The Jackson Hole symposium should embace lower inflation

Later this week the world’s central banks will gather at the economics symposium of the US Kansas Federal Reserve at Jackson Hole in Wyoming. The description can be found below.

The 2017 Economic Symposium, “Fostering a Dynamic Global Economy,” will take place Aug. 24-26, 2017.  (The program will be available at 6 p.m., MT, Aug. 24, 2017).

It is appropriate that they do not yet know the program as the world’s central bankers find themselves at a variety of crossroads which they are approaching from different directions. It is also true that after all their expansionary monetary policy and “masters ( and mistresses) of the universe” activities over the last decade or so they now approach one of the most difficult decisions which is how to exit these programs. For some this will simply mean a slowing of the expansion. This all looks very different to when a speech on Forward Guidance was eagerly lapped up by a receptive audience and quickly became policy in many countries. After all Open Mouth Operations make a central banker feel both loved and important as we all hang on every word. Oh and there is a clear irony in the title of “Fostering a Dynamic Global Economy” for a group of people whose propping up of many zombie banks has led to anything but. That is of course assuming anyone knows what the phrase means in practice!

The inflation issue

The issue here is highlighted by this from Bloomberg today.

The world’s top central bankers head to Jackson Hole amid growing unease about low inflation.

Of course central bankers and those in the media subject to their brainwashing program may think this but the ordinary worker and consumer will be relieved. Should any of the central bankers suffer from stomach problems no doubt they will be delighted to discover this from CNBC.

Hikma Pharmaceuticals Plc’s U.S. subsidiary has raised the price of a common diarrhea drug by more than 400 percent and is charging more for five other medicines as well, the Financial Times reported on Sunday……The average wholesale price of a 60 ml bottle of liquid Atropine-Diphenoxylate, a common diarrhea drug also known as Lomotil, went from about $16 a bottle to $84, the FT reported.

Central banker heaven apparently and what needs looking into in my opinion is the clear examples of price gouging we see from time to time. Also more mundane products are seeing price rises. From Mining.com last week.

The iron ore price is now trading up a whopping 43% from its 2017 lows struck just two months ago.

According to Yuan Talks the Dalian futures contract rose 6.6% today before price limits kicked in. It is not alone as the Nikkei Asian Review points out.

Three-month zinc futures were at their highest level in 10 years, at about $3,100 per ton, rising 26% over the same period.
Aluminum also rose 10% over the same period.

So as well as raising a smile on the face of the heads of the central banks of Canada and Australia there are hints of some commodity inflation about. This provides a counterpoint to the concerns about low inflation which in the Euro area and the US is not that far below especially when we allow for the margin of error.

Does QE lead to inflation?

Some care is needed here as of course we have seen waves of asset price inflation across a wide range of countries. But of course the statistical policy across most of the world is to avoid measuring that in consumer inflation. Then it can be presented as growth which for some it is but not for example for first time buyers. However one of the building blocks of economics 101 is that QE ( Quantitative Easing) leads to inflation. Yet the enormous programs in the US and the ongoing one in the Euro area have not got consumer inflation back to target and the leader of the pack in this regard Japan has 0% inflation. After all the money involved has it simply led to price shifts? That is especially awkward for Ivory Tower theorists as they are not supposed to be able to happen with ~0% inflation so I guess they sent their spouse out to fill up the car as the petrol/diesel price fell.

More deeply whilst the initial effect of QE should have some inflationary implications is there something in it such as the support of a zombie business culture that means inflation the fades. It could of course be something outside of the monetary environment such as changing demographics involving ageing populations. Perhaps it was those two factors which broke the Phillips Curve.

As to future prospects there are two issues at play. The US Federal Reserve will start next month on an exit road which I remember suggesting for the Bank of England in City-AM some 4 years ago. If you do not want QE to become a permanent feature of the economic landscape you have to start somewhere. The issue for the ECB is getting more complex mostly driven by the fiscal conservatism of Germany which means that a supply crunch is looming as it faces the prospect of running out of German bonds to buy.

Currency Wars

There are two specific dangers here which relate to timing ( during thin summer markets) and the fact that markets hang on every central banking word. Eyes will be on the Euro because it has been strong in 2017 and in particular since mid April when it did not quite touch 93 on its effective ( trade-weighted) index as opposed to the 98.7 the ECB calculated it at on Friday. It has put another squeeze on the poor battered UK Pound £ but of more international seriousness is yet another example of a problem for economics 101 as interest-rate rises should have the US Dollar rising. Of course there is a timing issue as the US Dollar previously rose anticipating this and maybe more, but from the point of Mario Draghi and the ECB there is the fear that cutting the rate of QE further might make the Euro rally even more. Although one might note that in spite of the swings and roundabouts along the way the Euro at 98.7 is not far away from where it all began.

The Bank of Japan is also facing a yen rallying against the US Dollar and this morning it briefly rose into the 108s versus the US Dollar. Whilst it is lower than this time last year the trend seemed to change a few months back and the Yen has been stronger again.

Comment

It is hard not to have a wry smile at a group of people who via Forward Guidance and Open Mouth Operations have encouraged markets to hang on their every word now trying to downplay this. If you create junkies then you face the choice between cold turkey or a gradual wind down. Even worse you face the prospect of still feeding addiction number one when a need for number two arises as sooner or later an economic slow down will be along. Or creating fears about low inflation when the “lost decades” of Japan has shown that the world does not in fact end.

If we move onto the concept of a total eclipse then I am jealous of those in the United States today. From Scientific American.

