with Richard Murphy as he makes a point you on here have been reading for years.

The first shenanigan is that the so-called independence of the Bank of England from the Treasury is blown apart by the fact that the Treasury completely controls the APF and the whole QE process. QE is a Treasury operation in practice, not a Bank of England one. ( APF = Asset Protection Fund)

Actual Debt Costs

These are extraordinarily low right now. Indeed in some areas we are even being paid to borrow. As I type this the UK two-year yield is -0.03% and the five-year yield is 0%. Even if we go to what are called the ultra longs we see that the present yield of the fifty-year is a mere 0.76%. To that we can add the pandemic effect on the official rate of inflation.

Interest payments on the government’s outstanding debt were £2.0 billion in October 2020, £4.4 billion less than in October 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index to which index-linked bonds are pegged.

As an aside this also explains the official effort to neuter the RPI measure of inflation and make it a copy of the CPIH measure so beloved of the UK establishment via the way they use Imputed Rents to get much lower numbers. I covered this issue in detail on the 18th of this month.

So far this financial year we have paid £24.1 billion in debt costs as opposed to the £33.9 billion we paid in the same April to October period last year.

Comment

The elephant in the room here is QE and by using it on such a scale the Bank of England has changed the metrics in two respects. Firstly the impact on the bond market of such a large amount of purchases has been to raise the price which makes yields lower. That flow continues as it will buy another £1.473 billion this afternoon. Having reduced debt costs via that mechanism it does so in another way as the coupons ( interest) on the debt it has bought are returned to HM Treasury. Thus the effect is that we are not paying interest on some £707 billion and rising of the debt that we owe.

Thus for now we can continue to borrow on a grand scale. One of the ways the textbooks said this would go wrong is via a currency devaluation but that is being neutered by the fact that pretty much everyone is at the same game. There are risks ahead with the money supply as it has been increased by this so looking ahead inflation is a clear danger which is presumably why the establishment are so keen on defining it away.

I have left until the end the economy because that is so unpredictable. We should see some strength in 2021 as the vaccines kick in.But we have a long way to go to get back to where we were in 2008. On a collective level we may need to face up to the fact that in broad terms economic growth seems to have at best faded and at worst gone away.

Podcast

 

 

Do we face austerity and tax rises after the Covid-19 pandemic?

We have been in uncertain times for a while now and this has only been exacerbated by the Covid-19 pandemic. One particular area of concern are the public finances of nations who are copying the “Spend! Spend! Spend!” prescription of football pools winner Viv Nicholson. For younger readers the football pools were what people did before lotteries. Indeed if we note the latest IMF Fiscal Monitor there was an issue even before the new era.

Prior to the pandemic, public and private debt were
already high and rising in most countries, reaching
225 percent of GDP in 2019, 30 percentage points
above the level prevailing before the global financial
crisis. Global public debt rose faster over the period,
standing at 83 percent of GDP in 2019.

We get a pretty conventional response for the IMF which has this as a mantra.

And despite access to financing varying sharply across countries, medium- to long-term fiscal strategies were needed virtually everywhere.

There is a counterpoint here which is that the fiscal strategies approved by the IMF have been a disaster. There is of course Greece but in a way Japan is worse. Following IMF advice it began a policy of raising its Consumption Tax to reduce its fiscal deficit. It took five years for it to take the second step as the first in 2014 caused quite a dive in the economy. Then the second step last year saw Japan’s economy contract again, just in time to be on the back foot as the Covid-19 pandemic arrived.

The IMF is expecting to see quite a change this year.

In 2020, global general government debt is estimated to make an unprecedented jump up to almost 100 percent of GDP. The major increase in the primary deficit and the sharp contraction in economic activity of 4.7 percent projected in the latest World Economic Outlook, are the main drivers of this development.

Oh and where have we heard this before? The old this is “temporary” line.

But 2020 is an exceptional year in terms of
debt dynamics, and public debt is expected to stabilize
to about 100 percent of GDP until 2025, benefiting
from negative interest-growth differentials.

I make the point not because I have a crystal ball but because I know I do not. Right now the path to the end of this year looks extremely uncertain with for example France imposing a curfew on Paris and other major cities and Germany hinting at another lockdown. So we have little idea about 2021 let alone 2025.

