Germany and Deutsche Bank both face economic problems

One of the supposed constants of the credit crunch era has been the economic performance of Germany. Earlier this week saw a type of confirmation of past trends as the European Central Bank or ECB updated its capital key, which is calculated on the basis show below.

The shares of the NCBs in the ECB’s capital are weighted according to the share of the respective Member States in the total population and gross domestic product of the European Union (EU), in equal measure.

Few will be surprised to read that in Euro area terms ( other European Union members are ECB shareholders with the Bank of England at 14.33%) the share of Germany has risen for 25.6% to 26.4%. That poses an issue for any future ECB QE especially as the Italian share has declined. But a little food for thought is provided by the fact that the Bank of England share went up proportionately more.

The economic outlook

As the latest monthly economic report from the Bundesbank points out the situation is not starting from its usual strength.

Economic output in Germany dipped slightly in
the third quarter of 2018. According to the
Federal Statistical Office’s flash estimate, real
gross domestic product (GDP) contracted by
0.2% in seasonal and calendar-adjusted terms
as compared to the previous quarter.

That has tended to be swept under the carpet by the media partly because of this sort of analysis.

This decline was mainly caused by a strong temporary
one-off effect in the automotive sector.

Central banks always tell you a decline is temporary until they are forced not too and in this instance we see two bits at this particular cherry as “temporary” finds “one-off” added to it. But the detail begs a question.

Major problems in connection with the introduction
of a new EU-wide standard for measuring exhaust emissions led to significant production
stoppages and a steep drop in motor vehicle
exports.

Fair enough in itself but we know from our past analysis that production boomed ahead of this so we are counting the down but omitting the up. Whereas next we got something I had been suggesting was on the cards.

At the same time, private consumption was temporarily absent as an important force driving the economy.

This reminds me of my analysis from October 12th.

 Regular readers will be aware of the way that money supply growth has been fading in the Euro area over the past year or so, and thus will not be surprised to see official forecasts of a boom if not fading to dust being more sanguine.

The official view blames the automotive sector but if we take the estimate of that below we are left with economic growth of a mere 0.1%.

 IHS Markit estimates that the autos drag on Germany was around -0.3 ppts on GDP in Q3

Apparently that is a boom according to the Bundesbank as its view is that the economy marches on.

Despite these temporary one-off effects, the economic
boom in Germany continues.

Indeed we might permit ourselves a wry smile as the usual consensus that good weather boosts an economy gets dropped like a hot potato.

as well as the exceptionally hot, dry
weather during the summer months.

No ice-creams or suntan oil apparently.

What about now?

The official view is of a powerful rebound this quarter but the Markit PMI survey seems to be struggling to find that.

 If anything, the underlying growth trajectory for the industry remains downward: German manufacturers reported a near stagnation of output in November, the sharpest reduction in total new orders for four years and a fall in exports not seen since mid-2013. Moreover, Czech goods producers, who are sensitive to developments in the autos sector, again commented on major disruption,

If we look wider we see this.

The Composite Output Index slipped to a near four-year low of 52.3 in November, down from 53.4 in October.

Moving to this morning’s official data we were told this.

In October 2018, production in industry was down by 0.5% from the previous month on a price, seasonally and calendar adjusted basis according to provisional data of the Federal Statistical Office (Destatis).

It was 1.6% higher than a year ago on the other side of the coin but Bundesbank hopes of a surge in consumption do not seem to be shared by producers.

The production of consumer goods showed a decrease of 3.2%.

Yesterday’s manufacturing orders posed their own questions.

+0.3% on the previous month (price, seasonally and calendar adjusted)
-2.7% on the same month a year earlier (price and calendar adjusted)

Deutsche Bank

The vultures are circling again and here is how the Wall Street Journal summed it up yesterday.

Deutsche Bank shares were down about 4% in afternoon trading Thursday in Frankfurt, roughly in line with European banks amid broader market declines. Deutsche Bank shares have fallen 51% this year to all-time lows below €8 ($9.08).

As I type this it has failed to benefit much from today’s equity market bounce and is at 7.73 Euros. Perhaps because investors are worried that if it has not done well out of “the economic boom” then prospects during any slow down look decidedly dodgy. Also perhaps buyers are too busy laughing at the unintentional comedy here.

Deutsche Bank on Thursday and last week defended senior executives. Improving compliance and money-laundering controls “has been a real emphasis of current management,” and the bank has made “enormous investments” in fighting financial crime, said Mr. von Moltke, who joined the bank in 2017, in the CNBC interview.

Could it do any worse? The numbers are something of a riposte also to those like Kenneth Rogoff who blame cash and Bitcoin for financial crime.

Deutsche Bank processed an additional €31bn of questionable funds for Danske Bank than previously thought – that takes the total amount of money processed by the German lender for Danske’s tiny Estonian branch to €163bn ( Financial Times).

