The currency peg problems of the Czech National Bank mount

A regular issue in economic  discussions is of course exchange-rates and their impact. There are strengths and weaknesses in both floating and fixed exchange-rates and today I am going to look at a variant of a fixed exchange-rate. The irony here is that it is caused by another fixed exchange-rate as we see yet another country struggling to cope with the consequences of being a near neighbour to the supermassive black hole that is the Euro project. We have at various times looked at Denmark, Sweden and Switzerland but today it is time to return to the Czech Republic. This feeds into another of my themes which is how do the central planners return to free markets? One issue that has arisen overnight is the one of some “being more equal than others” at such times. From Reuters.

Richmond Federal Reserve President Jeffrey Lacker abruptly left the U.S. central bank on Tuesday after admitting that a conversation he had with a Wall Street analyst in 2012 may have disclosed confidential information about Fed policy options.

The 2012 leak had triggered a criminal investigation after research firm Medley Global Advisors told its clients the details of a key Fed meeting a day before the Fed released its own record of the discussion.

At the Fed’s September 2012 policy meeting, officials laid the groundwork for the massive bond-buying stimulus they were to roll out later that year. Early knowledge of that discussion could have given some traders an unfair edge.

I do like the word “may” because if he did not do it why is he resigning? Also how has this dragged on to as it happens only 6 months before his retirement. Due to the scale of potential gains and losses here there should be a full investigation and maybe a criminal one. Ironically this is one of the few cases of central bank Forward Guidance being accurate which we can file with the foreign exchange dealings of the wife of a past head of the Swiss National Bank and the way the ECB used to privately brief its favourite hedge funds.

The Czech National Bank

Back in 2013 it did this.

The CNB Bank Board decided to use the exchange rate as a monetary policy instrument, and therefore to commence foreign exchange interventions, on 7 November 2013……This means the CNB will not allow the koruna to appreciate to levels it would no longer be possible to interpret as “close to CZK 27/EUR”. The CNB prevents such appreciation by means of automatic and potentially unlimited interventions, i.e. by selling koruna and buying foreign currency.

So a familiar move in that we see another central bank wanting a lower level for its currency. As ever the inflation target is used as cover for what is really yet another version of a competitive devaluation.

A weakening of the exchange rate of the koruna leads to an increase in import prices and thus also in the domestic price level.

Another familiar theme is the promise along the lines of “whatever it takes” or the infinite intervention promise made by the Swiss National Bank.

The CNB can use infinite amounts of koruna to purchase foreign currency, as it itself issues the Czech currency in both paper and electronic form. The CNB is resolved to intervene in such volumes and for such duration as needed to maintain the chosen exchange rate level.

The Czech economy

The labour market is one where the Czech economy has done extremely well according to the latest data. From Czech Statistics.

The general unemployment rate of the aged 15 – 64 years , seasonally adjusted, reached 3.5% in February 2017 and decreased by 0.8 p.p., year-on-year……..The employment rate , seasonally adjusted, reached 73.4% in February 2017 and increased by 1.9 percentage point (p.p.) compared to that in February 2016.

Even rarer was the strong growth in wages seen in 2016.

The continuous demand for labour force exerted pressure on the growth in earnings so the overall average wage increased nominally by 4.2%. The median wage, i.e. the wage of a middle employee determined from a mathematical-statistical model of the wage distribution, increased even more markedly by 6.0%.

They are by far the best labour market figures I have looked at for quite some time so let us continue with the good economic news.

In January 2017, working days adjusted industrial production increased at constant prices by 4.3%, year-on-year (y-o-y). Non-adjusted industrial production was by 9.6% higher. Seasonally adjusted industrial production increased by 3.5%, month-on-month (m-o-m). The value of new orders increased by 7.0%, y-o-y.

The main driver of this was the automobile sector.

manufacture of motor vehicles, trailers and semi-trailers (contribution +3.8 p.p., growth by 18.7%),

With the strong wages and employment data you will not be surprised to see that this morning’s retail sales data was positive as well.

In February 2017, seasonally adjusted sales in retail trade at constant prices increased by 0.9%, month-on-month (m-o-m). Sales adjusted for calendar effects increased by 4.8%, year-on-year (y-o-y).