The IMF is in favour of more spending this time around.

These high levels of public debt are hence not the
most immediate risk. The near-term priority is to
avoid premature withdrawal of fiscal support. Support
should persist, at least into 2021, to sustain the recovery and to limit long-term scarring. Health and education should be given prime consideration everywhere.

I would have more time for its view on wasteful spending and protection of the vulnerable if the places where it has intervened had actually seen much reform and protection.

Fiscally constrained economies should prioritize the
protection of the most vulnerable and eliminate
wasteful spending.

Economic Theory

The IMF view this time around is based on this view of public spending.

The Fiscal Monitor estimates that a 1 percent of
GDP increase in public investment, in advanced
economies and emerging markets, has the potential to push GDP up by 2.7 percent, private investment by
10 percent and, most importantly, to create between
20 and 33 million jobs, directly and indirectly. Investment in health and education and in digital and green
infrastructure can connect people, improve economy wide productivity, and improve resilience to climate
change and future pandemics.

If true we are saved! After all each £ or Euro or $ will become 2.7 of them and them 2.7 times that. But then we spot “has the potential” and it finishes with a sentence that reminds me of the  company for carrying on an undertaking of great advantage from the South Sea Bubble. For those unaware of the story it disappeared without trace but with investors money.

For newer readers this whole area has become a minefield for the IMF because it thought the fiscal multiplier for Greece would be 0.5 and got involved in imposing austerity on Greece. It then was forced into a U-Turn putting the multiplier above 1 as it was forced to do by the economic collapse which was by then visible to all.

Institute for Fiscal Studies

It has provided a British spin on these events although the theme is true pretty much everywhere we look.

The COVID-19 pandemic and the public health measures implemented to contain it will lead to a huge spike in government borrowing this year. We forecast the deficit to climb to £350 billion (17% of GDP) in 2020–21, more than six times the level forecast just seven months ago at the March Budget. Around two-thirds of this increase comes from the large packages of tax cuts and spending increases that the government has introduced in response to the pandemic. But underlying economic weakness will add close to £100 billion to the deficit this year – 1.7 times the total forecast for the deficit as of March.

I suggest you take these numbers as a broad brush as it will be a long economic journey to April exemplified by that fact that whilst I am typing this it has been announced that London will rise a tier in the UK Covid-19 restrictions from this weekend. I note they think that £250 billion of this is an active response and £100 billion is passive or a form of automatic stabiliser.

They follow the IMF line but with a kicker that it is understandably nervous about these days.

But, in the medium term, getting the public finances back on track will require decisive action from policymakers. The Chancellor should champion a general recognition that, once the economy has been restored to health, a fiscal tightening will follow.

They are much less optimistic than the IMF about the middle of this decade/

Under our central scenario, and assuming none of the temporary giveaways in 2020–21 are continued, borrowing in 2024–25 is forecast to be over £150 billion as a result of lower tax revenues and higher spending through the welfare system.

They do suggest future austerity.

Once the economy has recovered, policy action will be needed to prevent debt from continuing to rise as a share of national income. Even if the government were comfortable with stabilising debt at 100% of national income – its highest level since 1960 – it would still need a fiscal tightening worth 2.1% of national income, or £43 billion in today’s terms.

Comment

As you can see the mood music from the establishment and think tanks has changed somewhat since the early days of the credit crunch.Austerity was en vogue then but now we see that if at all it is a few years ahead. Let me now switch to the elephant in the room which has oiled this and it was my subject of yesterday, where the fall in bond yields means governments can borrow very cheaply and sometimes be paid to do it. That subject is hitting the newswires this morning.

The German 10-year bond yield declined to the lowest level in five months on Wednesday as coronavirus’s resurgence across the Eurozone strengthened the haven demand for the government debt. ( FXStreet)

It is -0.61% as I type this and even the thirty-year yield is now -0.22%. So all new German borrowing is better than free as it provides a return for taxpayers rather than investors. According to Aman Portugal is beginning to enjoy more of this as well.

According to the IGCP, which manages public debt, at the Bloomberg agency, €654 million were auctioned in bonds with a maturity of 17 October 2028 (about eight years) at an interest rate of -0.085%.