That compares to the present market value of 16 billion Euros for its shares. That poses more than a few questions for such a large bank and whilst banking sectors in general have been under pressure Deutsche Bank has been especially so. Personally I do not seem how merging it with Commerzbank would improve matters apart from putting a smoke screen over the figures for a year or two. One thing without doubt is that it would make the too big to fail issue even worse.

Comment

If we look at the broad sweep Germany has responded to the Euro area monetary slow down as we would have expected. What is less clear is what happens next? This quarter has not so far show the bounce back you might expect except in one area. The positive area is the labour market where employment is 1.2% higher than a year ago and wages have risen with some estimates around 3%. So the second half of 2018 seems set to be a relatively weak one.

One area which must be an issue is the role of the banks because as they, and Deutsche Bank especially, get weaker how can they support the economy via lending to businesses? At least with the fiscal position strong ( running a surplus) Germany has ammunition for further bailouts.

Moving back to the ECB I did say I would return to the capital key change. It means that under any future QE programme it would buy relatively more German bunds except with its bond yields so low with many negative it does not need it. Also should the slow down persist there is the issue of it being despite monetary policy being so easy.

 

 

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The challenge for the ECB remains Italy and its banks

This week has seen something of an expected shifting of the sands from the European Central Bank ( ECB) about the economic prospects for the Euro area. On Monday its President Mario Draghi told the European Parliament this.

The data that have become available since my last visit in September have been somewhat weaker than expected. Euro area GDP grew by 0.2% in the third quarter. This follows growth of 0.4% in both the first and second quarter of 2018. The loss in growth momentum mainly reflects weaker trade growth, but also some country and sector-specific factors.

What he did not say was that back in 2017 quarterly growth had risen to 0.7% for a time. Back then the situation was a happy one for Mario and his colleagues as their extraordinary monetary policies looked like they were bearing some fruit. However the challenge was always what happens when they begin to close the tap? Let me illustrate things by looking again at his speech.

The unemployment rate declined to 8.1% in September 2018, which is the lowest level observed since late 2008, and employment continued to increase in the third quarter…….. Wages are rising as labour markets continue to improve and labour supply shortages become increasingly binding in some countries.

There is a ying and yang here because whilst we should all welcome the improvement in the unemployment rate, we would expect the falls to slow and maybe stop in line with the reduced economic growth rate. So is around 8% it for the unemployment rate even after negative interest-rates ( still -0.4%) and a balance sheet now over 4.6 trillion Euros? That seems implied to some extent in talk of “labour supply shortages” when the unemployment rate is around double that of the US and UK and treble that of Japan. This returns us to the fear that the long-term unemployment in some of the Euro area is effectively permanent something we looked at during the crisis. In another form another ECB policymaker has suggested that.

I will focus my remarks today on the economies of central, eastern and south-eastern Europe (CESEE), covering both those that are already part of the European Union (EU) and those that are EU candidate countries or potential candidates………..Clearly, for most countries, convergence towards the EU-28 average has practically stalled since the outbreak of the financial crisis in 2008

Care is needed as only some of these countries are in the Euro but of course some of the others should be converging due to the application process. Even Benoit Coeure admits this.

And if there is no credible prospect of lower-income countries catching up soon, there is a risk that people living in those countries begin questioning the very benefits of membership of the EU or the currency union.

I have a couple of thoughts for you. Firstly Lithuania has done relatively well but the fact I have friends from there highlights how many are in London leading to the thought that how much has that development aided its economy? You may need to probe a little as due to the fact it was part of Russia back in the day some prefer to say they are Russian. Also the data reminds us of how poor that area that was once called Yugoslavia remains. It is hardly going to be helped by the development described below by Balkan Insight.

At the fifth joint meeting of the governments of Albania and Kosovo in Peja, in Kosovo, the Albanian Prime Minister Edi Rama backed the decision of the Kosovo government to raise the tax on imports from Serbia and Bosnia from 10 to 100 per cent.

Banks

Here the ECB is conflicted. Like all central banks its priority is “the precious” otherwise known as the banks. Yet it is part of the operation to apply pressure on Italy and take a look at this development.

As this is very significant let us break it down and yes in the world of negative interest-rates and expanded central bank balance sheets Unicredit has just paid an eye-watering 7.83% on some bonds. Just the 6.83% higher than at the opening of 2018 and imagine if you held similar bonds with it. Ouch! Of that there is an element driven by changes in Italy’s situation but the additional part added by Unicredit seems to be around 3.5%.