Someone said that it is like suddenly being in some sort of CGI of another world or maybe like a drug-induced hallucination that feels (and is) totally real.

No they have not switched to central banking analysis but if the excellent BBC 4 documentary ”  do we really need the moon?” is any guide we should enjoy solar eclipses whilst we still have them. Meanwhile of course there is Bonnie Tyler.

I don’t know what to do and I’m always in the dark
We’re living in a powder keg and giving off sparks.

 

 

 

 

The ECB faces the problem of what to do next?

Later this month ECB President Mario Draghi will talk at the Jackson Hole monetary conference with speculation suggesting he will hint at the next moves of the ECB ( European Central Bank). For the moment it is in something of a summer lull in policy making terms although of course past decisions carry on and markets move. Whilst there is increasing talk about the US equity market being becalmed others take the opportunity of the holiday period to make their move.

The Euro

This is a market which has been on the move in recent weeks and months as we have seen a strengthening of the Euro. It has pushed the UK Pound £ back to below 1.11 after the downbeat Inflation Report of the Bank of England last week saw a weakening of the £.  More important has been the move against the US Dollar where the Euro has rallied to above 1.18 accompanied on its way by a wave of reversals of view from banks who were previously predicting parity such as my old employer Deutsche Bank. If we switch to the effective or trade weighted index we see that since mid April it has risen from the low 93s at which it spent much of the early part of 2017 to 99.16 yesterday.

So there has been a tightening of monetary policy via this route as we see in particular an anti inflationary impact from the rise against the US Dollar because of the way that commodities are usually priced in it. I note that I have not been the only person mulling this.

Such thoughts are based on the “Draghi Rule” from March 2014.

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

Some think the effect is stronger but let us move on noting that whilst the Euro area consumer and worker will welcome this the ECB is more split. Yes there is a tightening of policy without it making an explicit move but on the other side of the coin it is already below its inflation target.

Monetary policy

Rather oddly the ECB choose to tweet a reminder of this yesterday.

In the euro area, the European Central Bank’s most important decision in this respect normally relates to the key interest rates…….In times of prolonged low inflation and low interest rates, central banks may also adopt non-standard monetary policy measures, such as asset purchase programmes.

Perhaps the summer habit of handing over social media feeds to interns has spread to the ECB as the main conversation is about this.

Public sector assets cumulatively purchased and settled as at 04/08/2017 €1,670,986 (31/07/2017: €1,658,988) mln

It continues to chomp away on Euro area government debt for which governments should be grateful as of course it lowers debt costs. Intriguingly there has been a shift towards French and Italian debt. Some of this is no doubt due to the fact that for example in the case of German sovereign debt it is running short of debt to buy. But I have wondered in the past as to whether Mario Draghi might find a way of helping out the problems of the Italian banks and his own association with them.

is the main story this month the overweighting of purchases of rising again to +2.3% in July (+1.8% in June) ( h/t @liukzilla ).

With rumours of yet more heavy losses at Monte Paschi perhaps the Italian banks are taking profits on Italian bonds ( BTPs) and selling to the ECB. Although of course it is also true that it is rare for there to be a shortage of Italian bonds to buy!.

Also much less publicised are the other ongoing QE programmes. For example Mario Draghi made a big deal of this and yet in terms of scale it has been relatively minor.

Asset-backed securities cumulatively purchased and settled as at 04/08/2017 €24,719 (31/07/2017: €24,661)

Also where would a central bank be these days without a subsidy for the banks?

Covered bonds cumulatively purchased and settled as at 04/08/2017 €225,580 (31/07/2017: €225,040) mln

 

This gets very little publicity for two reasons. We start with it not being understood as two versions of it had been tried well before some claimed the ECB had started QE and secondly I wonder if the fact that the banks are of course large spenders on advertising influences the media.

Before we move on I should mention for completeness that 103.4 billion has been spent on corporate bonds. This leaves us with two thoughts. The opening one is that general industry seems to be about half as important as the banks followed by the fact that such schemes have anesthetized us to some extent to the very large numbers and scale of all of this.

QE and the exchange rate

The economics 101 view was that QE would lead to exchange rate falls. Yet as we have noted above the current stock of QE and the extra 60 billion Euros a month of purchases by the ECB have been accompanied for a while by a static-ish Euro and since the spring by a rising one. Thus the picture is more nuanced. You could for example that on a trade weighted basis the Euro is back where it began.

My opinion is that there is an expectations effect where ahead of the anticipated move the currency falls. This is awkward as it means you have an effect in period T-1 from something in period T .Usually the announcement itself leads to a sharp fall but in the case of the Euro it was only around 3 months later it bottomed and slowly edged higher until recently when the speed of the rise increased. So we see that the main player is human expectations and to some extent emotions rather than a formula where X of QE leads to Y currency fall. Thus we see falls from the anticipation and announcement but that’s mostly it. As opposed to the continuous falls suggested by the Ivory Towers.

As ever the picture is complex as we do not know what would have happened otherwise and it is not unreasonable to argue there is some upwards pressure on the Euro from news like this. From Destatis in Germany this morning.

In calendar and seasonally adjusted terms, the foreign trade balance recorded a surplus of 21.2 billion euros in June 2017.

Comment

There is plenty of good news around for the ECB.

Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.1% in the euro area ……The euro area (EA19) seasonally-adjusted unemployment rate was 9.1% in June 2017, down from 9.2% in May 2017 and down from 10.1% in June 2016.