Although for our purposes we need to look at longer-term borrowing so the thirty-year issue at 0.47% is more relevant. But in the circumstances that is amazingly cheap.

In essence this is what is different this time around and it is one arm of government helping another as the enormous pile of bonds purchased by central banks continue to grow. The Bank of England bought another £4.4 billion this week. So we have a window where this matters much less than before. It does not mean we can borrow whatever we like it does mean that old levels of debt to GDP such as 90% ( remember it?) and 100% and even 120% are different now.

In the end the game changer is economic growth which in itself posts something of a warning as pre pandemic we had issues with it. Rather awkward that coincides with the QE era doesn’t it as we mull the way it gives with one hand but takes away with another?

UK National Grid

It was only last week I warned about this.

National Grid warns of short supply of electricity over next few days ( The Guardian)

Good job it has not got especially cold yet.

What is happening to the economy of Italy right now?

Today has brought the economy of Italy back into focus and before I look at the economics let me express my deepest sympathy for also those affected by the Corona Virus there.

Like a soul without a mind
In a body without a heart
I’m missing every part, ( Massive Attack)

Returning to the economics there were hopes from Italy of some financial and economic relief from the overnight Eurogroup meeting so let me hand you over to its President Mario Centeno.

After 16h of discussions we came close to a deal but we are not there yet. I suspended the #Eurogroup & continue tomorrow, thu. My goal remains: A strong EU safety net against fallout of #covid19 (to shield workers, firms &countries)& commit/ to a sizeable recovery plan

Let us consider what it could do? There are essentially four topics at play. Firstly there is the issue of extra spending.

Diplomatic sources and officials said a feud between Italy and the Netherlands over what conditions should be attached to euro zone credit for governments fighting the pandemic was blocking progress on half a trillion euros worth of aid. ( Reuters)

Although actually in a copying of the Juncker Plan that regular readers will recall a lot of this is borrowing and money from Special Purpose Vehicles.

Further proposals under discussions include credit lines from the euro zone bailout fund that would be worth up to 2% of a country’s economic output, or 240 billion euros in total. The conditions for gaining access to this money remain a sticking point.

Granting the European Investment Bank 25 billion euros of extra guarantees so it can step up lending to companies by a further 200 billion euros is another option.

The third is support for the EU executive’s plan to raise 100 billion euros on the market against 25 billion euros of guarantees from all governments in the bloc to subsidise wages so that firms can cut working hours rather than sack people. ( Reuters).

Actually there were apparently requests for even more money to be deployed.

ECB urges measures worth 1.5 trillion euros this year to tackle virus crisis . ( @TradingFloorAudio )

The next issue is how this will be paid for? We have already tip-toed onto that subject because the reference to the Euro bailout fund refers to the European Stability Mechanism or ESM. The catch with it is the issue of conditionality or if you prefer terms. This is awkward on two counts as the two main bits are that a country has to have lost access to market financing which is not true and that it is supposed to present a macroeconomic adjustment programme of austerity when in fact the plan would be to “Spend! Spend!Spend!”

The use of the European Investment Bank is complicated by the UK still being a 14% shareholder.

Finally in this sweep we have the elephant in the room which is the issuing of joint Euro area bonds or as they have been rebranded Corona Bonds. This has collided with a regular problem which is that the countries which would in effect be financing this are not keen at all whereas those that would benefit are very keen but cannot persuade the former. We have been down this road so many times now and have always ended up singing along with Talking Heads.

We’re on a road to nowhere
Come on inside
Taking that ride to nowhere
We’ll take that ride

Italy GDP

Before I look at the impact of the above on Italy we need to see where it stands in economic terms. The opening salvo was fired by the IHS Markit survey from only five days ago which now feels a bit like forever.

The Composite Output Index* dropped from 50.7 in February to 20.2 in March, falling a record 30.5 points and signalling the sharpest contraction in Italian private sector output since the series began in January 1998.
The downturn was most marked in the service sector,
although both services providers and manufactures reported record reductions in output during March.

This came with the lowest PMI number I can recall which was 17.4 for the services sector. We have learnt over time to take these surveys with several pinches of salt but it was clear we were seeing a large fall in economic output which in the case of Italy comes on the back of at best stagnation.