If we look back I recall describing Unicredit as a zombie bank on Sky News around 7 years ago. The official view in more recent times is that it has been a success story in the way it has dealt with non performing loans and the like. Although of course success is a relative term with a share price of 11.5 Euros as opposed to the previous peak of more like 370 Euros. Now it is paying nearly 8% for its debt we need not only to question even that heavily depreciated share price and it gives a pretty dreadful implied view for the weaker Italian banks such as Monte Paschi which Johannes mentions. Also those non-performing loans which were packaged up and sold at what we were told “great deals” whereas now they look dreadful, well on the long side anyway.

Perhaps this was what the Bank of Italy meant by this.

The fall in prices for Italian government securities has caused a reduction in capital reserves and
liquidity and an increase in the cost of wholesale funding. The sharp decline in bank share prices has resulted
in a marked increase in the cost of equity. Should the tensions on the sovereign debt market be protracted, the
repercussions for banks could be significant, especially for some small and medium-sized banks.

Comment

We can bring things right up to date with this morning’s money supply data.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, stood at 6.8% in October, unchanged from previous month.

So we are holding station to some extent although in real terms we are slightly lower as inflation has picked up to 2.2%. Thus the near-term outlook remains weak and we can expect a similar fourth quarter to the third. Actually I would not be surprised if it was slightly better but still weak..

Looking around a couple of years ahead the position is slightly better although we do not know yet how much of this well be inflation as opposed to growth.

Annual growth rate of broad monetary aggregate M3 increased to 3.9% in October 2018 from 3.6% in September (revised from 3.5%).

On the other side of the coin credit flows to businesses seem to have tightened.

Annual growth rate of adjusted loans to non-financial corporations decreased to 3.9% in October from 4.3% in September

Personally I think that the latter number is a lagging indicator but the ECB has trumpeted it as more of a leading one so let’s see.

The external factor which is currently in play is the lower oil price which will soon begin to give a boost and will reduce inflation if it remains near US $60 for the Brent Crude benchmark. But none the less the midnight oil will be burning at the ECB as it mulls the possibility that all that balance sheet expansion and negative interest-rates gave economic activity such a welcome but relatively small boost. Also it will be on action stations about the Italian banking sector. For myself I fear what this new squeeze on Italian banks will do to the lending to the wider economy which of course had ground to a halt as it is.

 

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

Can the Portuguese economic and house price boom continue?

It has been a little while since we looked at the western outpost of the Euro area which is Portugal. The good news is that it has now completed some five years of economic growth which in historical terms is a lengthy period for it. Albeit that rather ominously that length of growth ran straight into the credit crunch last time around. According to Portugal Statistics here is the current state of play.

In comparison with the second quarter of 2018, GDP increased 0.3% in real terms (0.6% in the previous quarter). The contribution of net external demand to the GDP quarter-on-quarter change rate became negative, after being null in the previous quarter, reflecting a decrease of Exports of Goods and Services more intense than that of Imports of Goods and Services. The positive domestic demand contribution increased in the third quarter, reflecting the higher growth of private consumption and Investment.

Firstly it has been nice to see Portugal have a better run as it badly needed it. For the last two quarters it has managed to grow faster than the Euro area average which it does not do often. However we do note that whilst it has done better than average it too was affected by the third quarter slow down too as the quarterly growth rate halved. This impacted on the annual rate.

The Portuguese Gross Domestic Product (GDP) increased by 2.1% in volume in the third quarter 2018, compared with
the same period of 2017 (2.4% in the previous quarter). Domestic demand registered a less intense positive
contribution to GDP year-on-year change rate, due to the deceleration of private consumption, as Investment presented a slightly more intense growth. Net external demand presented a negative contribution similar to that observed in the two previous quarters.

So still good in Portuguese terms as we note that a familiar issue which is trade being picked up on our radar screens. This matters on two counts firstly because the Euro area “internal competitiveness” austerity model was something which should be picked up in the trade balance. Secondly it is an old problem area for Portugal that has regularly led it into the arms of the International Monetary Fund or IMF.

Trade

As you can see the growth rates are very good but 2018 has seen export growth overtaken by import growth.

In the 3rd quarter 2018, exports and imports of goods increased by 6.1% and by 7.3% respectively, vis-à-vis the
same period of the previous year. In the 2nd quarter exports and imports recorded variations of +10.8% and +9.5% respectively. In accumulated terms, from January to September 2018, exports increased by 6.7% and imports grew by 7.8%.

Cars

The automotive sector is an important one for Portugal.

The auto sector – including car and component production – is a core sector of the Portuguese economy. It represents 4% of total GDP, is represented in 29 000 companies, is responsible for 124 000 direct jobs and a business volume of 23, 7 thousand millions of euros and 21,6 % of the total fiscal revenues in Portugal. ( Portugal IN)

A fair bit of this is Volkswagen and this from The Portugal News on the 30th of August was very upbeat.