So whilst we can debate its role in this the news is better and the summer espresso’s and glasses of Chianti for President Draghi will be taken with more of a smile. But there is something of a self-inflicted wound by aiming at an annual inflation target of 2% and in particular specifying 1.97% as the former ECB President Trichet did. Because with inflation at 1.3% there are expectations of continued easing into what by credit crunch era standards is most certainly a boom. Personally I would welcome it being low.

Let me sweep up a subject I have left until last which is the official deposit rate of -0.4% as I note that we have become rather used to the concept of negative interest-rates as well as yields. If I was on the ECB I would be more than keen to get that back to 0% for a start. Otherwise what does it do when the boom fades or the next recession turns up? In reality we all suspect that such moves will have to wait until the election season is over but the rub as Shakespeare would put it is that if we allow for a monetary policy lag of 18 months then we are looking at 2019/20. Does anybody have much of a clue as to what things will be like then?

 

Greece reaches a Euro area target or standard

Yesterday saw an announcement by the European Commission back on social media by a video of the Greek flag flying proudly.

The Commission has decided to recommend to the Council to close the Excessive Deficit Procedure (EDP) for Greece. This follows the substantial efforts in recent years made by the country to consolidate its public finances coupled with the progress made in the implementation of the European Stability Mechanism (ESM) support programme for Greece.

It sounds good although of course the detail quickly becomes more problematic.

Greece has been subject to the corrective arm of the Stability and Growth Pact since 2009. The deadline to correct its excessive deficit was extended several times. It was last set in August 2015 to be corrected, at the latest, by 2017.

That reminds us that even before the “Shock and Awe” of spring 2010 Greece had hit economic trouble. It also reminds us that the Euro area has seen this whole issue through the lens of fiscal deficits in spite of calamitous consequences elsewhere in both the economy and the country. I also note that “the corrective arm” is a rather chilling phrase. Here is the size of the change.

The general government balance has improved from a deficit of 15.1% in 2009 to a surplus of 0.7% in 2016

Greeks may have a wry smile at who is left behind in the procedure as one is at the heart of the project, one has been growing strongly and one is looking for the exit door.

If the Council follows the Commission’s recommendation, only three Member States would remain under the corrective arm of the Stability and Growth Pact (France, Spain and the United Kingdom), down from 24 countries during the financial crisis in 2011.

Let us wish Greece better luck than when it left this procedure in 2007. Also let us note some very curious rhetoric from Commissioner Dombrovskis.

Our recommendation to close the Excessive Deficit Procedure for Greece is another positive signal of financial stability and economic recovery in the country. I invite Greece to build on its achievements and continue to strengthen confidence in its economy, which is important for Greece to prepare its return to the financial markets.

Another positive signal?

That rather ignores this situation which I pointed out on the 22nd of May.

The scale of this collapse retains the power to shock as the peak pre credit crunch quarterly economic output of 63.3 billion Euros ( 2010 prices) fell to 59 billion in 2010 which led to the Euro area stepping in. However rather than the promised boom with economic growth returning in 2012 and then continuing at 2%+ as forecast the economy collapsed in that year at an annual rate of between 8% and 10% and as of the opening of 2017 quarterly GDP was 45.8 billion Euros.

Achievements? To achieve the holy grail of a target of a fiscal deficit on 3% of GDP they collapsed the economy. They also claimed that the economy would return to growth in 2012 and in the case of Commissioner Moscovici have claimed it every year since.

A return to financial markets?

Whilst politically this may sound rather grand this has more than a few economic issues with it. Firstly there is the issue of the current stock of debt as highlighted by this from the European Stability Mechanism on Monday.

Holding over 51% of the Greek public
debt, we are by far Greece’s biggest creditor a long-term partner

I note that the only reply points out that a creditor is not a partner.

The ESM already disbursed €39.4 bn to and combining EFSF it adds up to € 181.2 bn.

That is of course a stock measure so let us look at flow.

I am happy to announce the ESM
has today effectively disbursed €7.7 bn to Greece

I am sure he is happy as he has a job for life whether Greek and Euro area taxpayers are happy is an entirely different matter especially as we note this.

Of this disbursement, €6.9 bn will be used for debt servicing and €0.8 bn for arrears clearance

Hardly investment in Greece is it? Also we are reminded of the first rule of ECB ( European Central Bank ) club that it must always be repaid as much of the money will be heading to it. This gives us a return to markets round-tripping saga.

You see the ESM repays the ECB so that Greece can issue bonds which it hopes the ECB will buy as part of its QE programme. Elvis sang about this many years ago.

Return to sender
Return to sender

There is also something worse as we recall this from the ESM.

the EFSF and ESM loans lead to substantially lower financing costs for the country.

Okay why?

That is because the two institutions can borrow cash much more cheaply than Greece itself, and offer a long period for repayment. Greece will not have to start repaying its loans to the ESM before 2034, for instance.

Indeed and according to a speech given by ESM President Regling on the 29th of June this saves Greece a lot of money.

We have disbursed €175 billion to Greece already. This saves the Greek budget €10 billion each year because of the low lending costs of the ESM. This amounts to 5.6 percent of GDP, and allows Greece the breathing space to return to fiscal responsibility, healthy economic developments and debt sustainability.

No wonder the most recent plans involved Greece aiming for a fairly permanent budget surplus of 3.5% of GDP. With the higher debt costs would that be enough. If we are generous and say Greece will be treated by the markets like Portugal and it gets admitted to the ECB QE programme then its ten-year yield will be say 3% much more than it pays now. Also debt will have a fixed maturity as opposed to the “extend and pretend” employed so far by the ESM.