Yesterday the Italian Statistics Office produced its Monthly Report.

First signals of COVID -19 economic effects are displayed by March consumer and business surveys -which deteriorated sharply- and February extra EU trade and retail trade.

Okay let’s look back to February.

Extra Eu trade preliminary figures were influenced by the sharp fall of exports towards China (-21.6% with respect to
the same month of the previous year) were the epidemic originated. Retail trade improved possibly due to the
increase of precautionary expenditure for food in the first phases of the health emergency.

So the only good news was some precautionary buying of food and other essentials.

Now March and as BBC children’s TV used to say, are you sitting comfortably?

In March, the consumer confidence climate slumped. The heavy deterioration affected all index components. More
specifically, the economic climate current and future and the expectation on unemployment plummeted. These
negative signals suggest that there might be in the coming months a deterioration in income, consumption and labour
market figures.

They have modelled what they think the impact will be from this.

We provide two different scenarios, the first in which the lockdown will be concentrated in March and April and
the second in which the lockdown will last until June. In the first case consumption will be reduced by 4.1% on
yearly basis in the second case by 9.9% . The consumption fall would determine a value added contraction by 1.9% and 4.5% respectively.

If we now add in the other sectors we get an even larger GDP fall for example there is this.

More precisely, for sectors in lockdown or for which we assume that the turnover is near zero
(i.e. tourism) we evaluate the overall reduction of production and its impact on consumption.

If we factor in tourism as being virtually zero then the fall in GDP implied above doubles at least as it would be seen in the exports numbers rather than consumption.

Comment

If we look at the Italian situation we see that its own spending plans dwarf the Euro area ones. Here is Prime Minister Giuseppe Conte from Monday via Google Translate.

Today’s decree brings 400 billion of liquidity for businesses, with the #CuraItalia we had freed 350. We are talking about 750 billion, almost half of our GDP. The state is there and immediately puts its firepower into the engine of the economy. When Italy gets up it runs.

The next context is that this is way beyond the ability of the ESM to deal with alone.

 The ESM, with its unused financial firepower of €410 billion, could provide credit lines at low interest rates. ( Klaus Regling)

Actually that is more than we have been told in the past but as you can see the numbers are so large here even 10 billion is not especially material. As there would be calls from countries other than Italy the ESM presently needs more ammo.

If we look at the public debt of Italy it was 2.44 trillion Euros at the end of the third quarter of last year. So if the spending plans above come to fruition we will see it rise to more like 3.2 trillion. With the economy shrinking we could see a debt to GDP figure of the order of 200% for a time. The real issue is for how long a time?

As to the bond vigilantes then they have mostly been anaesthetised by the QE buying of the ECB which is likely to be around 15 billion Euros or so per month. Whilst the Eurogroup indecison has raised the benchmark ten-year yield by 0.08% today ( and I am assuming the ECB is buying more today to resist this) it is at 1.67% under control. But as you can see even the powered up Pac-Man of the ECB is in danger of being swamped by the size of the bond issuance.

Oh and as to Eurobonds well actually they do exist.

When both the EIB and the ESM increase their actions, they need to issue bonds to finance their lending. The EIB – and to a smaller extent the European Commission – issue such debt for all 27 EU Member States, and the ESM for the 19 euro area countries. These three institutions have issued mutualised debt, i.e. European debt, for many years already. Today, these institutions have around €800 billion in outstanding European debt. ( Klaus Regling)

Let me finish with something more optimistic Italy has a large grey economy estimated at over 200 billion Euros and it is a nation of savers.

The saving rate of consumer households was 8.2%, 0.1 percentage points lower than in the previous quarter. ( Istat)

Let us cross our fingers and hope that it can mobilise both.

 

 

What is the outlook for the US economy?

We see plenty of rhetoric about challenges and changes but the two biggest players in the world economy are the United States and the US Dollar. So it is time for us to peer under the bonnet again and let me open with the result from the third quarter.

Real gross domestic product (GDP) increased at an annual rate of 1.9 percent in the third quarter of 2019 , according to the “advance” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 2.0 percent. ( BEA )

There are several implications here of which the first is simply that this is better than we are seeing in most places with Germany and Japan reporting growth rates much lower in the last 24 hours. In general this is , however, weaker than last year although the last quarter of 2018 was particularly weak.