AutoEuropa has produced over 139,000 vehicles this year, surpassing its previous record of 138,890 in 1998, the company announced on an internal communication………According to the company’s data, in 2017” AutoEuropa’s sales weight on Portugal’s goods export was 3.4%……..AutoEuropa expects to double its sales in 2018 compared to 2017, meaning that Portugal’s goods export would grow 3.4%, and the weight on the exports would increase to 6.6%.

As you can see it has been driving both export and GDP growth and has been a success story for Portugal. Switching back to the trade figures we see that transport sector exports grew by 15.3% in the third quarter. This means that the overall picture conforms to this from FT Alphaville in April.

Portuguese earnings from selling goods to the rest of the world — particularly manufactures related to the Iberian motor vehicle supply chain — grew by more than 40 per cent from 2008 through 2017:

Thus we have an actual success for the internal devaluation model so well done to Portugal. Of course the car market even with all the help is only a certain size and it is not all gravy as some of this has been from other Euro area countries. Also we await the news from the last part of 2018 as we have seen car production slowing and temporary factory shut downs due to a reduction in demand from Asia and the Trump Tariffs.An example of this has just flashed across the newswires.

*VW GROUP OCT. DELIVERIES FALL 10% Y/Y; 846,300 VEHICLES…… *VW GROUP OCT. CHINA SALES FALL 8.3% Y/Y; 365,100 VEHICLES ( @mhewson_CMC )

Looking further ahead there is the issue that car production may move even further south as more and more producers look at places like Morocco.

Unemployment

This has been a success too no doubt driven by the developments above and helped by the tourism boom.

The unemployment rate for the 3 rd quarter of 2018 stood at 6.7%, corresponding to the lowest value of the data series
started in the 1st quarter of 2011. This value is equal to the one from the previous quarter and lower in 1.8 percentage
points (p.p.) from the same quarter of 2017.

The full picture is given here.

These reductions were also observed in the
correspondent rates, having the unemployment rate
dropped from 17.5% to 6.7% and the labour
underutilisation rate from 26.4% to 13.1%

The attempt to measure underemployment is welcome as is its drop although it is still high which is true of the number below.

The youth (15 to 24 years old) unemployment rate increased to 20.0%, the second lowest value of the data series started in the 1st quarter of 2011.

Comment

So far today we have charted some welcome progress but there are still issues of which number one was highlighted by the official data on Thursday.

In 2017, the resident population in Portugal was estimated at 10,291,027 people, which accounted for a 18,546 decline
from the previous year………. Despite the positive net
migration in 2017, the population’s downward trend observed since 2010 continued in 2017, although in the last four years at a slower pace.

There are simply fewer births than deaths and for a while many left. This mattered more than it may seem because the emigrants were often those with skills who could leave. Some have returned but many have not and for example I passed some of Little Portugal in Stockwell a couple of weekends ago with its Portuguese restaurants and delicatessens.

The five better years have coincided with the post “Whatever it takes to save the Euro” period and as we looked at on Friday there are now issues for what the ECB does next? Portugal has benefited in terms of a government bond yield of less than 2% for the tern-year benchmark as opposed to the 17/18% at the peak of the crisis. No doubt it has also helped some businesses borrow more cheaply although of course there is also this.

In the 2nd quarter of 2018 (last 12 months), the median house price of dwellings sales in Portugal was 969 €/m2
, an increase of +2% compared to the previous quarter and of +8.15% compared to the same period in the previous year.

Also the Golden Visa programme which has brought in Madonna for more than a holiday and Michael Fassbender for example is no doubt at play here.

The city of Porto (+24.7%), Lisboa (+23.4%), Amadora (+15.8%), Braga (+12.3%), Funchal (+10.4%) and Vila Nova de Gaia (+10.3%) scored the most significant growth rates, compared to the same period in the previous year.

Or as @WEAYL points out.

Housing in Lisbon (€3,381/m2) now more expensive than Madrid (€3,317/m2)

Actually if we look for the source which is JornalEconomico it points towards a familiar problem.

Buying a home as the first option is a wish of the Iberian families. It is not only in Portugal that acquiring housing is the dream of most people, also in Spain this is the first choice of families.

Although they should not be worried as apparently there is no inflation.

In October, the Portuguese HICP annual rate was 0.8% (1.8% in the previous month) while the monthly rate was
-0.5% (1.5% in September and 0.5% in October 2017).

So it is much more expensive but wages are under the influence of the “internal devaluation” model. As to a full perspective the previous peak of 45.76 billion Euros for GDP was finally passed in the second quarter with its 45.88 billion.

 

 

 

 

Mario Draghi and the ECB prepare for a change of course next month

After a week where the UK has dominated the headlines it is time to switch to the Euro area.  This is for two reasons.  We receive the latest inflation data but also because a speech from European Central Bank President Mario Draghi has addressed an issue we have been watching as 2018 has developed. We have been waiting to see how he and it will respond to the economic slow down that is apparent. This is especially important as during the credit crunch era the ECB has not only been the first responder to any economic downturns it has also regularly found itself to be the only one. Thus it finds itself in a position whereby in terms of negative interest-rates ( deposit rate of -0.4%) and balance sheet ( still expanding at 15 billion Euros per month ) and credit easing still heavily deployed. Accordingly this sentence from Mario echoes what we have been discussing for quite a while.