What if Greece joining the ECB QE programme coincides with further “tapers” or an end to it?

If you wish to gloss over all that then there is this from the Peterson Institute for International Economics.

http://www.ekathimerini.com/219950/opinion/ekathimerini/comment/time-for-greece-to-rejoin-global-markets

Is austerity really over?

There are issues with imposing austerity again so you can say it is now over. I looked at this on the 22nd of May.

The legislation contains more austerity measures, including pension cuts and a higher tax burden that will go into effect in 2019-20 to ensure a primary budget surplus, excluding debt servicing outlays, of 3.5 percent of gross domestic product.

It was noticeable that one of the tax rises was in the amount allowed to be earned before tax which will hit the poorest hardest. But according to Kathimerini yesterday the process continues.

The government is slashing state expenditure by 500 million euros for next year……..The purge will mainly concern health spending, while credit for salaries and pensions will be increased.

Comment

The background economic environment for Greece is as good as it has been for some time. Its Euro area colleagues are in a good phase for growth which should help exports and trade. According to Markit this is beginning to help its manufacturing sector.

Having endured a miserable start to 2017, the latest survey data is welcome news for Greek manufacturers as the headline PMI pointed to growth for the first time since August last year.

If we look for another hopeful signal it is from this as employment has been a leading indicator elsewhere.

The number of employed persons increased by 79,833 persons compared with April 2016 (a 2.2% rate of increase) and by 23,943 persons compared with March 2017 (a 0.6% rate of increase).

The catch is that in spite of the barrage of official rhetoric about reform that Greek economy has gone -1.1% and +0.4% in the last two quarters with the latter number being revised up from negative territory. But the worrying part is that elsewhere in the Euro area things are much better when Greece should be a coiled spring for economic growth. Let me give you an example from the building industry where it is good that the numbers are finally rising. But you see annual building was 80 million cubic meters in 2007 and 10 million yes 10 million in 2016. That is an economic depression and a half….

 

The ECB “taper” meets “To infinity! And beyond!”

Yesterday was central banker day when we heard from Mark Carney of the Bank of England, Mario Draghi of the ECB and Janet Yellen of the US Federal Reserve. I covered the woes of Governor Carney yesterday and note that even that keen supporter of him Bloomberg is now pointing out that he is losing the debate. As it happened Janet Yellen was also giving a speech in London and gave a huge hostage to fortune.

Yellen today: “Don’t see another crisis in our lifetimes” Yellen May 2016: “We Didn’t See The Financial Crisis Coming” ( @Stalingrad_Poor )

Let us hope she is in good health and if you really wanted to embarrass her you would look at what she was saying in 2007/08. However the most significant speech came at the best location as the ECB has decamped to its summer break, excuse me central banking forum, at the Portuguese resort of Sintra.

Mario Draghi

As President Draghi enjoyed his morning espresso before giving his keynote speech he will have let out a sigh of relief that it was not about banking supervision. After all the bailout of the Veneto Banks in Italy would have come up and people might have asked on whose watch as Governor of the Bank of Italy the problems built up? Even worse one of the young economists invited might have wondered why the legal infrastructure covering the Italian banking sector is nicknamed the “Draghi Laws”?

However even in the area of monetary policy there are problems to be faced as I pointed out on the 13th of March.

It too is in a zone where ch-ch-changes are ahead. I have written several times already explaining that with inflation pretty much on target and economic growth having improved its rate of expansion of its balance sheet looks far to high even at the 60 billion Euros a month due in April.

Indeed on the 26th of May I noted that Mario himself had implicitly admitted as much.

As a result, the euro area is now witnessing an increasingly solid recovery driven largely by a virtuous circle of employment and consumption, although underlying inflation pressures remain subdued. The convergence of credit conditions across countries has also contributed to the upswing becoming more broad-based across sectors and countries. Euro area GDP growth is currently 1.7%, and surveys point to continued resilience in the coming quarters.

That simply does not go with an official deposit rate of -0.4% and 60 billion Euros a month of Quantitative Easing. Policy is expansionary in what is in Euro area terms a boom.

This was the first problem that Mario faced which is how to bask in the success of economic growth whilst avoiding the obvious counterpoint that policy is now wrong. He did this partly by indulging in an international comparison.

since January 2015 – that is, following the announcement of the expanded asset purchase programme (APP) – GDP
has grown by 3.6% in the euro area. That is a higher growth rate than in same period following QE1 or QE2 in the United States, and a percentage point lower than the period after QE3. Employment in the euro area has also risen by more than four million since we announced the expanded APP, comparable with both QE2 and QE3 in the US, and considerably higher than QE1.

You may note that Mario is picking his own variables meaning that unemployment for example is omitted as are differences of timing and circumstance. But on this road we got the section which had an immediate impact on financial markets.

The threat of deflation is gone and reflationary forces are at play.

So we got an implicit admittal that policy is pro-cyclical or if you prefer wrong. A reduction in monthly QE purchases of 20 billion a month is dwarfed by the change in circumstances. But we have to be told something is happening so there was this.

This more favourable balance of risks has been already reflected in our monetary policy stance, via the adjustments we have made to our forward guidance.

You have my permission to laugh at this point! If he went out into the streets of Sintra I wonder how many would know who he is let alone be running their lives to the tune of his Forward Guidance!? Whilst his Forward Guidance has not been quite the disaster of Mark Carney the sentence below shows a misfire.

This illustrates that core inflation does not
always give us a clear reading of underlying inflation dynamics.

The truth is as I have argued all along that there was no deflation threat in terms of a downwards spiral for inflation because it was driven by this.