A supporting element for the US has been a strong labour market.

 Real disposable personal income increased 2.9 percent, compared with an increase of 2.4 percent.

Has the easier fiscal policy of President Trump been a factor? Yes but we simply get told this.

federal government spending,

If we shift to a potential consequence which is rising debt well actually the ability of the US to repay it looks strong too.

Current dollar GDP increased 3.5 percent, or $185.6 billion, in the third quarter to a level of $21.53 trillion. In the second quarter, GDP increased 4.7 percent, or $241.4 billion.

As you can see there has been an element of inflating away the debt in there.

What happens next?

The now cast system uses the latest official data to look ahead and just like last year it looks like being a weak end to the year.

The New York Fed Staff Nowcast stands at 0.7% for 2019:Q4.

News from this week’s data releases decreased the nowcast for 2019:Q4 by 0.1 percentage point.

Negative surprises from lower than expected exports and imports data accounted for most of the decrease.

Another factor in play is that the labour market is not providing the push it was.

Earnings growth is still below late 2018 levels……Payroll growth was moderate in October, but remained solid year-to-date.

Money Supply

Back on the 22nd February I posted my concerns about the prospects for 2019.

So we can expect a slowing economic effect from it as we note that some of the decline will be due to the QT programme…….So we move on with noting that a monetary brake for say the first half of 2019 has been applied to the economy.

Of course that was then and this is now as the reference to the now ended QT programme. For example this happened at the end of last month.

the Committee decided to lower the target range for the federal funds rate to 1-1/2 to 1-3/4 percent.

Yesterday saw Repo operations from the New York Fed which provided some US $73.6 billion of overnight liquidity and US $30.7 billion of 13 day liquidity. Thus the cash is flowing rather than being reduced and like so many things what was presented as temporary seems to keep going.

In accordance with the most recent FOMC directive, the Desk will continue to offer at least $35 billion in two-week term repo operations twice per week and at least $120 billion in daily overnight repo operations.

The Desk will also offer three additional term repo operations during this calendar period with longer maturities that extend past the end of 2019.  ( NY Fed )

That is for the next month and there will be more to come as they catch up with something we have been looking at for a couple of years now which is the year end demand for US Dollars.

These additional operations are intended to help offset the reserve effects of sharp increases in non-reserve liabilities later this year and ensure that the supply of reserves remains ample during the period through year end.

Returning to the money supply data you will not be surprised to read that the numbers have improved considerably. The outright fall of US $42 billion in the narrow money measure in March has been replaced by growth and indeed strong growth as both the last 3 months and 6 months have seen growth at an annual rate of the order of 8%. Back in February I noted that cash growth was strong and it was demand deposits which were weak and it is really the latter which have turned around. Demand deposits totalled US $1.45 trillion in March but had risen to US $1.57 trillion at the end of October.

Talk of the demise of what Stevie V called

Dirty cash I want you, dirty cash I need you, woh-oh
Money talks, money talks
Dirty cash I want you, dirty cash I need you, woh-oh

continues which is rather the opposite of official rhetoric.

Thus a monetary stimulus has been applied and for those of you who like to look at this in real terms might now that the inflation measures in GDP have faded making the impetus stronger for say the opening and spring of 2020.

Have the Repo operations influenced this? If you look at the September data I think that they have. But this comes with a cautionary note as QE operations do not flow into the monetary data as obviously as you might think and at times in the Euro area for example have perhaps taken quite a while.

Credit

By contrast a bit of a brake was applied in September.

Consumer credit increased at a seasonally adjusted annual rate of 5 percent during the third quarter. Revolving credit increased at an annual rate of 2-1/4 percent, while nonrevolving credit increased at an annual rate of 6 percent. In September, consumer credit increased at an annual rate of 2-3/4 percent.

Those sort of levels would have the Bank of England at panic stations. It makes me wonder if fears over the financial intermediation of the banks was a factor in the starting of Repo operations?

If you are wondering if car loans are a factor here we only get quarterly data and as of the end of the third quarter the annual rate of growth was 4.3% so definitely, maybe.