Actually with all the good news above the total number for economic activity disappoints but is still solid.

According to a refined estimate, the gross domestic product in the fourth quarter of 2016 increased by 0.4%, quarter-on-quarter (q-o-q), and by 1.9%, year-on-year (y-o-y). The GDP growth for the entire year 2016 was 2.3%.

Looking ahead the manufacturing business surveys look strong so far in 2017.


Back on the 10 th of January I highlighted this issue.

Consumer prices in December increased compared with November by 0.3%…….. The year-on-year growth of consumer prices amounted to 2.0%, i.e. 0.5 percentage points up on November. It is the highest year-on-year price growth since December 2012.

Well it isn’t the highest for that period anymore.

Consumer prices in February increased compared with January by 0.4%. This development was primarily due to a rise in prices in ‘food and non-alcoholic beverages’, ‘recreation and culture’. The year-on-year growth of consumer prices amounted to 2.5%, i.e. 0.3 percentage points up on January.

It was a grim month for healthy eaters in particular.

the increase in prices of vegetables by 15.2%, of which prices of potatoes rose by 24.1% and prices of vegetables cultivated for their fruit increased by 28.1%.

We are likely to see a fall in the annual rate in March if the experience elsewhere is repeated but none the less the objective has been reached.


The Czech economy is in good shape in many respects and quite a few countries would switch circumstances. Economic growth with a very healthy looking labour market although past central bankers might be wondering about responding especially with an interest-rate called “technical zero”. Added to this one could use the phrase “mission accomplished” on the inflation front so how do they respond?

sustainable fulfilment of the 2% inflation target in the future. Sustainable fulfilment of the target following the return to the conventional monetary policy regime is crucial for the timing of the exit from the exchange rate commitment.

The central planners fear an uncertain future and have got cold feet. The catch is that they are applying a very strong economic stimulus to an economy which is doing well so the policy is inappropriate also the countries the Czech Republic trades with will have good reason to wonder how much of the economic activity is being poached from them?

What is the exit strategy and will we see a Swiss National Bank style debacle?

House Prices

A familiar tale comes from the Global Property Guide.

Wow!  The average price of apartments in the Czech Republic surged by 11.87% (11.24% inflation-adjusted) during the year to Q3 2016, the country´s eleventh consecutive quarter of strong price hikes, according to the Czech Statistical Office (CZSO),

Are the currency wars still raging?

One of the features of the post credit crunch era is that economies are less able to take further economic stress. This leads us straight into today’s topic which is the movements in exchange rates and the economic effects from that. Apart from dramatic headlines which mostly concentrate on falls ( rises are less headline grabbing I guess…) the media tends to step back from this. However the central banks have been playing the game for some time as so many want the “cheap hit” of a lower currency which is an implicit reason for so much monetary easing. The ( President ) Donald was on the case a couple of months ago. From the Financial Times.

“Every other country lives on devaluation,” said Mr Trump after meeting with US motor industry executives. “You look at what China’s doing, you look at what Japan has done over the years. They play the money market, they play the devaluation market and we sit there like a bunch of dummies.”

Actually the FT was on good form here as it pointed out that perhaps there were better examples elsewhere.

South Korea has a current account surplus of nearly 8 per cent of gross domestic product, according to the International Monetary Fund, compared with just 3 per cent for China and Japan. Taiwan, meanwhile, has a colossal surplus of 15 per cent of GDP while Singapore is even higher at 19 per cent.

Care is needed here as a balance of payments surplus on its own is not the only metric and we do know that both Japan and China have had policies to weaken their currencies in recent years. So the picture is complex but I note there seems to be a lot of it in the Far East.


Ironically in a way the Japanese yen has been strengthening again and has done so by 1% over the weekend as it as headed towards 110 versus the US Dollar. So the Abenomics push from 76 was initially successful as the Yen plunged but now it is back to where it was in September 2014. Also for perspective the Yen was so strong partly as a consequence of US monetary easing. Oh what a tangled web and that.

The Bank of Japan will be ruing the rise ( in Yen terms) from 115 in the middle of this month to 110.25 as I type this because it is already struggling with this from this morning’s minutes.