Oil-related base effects are also the main driver of the considerable volatility in headline inflation that we have seen, and will be seeing, in the euro area………. As a result, in the first quarter of 2017, oil-sensitive items  were still holding back core inflation.

I guess the many parts of the media which have copy and pasted the core inflation/deflation theme will be hoping that their readers have a bout of amnesia. Or to put it another way that Mario has set up a straw (wo)man below.

What is clear is that our monetary policy measures have been successful in avoiding a deflationary spiral and securing the anchoring of inflation expectations.

Actually if you look elsewhere in his speech you will see that if you consider all the effort put in that in fact his policies had a relatively minor impact.

Between 2016 and 2019 we estimate that our monetary policy will have lifted inflation by 1.7 percentage points,
cumulatively.

So it took a balance sheet of 4.2 trillion Euros ( and of course rising as this goes to 2019) to get that? You can look at the current flow of 60 billion a month which makes it look a little better but it is not a lot of bang for your Euro.

Market Movements

There was a clear response to the mention of the word “reflationary” as the Euro rose strongly. It rose above 1.13 to the US Dollar as it continued the stronger  phase we have been seeing in 2017 as it opened the year more like 1.04.  Also government bond yields rose although the media reports of “jumps” made me smile as I noted that the German ten-year yield was only 0.4% and the two-year was -0.57%! Remember when the ECB promised it was fixing the issue of demand for German bonds?

Comment

On the surface this is a triumph for Forward Guidance as Mario’s speech tightens monetary policy via higher bond yields and a higher value for the Euro on the foreign exchanges. Yet if we go back to March 2014 he himself pointed out the flaw in this.

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

You see the effective or trade-weighted index dipped to 93.5 in the middle of April but was 97.2 at yesterday’s close. If we note that Mario is not achieving his inflation target and may be moving away from it we get food for thought.

Euro area annual inflation was 1.4% in May 2017, down from 1.9% in April.

So as the markets assume what might be called “tapering” ( in terms of monthly QE purchases) or “normalisation” in terms of interest-rates we can look further ahead and wonder if “To infinity! And Beyond!” will win? After all if the economy slows later this year  and inflation remains below target ………

There are two intangible factors here. Firstly the path of inflation these days depends mostly in the price of crude oil. Secondly whilst I avoid politics like the plague it is true that we will find out more about what the ECB really intends once this years major elections are done and dusted as the word “independent” gets another modification in my financial lexicon for these times

 

Of Denmark its banks and negative interest-rates

The situation regarding negative interest-rates mostly acquires attention via the Euro or the Yen. If the media moves beyond that it then looks at Switzerland and maybe Sweden. But there is an outbreak of negative interest-rates in the Nordic countries if we note that we have already covered Sweden, Finland is in the Euro and the often ignored Denmark has this.

Effective from 8 January 2016, Danmarks Nationalbank’s ( DNB ) interest rate on certificates of deposit is increased by 0.10 percentage point to -0.65 per cent.

Actually Denmark is just about to reach five years of negative interest-rates as it was in July of 2012 that the certificate of deposit rate was cut to -0.2% although it has not quite been continuous as it there were a few months that it rose to the apparently giddy heights of 0.05%.

In case you are wondering why Denmark has done this then there are two possible answers. Geography offers one as we note that proximity to the Euro area is associated with ever lower and indeed negative interest-rates. Actually due to its exchange rate policy Denmark is just about as near to being in the Euro as it could be without actually being so.

Denmark maintains a fixed-exchange-rate policy vis-à-vis the euro area and participates in the European Exchange Rate Mechanism, ERM 2, at a central rate of 746.038 kroner per 100 euro with a fluctuation band of +/- 2.25 per cent.

Currently that involves an interest-rate that is -0.25% lower than in the Euro area but the margin does vary as for example when the interest-rate rose in 2014 when the DNB tried to guess what the ECB would do next and got it wrong.

A Problem

If we think of the Danish economy then we think of negative interest-rates being implemented due to weak economic growth. Well the DNB has had to face up to this.

However, the November revision stands out as an unusually large upward revision of the compilation of GDP level and
growth……… average annual GDP growth has now
been compiled at 1.3 per cent for the period 2010-
15, up from 0.8 per cent in the previous compilation.
GDP in volume terms is now 3.4 per cent higher in
2015 than previously compiled,

Ooops! As this begins before interest-rate went negative we have yet another question mark against highly activist monetary policy. The cause confirms a couple of the themes of this website.

new figures for Danish firms’ foreign
trading in which goods and services do not cross the
Danish border entailed substantial revisions

So the trade figures were wrong which is a generic statement across the world as they are both erratic and unreliable. Also such GDP shifts make suggestions like this from former US Treasury Secretary Larry Summers look none too bright.

moving away from inflation targeting to something like nominal gross domestic product-level targeting would be a better idea.

In this situation he would be targeting a number which was later changed markedly, what could go wrong?

Also there is a problem for the DNB as we note that it has a negative interest-rate of -0.65% but faces an economy doing this.

heading towards a boom with output above the normal level of capacity utilisation……….The Danish economy is very close to its capacity limit.

Whatever happened to taking away the punchbowl as the party starts getting going?

Oh and below is an example of central banker speech not far off a sort of Comical Ali effort.

Despite the upward revision of GDP, Danmarks Nationalbank’s assessment of economic developments
since the financial crisis is basically unchanged.

The banks

This is of course “the precious” of the financial world which must be preserved at all costs according to central bankers. We were told that negative interest-rates would hurt the banks, how has that turned out? From Bloomberg.