The US Dollar

The official view is expressed like this.

NEW YORK (Reuters) – President Donald Trump on Tuesday renewed his criticism of the Federal Reserve’s raising and then cutting of interest rates, saying the central bank had put the United States at a competitive disadvantage with other countries and calling for negative interest rates.

He wants lower interest-rates and a lower US Dollar. What we have seen is a trade-weighted index which has risen from 116 in February of last year to above 129 as I type this. So not much luck for the Donald

Comment

As you can see things are better than some doom mongers would have us believe. The monetary situation has picked up albeit with weaker consumer credit and there is the fiscal stimulus. But that is too late for this quarter and there are ongoing issues highlighted by the weak data we have seen out of China this week which the New York Fed summarises like this.

China’s monthly economic activity data is steady at a lower level.

Then there is the ongoing sequence of interest-rate cuts around the world which rose by 2 yesterday as Mexico and Egypt got on the bandwagon. That makes 770 for the credit crunch era now.

Meanwhile for those who have equities the Donald thinks that life is good.

Hit New Stock Market record again yesterday, the 20th time this year, with GREAT potential for the future. USA is where the action is. Companies and jobs are coming back like never before!

 

 

 

 

 

 

The success story of Spain faces new as well as old challenges

Back in the Euro area crisis the Spanish economy looked in serious trouble. The housing boom and bust had fit the banking sector mostly via the cajas and the combination saw both unemployment and bond yields soar. It seems hard to believe now that the benchmark bond yield was of the order of 7% but it posed a risk of the bond vigilantes making Spain look insolvent. That was added to by an unemployment rate that peaked at just under 27%. The response was threefold as the ECB bought Spanish bonds under the Securities Markets Programme to reduce the cost of debt. There was also this.

In June 2012, the Spanish government made an official request for financial assistance for its banking system to the Eurogroup for a loan of up to €100 billion. It was designed to cover a capital shortfall identified in a number of Spanish banks, with an additional safety margin.

In December 2012 and January 2013, the ESM disbursed a total of €41.3 billion, in the form of ESM notes, to the Fondo de Restructuración Ordenada Bancaria (FROB), the bank recapitalisation fund of the Spanish government. ( ESM)

Finally there was the implementation of the “internal competitiveness” model and austerity.

What about now?

Things are very different as Spain has been in a good run. From last week.

Spanish GDP registers a growth of 0.4% in the third quarter of 2019 compared to to the previous quarter in terms of volume. This rate is similar to that recorded in the
second trimester.The interannual growth of GDP stands at 2.0%, similar to the previous quarter.

There are two ways of looking at this in the round. The first is that for an advanced economy that is a good growth rate for these times, and the second is that it will be especially welcome on the Euro area. Combining Spain with its neighbour France means that any minor contraction in Germany does not pull the whole area in negative economic growth.

However there is a catch for the ECB as Spain has slowed to this rate of economic growth and had thus exceeded the “speed limit” of 1.5% per annum for quite a while now. That will keep its Ivory Tower busy manipulating, excuse me analysing output gaps and the like. In fact once the dog days of the Euro area crisis were over Spain’s economy surged forwards with annual economic growth peaking at 4.2% in the latter part of 2015 and then in general terms slowing to where we are now. As to why the ESM explanation is below.

 Strong job creation followed the economic expansion, and employment has recovered by more than 2.5 million. Structural reforms have been paying off: competitiveness gains have supported economic rebalancing towards tradable sectors, and exports of goods and services have stabilised at historical highs (above 30% of GDP). The large and persistent current account deficit, which had reached 9.6% of GDP in 2007, has turned into a surplus averaging 1.5% of GDP in 2014-18.

Actually the IMF must be disappointed it did not join the party as turning around trade problems used to be its job before it came under French management. But Spain certainly rebounded in economic terms.and has been a strength of the Euro area.

Looking at the broader economy, Spain returned to economic growth in 2014 and continues to perform above the euro area average in that category

Over the past six months external trade has continued to boost the economy in spite of conditions being difficult.

On the other hand, the demand external presents a contribution of 0.2 points, eight tenths lower than the quarter past.

The impact of all this has improved the employment situation considerably.