The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is around 0 percent, and is expected to gradually increase toward 2 percent, due in part to the upward pressure on general prices stemming from developments in commodity prices such as crude oil prices.

Even worse for the Bank of Japan and Abenomics – but not the Japanese worker and consumer – the price of crude oil has also been falling since these minutes were composed. Time for more of what is called “bold action”?


It is not that often on these lists because the currency manipulation move by Germany came via its membership of the Euro where it added itself to weaker currencies. But its record high trade surpluses provide a strong hint and the European Central Bank has provided both negative interest-rates and a massive expansion of its balance sheet as it has tried to weaken the Euro. So we see that an exchange-rate that strengthened as the the credit crunch hit to 1.56 versus the US Dollar is now at 1.086.

So the recent bounce may annoy both the ECB and Germany but it is quite small compared to what happened before this. Putting it another way if we compare to Japan then a Euro bought 148 year in November 2014 but only 120 now.

The UK

In different circumstances the UK might recently have been labelled a currency manipulator as the Pound £ fell. As ever Baron King of Lothbury seems keen on the idea as he hopes that one day his “rebalancing” mighty actually happen outside his own personal Ivory Tower. There is food for thought for our valiant Knight of the Garter in the fact that we were at US $2.08 when her bailed out Northern Rock and correct me if I am wrong but we have indeed rebalanced since, even more towards our services sector.

However it too has seen a bounce against the US Dollar in the last fortnight or so and at US £1.256 as I type this there are various consequences from this. Firstly the edge is taken off the inflationary burst should this continue especially of we allow for the lower oil price ( down 11.2% so far this quarter according to Amanda Cooper of Reuters). That is indeed welcome or rather will be if these conditions persist. A small hint of this came at the weekend. From the BBC.

Motorists will see an acceleration in fuel price cuts over the weekend as supermarkets take up to 2p off a litre of petrol and diesel.

Not everybody welcomes this as I note my sparring partner on BBC 4’s MoneyBox Tony Yates is again calling for higher inflation (targets). He will then “rescue” you from the lower living-standards he has just created….

The overall picture for the UK remains a lower currency post EU vote and it is equivalent to a 2.5% reduction in Bank Rate for those considering the economic effect. Meanwhile if I allow for today’s rise it is pretty much unchanged in 2017 in effective or trade-weighted terms. Not something in line with the media analysis is it?

South Africa

This has featured in the currency falling zone for a while now, if you recall I looked at how cheap property had become in foreign currencies. There had been a bounce but if we bring things right up to date there has been a hiccup this morning. From the FT.

The rand plunged almost 2 per cent in less than half an hour on Monday morning after the latest row between president Jacob Zuma and his finance minister Pravin Gordhan, only moments after it had risen to its highest level since July 2015.

Perhaps the air got a bit thin up there.

The rand has been the best-performing currency in the world over the last 12 months, strengthening more than 23 per cent against the dollar, but it has suffered a number of knock backs prompted by the president and finance minister’s battles.

Back to where it was in the late summer of 2015.


If we look at the crypto-currency then there has been a lot of instability of late. At the start of this month it pushed towards US $1300 but this morning it fell to below US $940 and is US $991 as I type this. Not for widows and orphans…


There is much to consider here as we wonder if the US Dollar is merely catching its breath or whether it is perhaps a case of “buy the rumour and sell the fact”. Or perhaps facts as you can choose the election of the Donald and or a promised acceleration in the tightening of monetary policy by the US Federal Reserve. But we see an amelioration in world inflation should this persist which of course combines as it happens with a lower oil price.

So workers and consumers in many countries will welcome this new phase but the Bank of Japan will not. Maybe both Euro area workers and consumers and the ECB can as the former benefit whilst the latter can extend its monetary easing in 2017 and, ahem, over the elections. Whilst few currencies are stable these days the crypto one seems out of control right now.

Would the Bundesbank of Germany raise interest-rates if it could?

At the heart of the Euro area economy is Germany but as we have discussed before it has something of an irregular heartbeat in the way it affects its Euro area partners. For example as I pointed out on the 9th of January it is a deflationary influence on them via its balance of payments surplus.