The key issue at stake is as follows: are we witnessing a temporary “soft patch” or a more lasting deterioration in the growth outlook?

The latter would be somewhat devastating for the man who was ready to do “whatever it takes” to save the Euro as it would return us to discussions about its problems a major one of has been slow economic growth.

Some rhetoric

It seems to be a feature these days of official speeches that they open with what in basketball terms would be called a head fake. Prime Minister Theresa May did it yesterday with an opening sentence which could have been followed by a resignation and Mario opened with what could have been about “broad based” economic growth.

The euro area economy has now been growing for five years, and we expect the expansion to continue in the coming years.

Of course central bankers always expect the latter until there is no other choice. Indeed he confirms that line of thought later.

There is certainly no reason why the expansion in the euro area should abruptly come to an end.

As we move on we get an interesting perspective on the past as well as a comparison with the United States.

Since 1975 there have been five periods of rising GDP in the euro area. The average duration from trough to peak is 31 quarters, with GDP increasing by 21% over that period. The current expansion in the euro area, however, has lasted just 22 quarters and GDP is only around 10% above the trough. In contrast, the expansion in the United States has lasted 37 quarters, and GDP has risen by 21%.

The obvious point is whether you can use the Euro area as a concept before it even existed?! Added to that via the “convergence” promised by the Euro area founders economic growth should be better now than then, except of course we have seen plenty of divergence too. Also you might find it odd to be pointing out that the US has done better especially as the way it is put which reminds us that for all the extraordinary monetary action the Euro area has only grown by 10%. Even that relies on something of a swinging ball as of course he is comparing with the bottom of the dip rather than the past peak as otherwise the number would be a fair bit weaker. Mario is leaving a bit of a trap here, however, or to be more precise he thinks he is.

How have we got here?

First we open with two standard replies the first is that whilst any growth is permanent setbacks are temporary and the other fallback is to blame the weather.

The first is one-off factors, which have clearly played an important role in the underperformance of growth since the start of the year. In the first half of 2018, weather, sickness and industrial action affected output in a number of countries.

Actually that makes the third quarter look even worse as they had gone by then yet growth slowed. He is on safer ground here though.

Production slowed as carmakers tried to avoid building up inventory of untested models, which weighed heavily on economies with large automobile sectors, such as Germany. Indeed, the German economy actually contracted in the third quarter, removing at least 0.1 percentage points from quarterly euro area growth.

This is another marker being put down because it you are thinking that you might need to further expand monetary policy it is best to try to get the Germans onside and reminding them that they too have issues will help. Indeed for those who believe that ECB policy is essentially set for Germany it may be not far off a clincher.

There is something that may worry German car producers if they are followers of ECB euphemisms.

The latest data already show production normalising.

After all the ECB itself may not achieve that.

Trade

This paragraph is interesting on quite a few levels.

The second source of the slowdown has been weaker trade growth, which is broader-based. Net exports contributed 1.4 percentage points to euro area growth in 2017, while so far this year they have removed 0.2 percentage points. World trade growth decelerated from 5.2% in 2017 to 4.6% in the first half of this year.

Oddly Mario then converts a slow down in growth to this.

We are witnessing a long-term slowdown in world trade.

As we note the change in the impact of trade on the Euro area there are several factors in play. You could argue that 2017 was a victory for the “internal competitiveness” austerity model applied although when we get to the collective that is awkward as the Euro area runs a large surplus driven by Germany. From the point of view of the rest of the world they would like it to reduce although the preferable route would be for the Euro area ( Germany ) to import more.

Employment

Mario cheers rightly for this.

Over the past five years, employment has increased by 9.5 million people, rising by 2.6 million in Germany, 2.1 million in Spain, 1 million in France and 1 million in Italy.

I bet he enjoyed the last bit especially! But later there is a catch which provides food for thought.

 But since 2013 more than 70% of employment growth has come from those aged 55-74. This partly reflects the impact of past structural reforms, such as to pension systems.

Probably not the ECB pension though as we are reminded of “Us and Them” by Pink Floyd.

Forward he cried from the rear
And the front rank died
And the general sat
And the lines on the map
Moved from side to side.

Also whilst no doubt some of these women wanted to work there will be others who had no choice.

The share of women in work has also risen by more than 10 percentage points since the start of EMU to almost 60% – its highest level ever

Put another way this sentence below could fit into a section concerning the productivity crisis.