In interannual terms, employment increases at a rate of 1.8%, rate seven tenths
lower than the second quarter, which represents an increase of 332 thousand jobs
( full time equivalents) in one year.

In terms of a broad picture GDP in Spain peaked at 104.4 in the latter part of 2007 then had a double-dip to 94.3 in the autumn of 2013 and now is at 110.9. So it has recovered and moved ahead albeit over the 12 years not made much net progress.

Problems?

According to the ESM the banks remain a major issue.

Several legacy problems also remain in the banking sector. These include larger and more persistent-than-expected losses of SAREB, which pose a contingent liability to the state. Banks have adequate capital buffers, but should further strengthen them towards the euro area average to withstand any future risks. In addition, the privatisation of Bankia and the reform of cajas need to be completed.

Of course banking reform has been just around the corner on a Roman road in so many places. Also the balance sheet of the Spanish banks has received what Arthur Daley of the TV series Minder would call a “nice little earner”.

Housing prices rise 1.2% compared to the previous quarter.The annual variation rate of the Housing Price Index has decreased 1.5 points to 5.3%,

Annual house price growth returned in the spring of 2014 which the banks will welcome. The index based in 2015 is now at 124.2.

However not all ECB policies are welcomed by the banks.

Finally, banks still face pressure on profitability due to the low interest rate environment, and potentially from a price correction in financial assets if the macro environment deteriorates. ( ESM )

An official deposit rate of -0.5% does that to banking profitability. I do not recall seeing signs of the Spanish banks passing this on in the way that Deutsche Bank announced yesterday but the heat is on. I see that the ESM is covering its bases should house prices fall again.

If we look at mortgage-rates then they are falling again as the Bank of Spain records them as 1.83% in September which looks as though it may be an all time low but we do not have the full data set.

Comment

The new phase of economic growth has brought better news on another problem area as the Bank of Spain reports.

Indeed, the non-financial private sector debt ratio
relative to GDP stood at 132%, 5 pp down on a year earlier and 4 pp below the euro area average.

The ratio of the national debt to GDP has fallen to this.

Also, in June 2019 the public debt/GDP ratio stood at 98.9%, a level still 13 pp higher than the euro area average.

 

and these days it is much cheaper to finance as the 7% yields of the Euro area crisis have been replaced by some negative yields and even the benchmark ten-year being a mere 0.31%.

On the other side of the coin first-time buyers will not welcome the new higher house prices and there are areas of trouble.

In this respect, consumer credit grew in June 2019 at a year-on-year rate of around 12%, and non-performing consumer loans at 26%, raising the NPL ratio slightly to 5.6% ( Bank of Spain)

What could go wrong?

Another signal is the way that the growth in employment has improved things considerably but Spain still has an unemployment rate that has only just nudged under 14%.So there is still much to do just as we fear the next downturn may be in play.

A fifth successive monthly deterioration in Spanish
manufacturing operating conditions was signalled in October as a challenging business climate negatively impacted on sales and output……At 46.8, down from 47.7 in September, the index also posted its lowest level for six-and-half years.   ( Markiteconomics )

 

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

 

 

Mark Carney claims “this is not a debt fuelled expansion” and interest-rates will rise “sooner than markets expect” yet again!

One of the features of the credit crunch era is the way that those in authority so often get given pretty much a free pass from the media, This is illustrated starkly by the BBC’s senior economics correspondent Dharshini David.

Today the Bank of England’s Governor admitted to me that rates are likely to rise faster than the markets expect. So when can we expect the first move? My analysis for

Perhaps Dharshini was giddy after being given the first question at the press conference. Sadly she asked a question which might have been written by Governor Carney himself and accordingly he seemed like Roger Federer as he volleyed it nonchalantly at the net.

Missing is any questioning of the assertion such as pointing out Governor Carney told us that interest-rates would rise “sooner than markets expect” in his Mansion House speech in June 2014. When this did not happen he acquired this moniker.

The Bank of England has acted like an “unreliable boyfriend” in hints over interest rate rises, according to MP Pat McFadden. ( BBC)

The reality was that his next move was to cut interest-rates In August 2016 followed by promises of another cut that November before yet another U-Turn. Then there was another U-Turn just over a year ago which if you recall was followed by a sharp drop in the value of the Pound £.