Despite half a decade of negative interest rates, Denmark’s banks are making more money than ever before.

What does the DNB think?

Overall, the largest Danish banks achieved their
best ever performance in 2016, and their financial
statements for the 1st quarter of 2017 also recorded
sound profits…………In some areas, financial developments are similar to developments in the period up to the financial crisis in 2008, so there is every reason to watch out for
speed blindness.

Still no doubt the profits have gone towards making sure “this time is different”? Er, perhaps not.

On the other hand, the capital base has not increased notably since 2013, unlike in Norway and Sweden where the banks have higher capital adequacy.

What about house prices?

Both equity prices and prices of owner-occupied
homes have soared, as they did in the years prior to
the financial crisis.

Although the DNB is keen to emphasise a difference.

As then, prices of owner-occupied homes in Copenhagen have risen considerably, but with the difference that the price rises have not yet spread to the rest of Denmark to the same degree. The prices of rental properties have also increased and are back at the 2007 level immediately before
the financial crisis set in

It will have been relieved to note a dip in house price inflation to 4.2% at the end of 2016 although perhaps less keen on the fact that house prices are back to the levels which caused so much trouble pre credit crunch. Of course the banking sector will be happy with higher house prices as it improves their asset book whereas first-time buyers will be considerably less keen as prices move out of reach.

In spite of the efforts of the DNB I note that the Danes have in fact been reining in their borrowing. If we look at the negative interest-rate era we see that the household debt to GDP ratio has fallen from 135% to 120% showing that your average Dane is not entirely reassured by developments. A more sensible strategy than that employed by some of the smaller Danish banks who failed the more extreme version of the banking stress tests.

A Space Oddity

Politician’s the world over say the most ridiculous things and here is the Danish version.

Denmark should cut taxes to encourage people to work more, which would increase the supply of labour and help prevent the economy from overheating in 2018, Finance Minister Kristian Jensen said…

So we fix overheating by putting our foot on the accelerator?

Comment

If we look wider than we have so far today we see that international developments should be boosting the Danish economy in 2017. This mostly comes from the fact that the Euro area economy is having a better year which should boost the Danish trade figures if this from the Copenhagen News is any guide.

Denmark has been ranked seventh in the new edition of the World Competitiveness Yearbook for 2017, which has just published by the Swiss business school IMD.

But if we allow for the upwards revision to growth we see that monetary policy is extraordinarily expansionary for an economy which seems to be growing steadily ( 0.6% in Q1) . What would they do in a slow down?

We also learn a few things about negative interest-rates. Firstly the banking sector has done rather well out of them – presumably by a combination of raising margins and central bank protection as we have discussed on here frequently – and secondly they did not turn out to be temporary did they?

Yet as we see so often elsewhere some events do challenge the official statistics. From the Copenhagen Post.

Aarhus may be enjoying ample wind in its sails by being the European Capital of Culture this year, but not everything is jovial in the ‘City of Smiles’.

On average, the Danish aid organisation Kirkens Korshær has received 211 homeless every day in Aarhus from March 2016-March 2017, an increase of 42 percent compared to the previous year, where the figure was 159.

Portugal

Let me offer my deepest sympathies to all those affected by that dreadful forest fire yesterday.

The problems of the banks of Italy part 101

It is time to look again at a topic which is a saga of rinse and repeat. Okay I am not sure it is part 101 but it certainly feels like a never-ending story. Let us remind ourselves that the hands of the current President of the ECB ( European Central Bank) Mario Draghi are all over this situation. Why? Well let me hand you over to the ECB itself on his career so far.

1997-1998: Chair of the Committee set up to revise Italy’s corporate and financial legislation and to draft the law that governs Italian financial markets (also known as the “Draghi Law”)

It is a bit awkward to deny responsibility for the set of laws which bear you name! This happened during the period ( 1991-2001) that Mario was Director General of the Italian Treasury. After a period at the Vampire Squid ( Goldman Sachs) there was further career progression.

2006-October 2011Governor, Banca d’Italia

There were also questions about the close relationship and dealings between the Italian Treasury and the Vampire Squid over currency swaps.

https://ftalphaville.ft.com/2010/02/09/145201/goldmans-trojan-greek-currency-swap/?mhq5j=e2

But with Mario linking the Bank of Italy and the ECB via his various roles the latest spat in the banking crisis saga must be more than an embarrassment.

The inspection at Banca Popolare di Vicenza that began in 2015 was launched at the request of the Bank of Italy and was conducted by Bank of Italy personnel. Any subsequent decisions were not the responsibility of the Bank of Italy but of the European Central Bank, because in November 2014 Banca Popolare di Vicenza had become a ‘significant’ institution and was subject to the European Single Supervisory Mechanism (SSM). ( h/t @FerdiGiugliano )

So we can see that the Bank of Italy is trying to shift at least some of the blame for one of the troubled Veneto banks to the ECB. At this point Shaggy should be playing on its intercom system.

It wasn’t me…….It wasn’t me

An official denial

At the end of last month the Governor of the Bank of Italy gave us its Annual Report.

At the end of 2016 Italian banks’ non-performing loans, recorded in balance sheets net of write-downs, came to €173 billion or 9.4 per cent of total loans. The €350 billion figure often cited in the press refers to the nominal value of the exposures and does not take account of the losses already entered in balance sheets and is therefore not indicative of banks’ actual credit risk.

Indeed he went further.

Those held by intermediaries experiencing difficulties, which could find themselves obliged to offload them rapidly, amount to around €20 billion.