 In addition, countries that have implemented structural reforms have in general seen a rise in labour demand in recent years compared with the pre-crisis period. Germany, Portugal and Spain are all good examples.

There is a section on wages but Mario end up taking something of an each-way bet on this.

But in the light of the lags between wages and prices after a period of low inflation, patience and persistence in our monetary policy is still needed.

Money Supply and Credit

This is how central bankers report a sustained and considerable slow down in the money supply.

The cost of bank borrowing for firms fell to record lows in the first half of this year across all large euro area economies, while the growth of loans to firms stood at its highest rate since 2012. The growth rate of loans to households is also the strongest since 2012, with consumer credit now acting as the most dynamic component, reflecting the ongoing strength of consumption.

Also the emphasis below is mine and regular readers are permitted a wry smile.

Household net worth remains at solid levels on the back of rising house prices and is adding to continued consumption growth.

Comment

We are being warmed up for something of a change of course in case it is necessary.

When the Governing Council met in October, we confirmed our confidence in the economic outlook………….When the latest round of projections is available at our next meeting in December, we will be better placed to make a full assessment of the risks to growth and inflation.

As if they are not already thinking along those lines! The next bit is duo fold. It reminds us that the Euro area has abandoned fiscal policy but does have a kicker for the future.

To protect their households and firms from rising interest rates, high-debt countries should not increase their debt even further and all countries should respect the rules of the Union.

The kicker is perhaps a hint that there is a solution to that as well.

In conclusion, I want to emphasise how completing Economic and Monetary Union has become more urgent over time not less urgent – and not only for the economic reasoning that has always underpinned my remarks, but also to preserve our European construction………….more Europe is the answer.

There Mario leaps out of his apparent trap singing along to Luther Vandross.

I just don’t wanna stop
Oh my love, a million days in your arms
Is never too much (never too much, never too much, never too much)

Podcast

 

Slowing growth and higher inflation is a toxic combination for the Euro area

Sometimes life comes at you fast and the last week will have come at the European Central Bank with an element of ground rush. It was only on the 30th of last month we were looking at this development.

Seasonally adjusted GDP rose by 0.2% in the euro area (EA19) and by 0.3% in the EU28 during the third quarter
of 2018,

Which brought to mind this description from the preceding ECB press conference.

Incoming information, while somewhat weaker than expected, remains overall consistent with an ongoing broad-based expansion of the euro area economy and gradually rising inflation pressures. The underlying strength of the economy continues to support our confidence ……..

There was an issue with broad-based as the Italian economy registered no growth at all and the idea of “underlying strength” did not really go with quarterly growth of a mere 0.2%. But of course one should not place too much emphasis on one GDP reading.

Business Surveys

However this morning has brought us to this from the Markit Purchasing Managers Indices.

Eurozone growth weakens to lowest in over two years

The immediate thought is, lower than 0.2% quarterly growth? Let us look deeper.

Both the manufacturing and service sectors
recorded slower rates of growth during October.
Following on from September, manufacturing
registered the weaker increase in output, posting its
lowest growth in nearly four years. Despite
remaining at a solid level, the service sector saw its
slowest expansion since the start of 2017.

There is a certain sense of irony in the reported slow down being broad-based. The issue with manufacturing is no doubt driven by the automotive sector which has the trade issues to add to the ongoing diesel scandal. That slow down has spread to the services sector. Geographically we see that Germany is in a soft patch and I will come to Italy in a moment. This also stuck out.

France and Spain, in contrast, have
seen more resilient business conditions, though both
are registering much slower growth than earlier in
the year.

Fair enough for Spain as we looked at only last Wednesday, but France had a bad start of 2018 so that is something of a confused message.

Italy

The situation continues to deteriorate here.

Italy’s service sector suffered a drop in
performance during October, with business activity
falling for the first time in over two years. This was
partly due to the weakest expansion in new
business in 44 months.

Although I am not so sure about the perspective?

After a period of solid growth in activity

The reality is that fears of a “triple-dip” for Italy will only be raised by this. Also the issue over the proposed Budget has not gone away as this from @LiveSquawk makes clear.

EU’s Moscovici: Sanctions Can Be Applied If There Is No Compromise On Italy Budget -Policy In Italy That Entails Higher Public Debt Is Not Favourable To Growth.

Commissioner Moscovici is however being trolled by people pointing out that France broke the Euro area fiscal rules when he was finance minister. He ran deficits of 4.8% of GDP, followed by 4.1% and 3,9% which were above the 3% limit and in one instance double what Italy plans. This is of course awkward but not probably for Pierre as his other worldly pronouncements on Greece have indicated a somewhat loose relationship with reality.

Actually the Italian situation has thrown up another challenge to the Euro area orthodoxy.