So you can see that it is really rather extraordinary that Dharshini either ignored or is unaware of this. I am not sure what to make of the sentence below.

But that doesn’t mean that Mark Carney or his colleagues are asleep at the wheel.

She was nearer the mark with this.

Report press conference was perhaps unprecedented number of female hacks… taken a while but face of financial journalism is changing, all the better to reflect our audiences

However there was no mention of the “woman  overboard” problem at the Bank of England which was illustrated by the 100% middle-aged male make up of its panel. The press conference highlighted this as in response to a question about diversity at the Bank of England Governor Carney responded with a barrage of “ums” and “ers”.

Still we can have a wry smile at this.

Growth actually isn’t that different to what was expected a year ago……..UK growth in the first quarter is likely to have been 0.5%, double what the Bank expected just three months ago.

Governor Carney kept pointing to the former forecast as he had a rare opportunity to bathe in a correct forecast, although he was not challenged on why they then cut the growth forecast to 0.2% so recently?

Pinocchio

In response to a rather good question about the growth of fixed-rate mortgages and its effect on the responsiveness of the economy to Bank Rate changes the Governor claimed this was nothing to do with him.  Nobody pointed out that in his first phase of Forward Guidance promising interest-rate increases there were people who were listening to him as there was a shift towards foxed-rate mortgages. Sadly, they were then shafted when Governor Carney cut interest-rates.

The point above was in a way the media catching up with one of my earliest themes from 2010 as I pointed out how market interest-rates were following official ones much less closely than before. However there was an even bigger humdinger out of Governor Carney’s mouth.

This is not a debt fuelled expansion

He has said this before and there are two main issues with this. The first is that the main policy over his tenure has been the funding for lending scheme which turned net mortgage lending positive. So more debt as shown by Wednesday’s figures.

Net lending for mortgages increased to £4.1 billion in March.

In the month before Governor Carney’s arrival the net increase was £785 million and whilst the rise has not been smooth ( early 2016 saw an incredible surge due to the buy to let changes) I think the numbers speak for themselves

Also the past three years or so has seen quite an extraordinary surge in unsecured credit something which I have been regularly documenting. It was £156.4 billion and is now around 38% higher at £216.7 billion. Can anybody think of anything else that has risen that fast as wage growth and GDP have been left far behind?

A factor in this has been something we have followed closely and was highlighted by the Office of Budget Responsibility.

 Data from the Finance & Leasing Association suggest that, between 2012 and 2016, dealership car finance contributed around three-fifths of the growth in total net consumer credit flows. Within that, around four-fifths reflected strong growth in car sales, with the remainder accounted for by a higher proportion of cars bought using dealership car finance.

So “this is not a debt fuelled recovery” means we have pumped up mortgage lending and seen quite a surge in car finance.

Inflation

Sadly for those who parroted the Bank of England line there was this. From @NicTrades

Bank of England Carney signals more than 1 hike may be needed to keep inflation in Check, while at the same time he cuts inflation forecasts.

Thus according to its inflation targeting regime an interest-rate increase is less and not more likely. Even worse the absent-minded professor Ben Broadbent gave us quite a spiel on oil markets as he tried to look on the ball, but to anyone market savvy that will have backfired too as they will have been thinking that the oil price has been falling recently. The price of a barrel of Brent Crude Oil is as I type this nearly US $5 lower since President Trump indulged in his own open mouth operation on Twitter last Friday.

Comment

The era of Forward Guidance has turned out to be anything but for the Bank of England. Governor Carney seems to have set the boy who cried wolf as his role model and the fact that he has actively misled people gets mostly overlooked. Still let us hope he is right that UK GDP grew by 0.5% in the first quarter of this year. If true that will also pose a question for the Markit series of business surveys.

At 50.9 in April, up from 50.0 in March, the seasonally
adjusted All Sector Output Index revealed a return to growth for private sector business activity.

Meanwhile our supposed football fan missed an opportunity that was taken by the ECB.

Best of luck to our local team for tonight’s semi-final!

Perhaps I am more sensitive on that front as I am a Chelsea fan, but Arsenal fans may wonder too.