I suppose your view on this depends on whether you think that 20 billion Euros is a lot or a mere bagatelle. It makes you wonder why the problems at the Veneto banks and Monte Paschi seem to be taking so long to solve does it not?

Meanwhile he did indicate a route to what Taylor Swift might call “Trouble, trouble,trouble”.

At the current rate of growth, GDP would return to its 2007 level in the first half of the 2020s.

An economy performing as insipidly as that is bound to cause difficulties for its banks, but not so for the finances of its central bank.

The 2016 financial year closed with a net profit of €2.7 billion; after allocations to the ordinary reserve and dividends paid to the shareholders, €2.2 billion were allocated to the State, in addition to the €1.3 billion paid in taxes.

The QE era has seen a boom in the claimed profits for central banks and as you can see they will be very popular with politician’s as they hand them over cash to spend.

The ECB is pouring money in

The obvious problem with telling us everything is okay is that Governor Visco is part of the ECB which is pouring money into the Italian banks. From the Financial Times.

According to ECB data as of the end of April, Italian banks hold just over €250bn of the total long-term loans — almost a third of the total.

There is a counter argument that the situation where the Italian banks rely so much on the ECB has in fact simply kicked that poor battered can down the road.

“Some of them [Italian banks] are unprofitable even with the ECB’s cheap funding,” adds Christian Scarafia, co-head of Western European Banks at Fitch.

Fitch also observes that the TLTRO funding is tied up with Italy’s management of the non-performing loans that beset its banks. “The weak asset quality in Italy is certainly the big issue in the country and access to cheap ECB funding has meant that banks could continue to operate without having to address the asset quality problem in a more decisive manner,” says Mr Scarafia. (FT)

It was intriguing to note that the Spanish bank BBVA declared 36 million Euros of profits in April from the -0.2% interest-rate on its loans from the ECB. A good use of taxpayer backed money?

The Veneto Banks

For something that is apparently no big deal and according to Finance Minister Padoan has been “exaggerated” this keeps returning to the news as this from Reuters today shows.

Italian banks are considering assisting in a rescue of troubled lenders Popolare di Vicenza and Veneto Banca by pumping 1.2 billion euros (1.1 billion pounds) of private capital into the two regional banks, sources familiar with the matter said.

Good money after bad?

Italian banks, which have already pumped 3.4 billion euros into the two ailing rivals, had said until now that they would not stump up more money.

As you can see the ball keeps being batted between the banks, the state , and the Atlante fund which is a mostly private hybrid of bank money with some state support. Such confusion and obfuscation is usually for a good reason. A bail in has the problem of the retail depositors who were persuaded to invest in bank bonds.

Monte Paschi

On the 2nd of this month we were told that the problem had been solved and yet the saga like so many others continues on.

HEDGE FUND SAID IN TALKS TO BUY $270 MILLION MONTEPASCHI LOANS ( h/t @lemasabachthani )

Seems odd if it has been solved don’t you think? Mind you according to the FT the European Banking Authourity may have found a way of keeping it out of the news.

The EBA said it would be up to supervisors to decide whether to include any bank in restructuring within the stress tests, and European Central Bank supervisors have decided not to include Monte dei Paschi, people briefed on the matter said.

So bottom place is available again.

Comment

This has certainly been more of a marathon than a sprint and in fact maybe like a 100 or 200 mile race. The Italian establishment used to boast that only 0.2% of GDP was used to bailout Italian banks but of course it is now absolutely clear that this effort to stop its national debt rising even higher allowed the banking sector to carry on in the same not very merry way. This week the environment has changed somewhat with Santander buying Banco Popular for one Euro. Although of course the capital raising of 7 billion Euros needs to be factored into the equation. I guess Unicredit has troubles enough of its own and could not reasonably go for yet another rights issue!

Me on TipTV Finance

http://tiptv.co.uk/living-extraordinary-times-not-yes-man-economics/

 

The British and Irish Lions

I have been somewhat remiss in not wishing our players well on what is the hardest rugby tour of all which is a trip into the heart of the All Blacks. I am thoroughly enjoying it although of course we need to raise our game after a narrow win and a loss. Here’s hoping!

 

 

 

Will 2017 see an economic rennaisance for France?

This morning has opened with some better economic news for France as GDP ( Gross Domestic Product) growth was revised higher.

In Q1 2017, GDP in volume terms* rose barely less fast (+0.4%) than in Q4 2016 (+0.5%).

The French statistical service have put in it downbeat fashion and you have to read to the end to spot it as it is right at the bottom.

The GDP growth for Q1 2017 is raised from +0.3% to +0.4%.

There was also a good sign in the fact that investment was strong.

In Q1 2017, total GFCF accelerated sharply (+1.2% after +0.5%), especially that of enterprises (+1.9% after +0.9%)……Investment in manufactured goods was more dynamic (+1.6% after +0.4%), notably in equipment goods. Similarly, GFCF in market services accelerated sharply (+1.9% after +0.7%), notably in information-communication and business services.

However it was not a perfect report as there were signs of what you might call the British problem as trade problems subtracted from the growth.

Exports fell back in Q1 2017 (−0.8% after +1.0%), especially in transport equipment and “other manufactured goods”. Imports accelerated (+1.4% after +0.6%)………..All in all, foreign trade balance weighed down on GDP growth by −0.7 points, after a contribution of +0.1 points in the previous quarter.

If we look back there may be an issue building here as import growth was 4.2% in 2016 which considerably exceeded export growth at 2.1%. So it may well be true that the French are getting more like the British which is something of an irony in these times.