 

Regular readers will be aware I am no fan of simply projecting the pre credit crunch period forwards but I do think that the Brad Setser point that Italy is nowhere near regaining where it was is relevant. If you think that such a situation is “above potential” then you have a fair bit of explaining to do. Some of this is unfair on the ECB in that it has to look at the whole Euro area as if it was a sovereign nation it would be a situation crying out for some regional policy transfers. Like say from Germany with its fiscal surplus. Anyway I will leave that there and move on.

Ch-ch-changes

This did the rounds on Friday afternoon.

ECB Said To Be Considering Fresh TLTRO – MNI ( @LiveSquawk )

Targeted Long-Term Refinancing Operation in case you were wondering and as to new targets well Reuters gives a nod and a wink.

Euro zone banks took up 739 billion euros at the ECB’s latest round of TLTRO, in March 2017. Of this, so far 14.6 has been repaid, with the rest falling due in 2020 and 2021.

This may prove painful in countries such as Italy, where banks have to repay some 250 billion euros worth of TLTRO money amid rising market rates and an unfavorable political situation.

So the targets of a type of maturity extension would be 2020/1 in terms of time and Italy in terms of geography. More generally we have the issue of oiling the banking wheels. Oh and whilst the Italian amount is rather similar to some measures of how much they have put into Italian bonds there is no direct link in my view.

Housing market

If you give a bank cheap liquidity then this morning’s ECB Publication makes it clear where it tends to go.

The upturn in the euro area housing market is in its fourth year. Measured in terms of annual growth rates, house prices started to pick up at the end of 2013, while the pick-up in residential investment started somewhat later, at the end of 2014. The latest available data (first quarter of 2018) indicate annual growth rates above their long-term averages, for both indicators.

How has this been driven?

 In addition, financing conditions remained favourable, as reflected in composite bank lending rates for house purchase that have declined by more than 130 basis points since 2013 and by easing credit standards. This has given rise to a higher demand for loans for house purchase and a substantial strengthening in new mortgage lending.

Indeed even QE gets a slap on the back.

Private and institutional investors, both domestically and globally based, searching for yield may thus have contributed to additional housing demand.

It is at least something the central planners can influence and watch.

Housing market developments affect investment and consumption decisions and can thus be a major determinant of the broader business cycle. They also have wealth and collateral effects and can thus play a key role in shaping the broader financial cycle. The housing market’s pivotal role in the business and financial cycles makes it a regular subject of monitoring and assessment for monetary policy and financial stability considerations.

 

Comment

The ECB now finds itself between something of a rock and a hard place. If we start with the rock then the question is whether the shift is just a slow down for a bit or something more? The latter would have the ECB shifting very uncomfortably around its board room table as it would be facing it with interest-rates already negative and QE just stopping in flow terms. Let me now bring in the hard place from today’s Markit PMI survey.

Meanwhile, prices data signalled another sharp
increase in company operating expenses. Rising
energy and fuel prices were widely reported to have
underpinned inflation, whilst there was some
evidence of higher labour costs (especially in
Germany).

Whilst there may be some hopeful news for wages tucked in there the main message is of inflationary pressure. Of course central bankers like to ignore energy costs but the ECB will be hoping for further falls in the oil price, otherwise it might find itself in rather a cleft stick. It is easy to forget that its “pumping it up” stage was oiled by falling energy prices.

Yet an alternative would be fiscal policy which hits the problem of it being a bad idea according to the Euro area’s pronouncements on Italy.

 

The economy of Spain provides some welcome good news for the ECB

A rush of economic data over the past 24 hours allows us as to follow Sylvia’s “I’m off to sunny Spain”. This gives us another perspective as we switch from the third largest economy ( Italy) yesterday where economic growth has ground to a halt again whereas in the fourth largest it is doing this according to the statistics office.

The Spanish GDP registers a growth of 0.6% in the third quarter of 2018 to the previous quarter in terms of volume. This rate is similar to that registered in the second quarter of the year. The annual growth of GDP stands at 2.5%, a rate similar to that of the quarter preceding.

As you can see two countries which were part of the Euro area crisis are now seeing very different circumstances. At the moment Spain is a case of steady as she goes because quarterly growth has been 0.6% for each of 2018’s quarters so far.

If we back for some perspective we are reminded of the trouble that hit Spain. It did begin to recover from the initial impact of the credit crunch but then the Euro area crisis arrived at economic growth headed into negative territory in 2011-13 peaking at a quarterly decline of 1% at the end of 2013. This was followed by improvements in 2014 such that quarterly growth reached 1.2% in the first quarter of 2015. Since then quarterly growth has been strong for these times varying between the current 0.6% and the 0.9% of the opening of 2017.

So we see that Spain saw the hard times with annual economic growth falling to -3.5% late in 2012 but can rebound as illustrated by the 4.1% of late 2015. Those who have followed my updates on Greece will recall that I often refer to the fact that after its precipitous and sustained decline it should have had in terms of economic recovery a “V-shaped” rally in economic growth. Well Spain gives an example of that whereas Greece has not. If we switch to yesterday’s theme Spain is a much happier case for the “broad-based economic expansion” claims of Mario Draghi and the ECB because whilst economic growth has slowed it is still good and is pulling the Euro area average higher.

Inflation

If we continue with the mandate of the ECB we were told this by Spain statistics yesterday.

The annual change in the flash estimate of the CPI stands at 2.3% in October, the same registered in September
The annual rate of the flash estimate of the HICP is 2.3%.

So inflation is over target and has been picking up in 2018 with the current mix described below.

In this behavior, the decrease in the prices of electricity stand out, compared to the increase
registered in 2017, and the rise in gas prices.

From the point of the ECB if we look at inflation above target and the economic growth rate and point out that it is withdrawing the stimulus provided by monthly QE. However the water gets somewhat choppier if we look at another inflation measure.

The annual variation rate of the Housing Price Index (HPI) in the second quarter of 2018 increased six tenths, standing at 6.8%. By type of housing, the variation rate of new housing stood at 5.7%, remaining unchanged
as compared with the previous quarter. On the other hand, the annual variation of second-hand housing increased by seven tenths, up to 7.0%.

The first impact is the rate of annual change and this is more awkward for the ECB as it is hard not to think of the appropriateness of its -0.4% deposit rate for Spain. Its impact on mortgage rates especially when combined with the other monetary easing has put Spain on a road which led to “trouble,trouble,trouble” last time around. For those of you wondering what Spanish mortgage rates are here via Google Translate is this morning’s update.

In mortgages on homes, the average interest rate is 2.62% (4.3%) lower than August 2017) and the average term of 24 years. 59.8% of mortgages on housing is made at a variable rate and 40.2% at a fixed rate. Mortgages at a fixed rate they experience an increase of 3.9% in the annual rate. The average interest rate at the beginning is 2.43% for mortgages on variable-rate homes. (with a decrease of 5.5%) and 2.99% for fixed rate (3.1% lower).

As fixed-interest mortgages are only around half a percent per annum higher the number taking variable-rate ones seems high. However I have to admit my view is that Mario Draghi has no intention of raising interest-rates on his watch and the overall Euro area GDP news from yesterday backs that up. Of course we are switching from fact to opinion there and as a strategy I would suggest that any narrowing of the gap between the two types gives an opportunity to lock in what are in historical terms very low levels.

Labour Market

The economic growth phase that Spain has seen means we have good news here.

The number of employed increases by 183,900 people in the third quarter of 2018 compared to the previous quarter (0.95%) and stands at 19,528,000. In terms seasonally adjusted, the quarterly variation is 0.48%. Employment has grown by 478,800 people (2.51%) in the last 12 months.

Higher employment does not necessarily mean lower unemployment but fortunately in this instance it does.

The number of unemployed persons decreased this quarter by 164,100 people (-4.70%) and it stands at
3,326,000. In seasonally adjusted terms, the quarterly variation is -2.29%. In recent months unemployment has decreased by 405,800 people (-10.87%).  The unemployment rate stands at 14.55%, which is 73 hundredths less than in the previous quarter. In the last year this rate has fallen by 1.83 points.

But whilst the news is indeed better we get some perspective by the fact that the unemployment rate at 14.55% is not only still in double-digits but is well over that Euro area average. Indeed it is more than 10% higher than in the UK or US and around 12% higher than Japan.

As to the youth employment situation the good news is that the number of 16-19 year olds employed rose by nearly 12% to 165.500 over the past year. However some 137,800 are recorded as unemployed.

Comment

The Spanish economy has provided plenty of good news for the Euro area in the past few years, but that does not mean that there are no concerns. We have already looked at the issue of house prices and the past fears which arise from their development. Also for those who consider this to be because of the “internal competitiveness” model will be worried by this described by El Pais.

External demand, which helped in the worst moments to pull the Spanish economy, subtracted 0.5 points per year from GDP. And in the quarter, exports fell by 1.8%, entering for the first time negative rates since the third quarter of 2013. While it is true that imports also decreased by 1.2%.

Some of this no doubt relates to the automotive sector which for those who have not followed developments has been a success for Spain albeit that some of the gains have come from cannibalising production from elsewhere in the Euro area. An example of a troubled 2018 has been provided by Ecomotor today by revealing that VW Navarra has cut its production target by 10,000 cars for 2018. Oh and I nearly forgot to mention the Spanish banks especially the smaller ones hit by the court ruling on Stamp Duty.

But returning to the good news the economic growth means that Spain has seen the debt to GDP ratio that had nudged above 100% drop back to 98.3%. That is the road to a ten-year bond yield less than half that of Italy at 1.56% in spite of the fact that the planned fiscal deficit at 2.7% is higher.