You may be wondering how there was any economic growth after the net trade deficit and that is because inventories swung the other way and offset it.

In Q1 2017, the contribution of changes in inventories to GDP growth amounted to +0.7 points (after −0.2 points at the end of 2016). They increased especially in transport equipment and “other industrial goods” (pharmaceuticals, metallurgy and chemicals).

The optimistic view on this is that French businesses are stocking up for a good 2017 with the danger being that any disappointment would subtract for growth later this year.

Also as feels so common in what we consider to be the first world the manufacturing industry continues to struggle.

Manufacturing output fell back (−0.2% after +0.7%), mainly due to a sharp decline in the coke and refined petroleum branch and a slowdown in transport equipment.

Looking ahead

The good news is that the private-sector business surveys are very optimistic at the moment.

The latest PMI data points to further strong growth momentum in the French private sector, with the expansion quickening to a six-year peak.

Of course France has been in a rough patch so that may not be as good as it reads or sounds so let us look further.

The service sector saw activity increase for the eleventh time in as many months. Moreover, the rate of expansion accelerated to a six-year high and was sharp overall. Manufacturing output also continued to rise markedly, albeit to a fractionally weaker extent than in April.

As you can see the service sector is pulling the economy forwards and manufacturing is growing as well according to the survey. Unusually Markit do not make a GDP prediction from this but we can if we note they think this for the Euro area which has a lower reading than France.

consistent with 0.6- 0.7% GDP growth.

So let us say 0.7% then and also remind ourselves that it has not been common in recent years for there to be an expectation that France will outperform its Euro area peers.

However this morning’s official survey on households did come with a worrying finale to the good news stream.

In May 2017, households’ confidence in the economic situation has improved anew after a four-month stability: the synthetic index has gained 2 points, reaching 102, above its long-term average and at its highest level since August 2007.

What could go wrong?

Unemployment

This has been the Achilles heel for France in the credit crunch era but this too has seen some better news.

In Q1 2017, the average ILO unemployment rate in metropolitan France and the overseas departments (excluding Mayotte) stood at 9.6% of active population, after 10.0% in Q4 2016.

The good news is that we see the unemployment rate finally fall into single digits. The bad news is that it mostly seems to be people who have given up looking for work.

The activity rate of people aged 15-64 stood at 71.4% in Q1 2017. It decreased by 0.3 percentage points compared to the previous quarter and a year earlier.

The business surveys are optimistic that employment is now improving as we see here.

Bolstered by strong client demand, French private sector firms raised their staffing numbers in May, thereby continuing a trend that has been evident since November last year. Furthermore, the rate of job creation quickened to a 69-month high.

Monetary policy

Yesterday we heard from ECB ( European Central Bank ) President Mario Draghi and he opened with some bombast.

Real GDP in the euro area has expanded for 16 consecutive quarters, growing by 1.7% year-on-year during the first quarter of 2017. Unemployment has fallen to its lowest level since 2009. Consumer and business sentiment has risen to a six-year high,

You might be wondering about monetary policy after such views being expressed but in fact we got this.

For domestic price pressures to strengthen, we still need very accommodative financing conditions, which are themselves dependent on a fairly substantial amount of monetary accommodation.

Is that a Tom Petty style full speed ahead and “Damn The Torpedoes”? For now perhaps but there are two other influences. In terms of a tactical influence Mario Draghi will have noted the rise of the Euro since it bottomed versus the US Dollar in December last year and would prefer it to be lower than the 1.12 it has risen to. Also more strategically as we have discussed on here before he will be waiting for the Euro area elections to pass before making any real change of course in my opinion. That leaves us mulling once again the concept of an independent central banker as we note that economic growth is on the upswing in election year.

Thus France finds itself benefiting from 293.7 billion Euros of sovereign bond purchases meaning it can issue and be paid for it out to around the 6 years maturity and only pay 0.74% on ten-year bonds. This is a considerable help to the fiscal situation and the government. In addition there are the corporate bond purchases and the covered bond purchases to help the banks. The latter gets so little publicity for the 232 billion Euros on the ECB’s books. Plus we have negative interest-rates and a Euro exchange rate pushed lower.

Has monetary policy ever been so expansionary at this stage of the economic cycle?

House prices

There was some further news to warm the cockles of Mario Draghi’s heart this morning.

In Q1 2017, the prices of second-hand dwellings kept increasing: +1.9% compared to the previous quarter (provisional seasonally adjusted results). The increase is virtually similar for flats (+1.9%) and for houses (+1.8%).

Over a year, the increase in prices was confirmed and strengthened: +3.0% compared to Q1 2016 after +1.5% the quarter before.

Up until now we have seen very little house price inflation in France and whilst the rate is relatively low it does look to be on the rise which represents a clear change. If you add this to the house price rises in Germany that I analysed on the 8th of this month then the ECB will be pleased if first-time buyers will not be.

Comment

It looks as though France is in a better phase of economic growth. This is certainly needed as we look at the unemployment rate issue but there is also another factor as this from French statistics indicates.

 2016 (GDP growth unchanged, at +1.1% WDA), 2015 (−0.2 points at +1.0%) and 2014 (+0.3 points at +1.0%)

As you can see the annual rate of economic growth has been essentially 1% as we note something of a reshuffle in the timing. Indeed in spite of a better couple of quarters the current annual rate of economic growth in France is you guessed it 1%! Somehow 1% became the new normal as we wait and hope for better news as 2017 develops. Should we get that then at this stage of the cycle I fear we may then be shifting to how long can it last?!