In November 2016, Germany exported goods to the value of 63.2 billion euros to the Member States of the European Union (EU), while it imported goods to the value of 56.9 billion euros from those countries.

One does not wish to be critical of it for its relative economic success but there are clear side-effects as well as benefits from it. One is the trade position above another is that fact that its membership of the Euro makes its exchange-rate higher.. For all the talk and indeed promises of economic convergence the fact is that many Euro area countries have economies with little in common with Germany. For example later this year Italy seems likely to move into economic growth territory for its membership of the Euro which is very different to the German situation. Let us investigate the German economy.


On Wednesday this was released by the Federal Statistics Office.

The inflation rate in Germany as measured by the consumer price index is expected to be 2.2% in February 2017. Such a high rate of inflation was last measured in August 2012. Based on the results available so far, the Federal Statistical Office (Destatis) also reports that the consumer prices are expected to increase by 0.6% on January 2017.

The Euro area standard measure was also 2.2% although it rose by 0.7% on the month. We have a complete switch on the disinflationary period just passed which showed low and at times falling inflation for goods prices as they rose by 3.2%. These were led by energy at 7.2% and food at 4.4%.

This was reinforced only yesterday by this.

the index of import prices increased by 6.0% in January 2017 compared with the corresponding month of the preceding year. This was the highest increase of a yearly rate of change since May 2011 (+6.3%). In December and in November 2016 the annual rates of change were +3.5% and +0.3%, respectively. From December 2016 to January 2017 the index rose by 0.9%.

As you can see there are inflationary pressures in the system and it looks as though imported raw materials will impact the system especially the price of oil which was approximately half the rise. If German economic policy was set by the Bundesbank then there is no way it would have a negative interest-rate in the face of such pressure.


This has traditionally been a weaker link in the German economy and that seems to be continuing as the numbers below have an extra day in them compared to last year.

According to provisional data turnover in retail trade in January 2017 was in real terms 2.3% and in nominal terms 4.5% larger than that in January 2016.

We do get a like for like update on a monthly basis.

Calendar and seasonally adjusted (Census X-12-ARIMA), sales in January 2017 were 0.8% lower than in December 2016 and 0.2% lower in nominal terms.

If we look back to 2010 and mark it at 100 we see that January 2017 was at 106.1 which shows the German economy is not powered by retail sales.

Economic output

This has been a better phase for Germany as this official data shows.

The economic situation in Germany in 2016 thus was characterised by solid and steady growth (+0.7% in the first quarter, +0.5% in the second quarter and +0.1% in the third quarter). For the whole year of 2016, this was an increase of 1.9% (calendar-adjusted: +1.8%).

I am not sure that 0.7%,0.5%, 0.1% and then 0.4% is steady but it was solid! To be fair it was more consistent in annual terms although if we look further at the year it had a feature you might not expect.

government final consumption expenditure was up by as much as 3.2%.

Also Germany did shift a little in terms of one of the world economic issues which is the balance of payments surplus.

exports of goods and services rose by 3.3% compared with the previous year. There was however a larger increase in imports (+4.5%) in the same period. Consequently, the balance of exports and imports had a downward effect, in arithmetical terms, of –0.2 percentage points on GDP growth compared with the previous year.

There was also another sign of a German economic strength ticked away there.

the economic performance in the fourth quarter of 2016 was achieved by 43.7 million persons in employment, which was an increase of 267,000, or 0.6%, on a year earlier.

This performance allowed the headline writers some click bait. From the Guardian.

Germany overtook the UK as the fastest growing among the G7 states during 2016. Europe’s largest economy expanded at the fastest rate in five years, showing growth of 1.9% last year.

Of course the numbers are not precise to 0.1% after all if they were then this adjustment from 2014 as matters such as military expenditure and Research and Development saw new rules would not be necessary.

The conceptual changes have led to an increase in the level of the German GDP, amounting to roughly 3%

Public Finances

These were very strong in spite of the rise in spending.

A strong economic backdrop has helped Germany post a record budget surplus of €23.7bn in 2017 ( they mean 2016), fuelled by higher tax revenues, rising employment and low debt costs. It was the highest budget surplus since reunification in 1990 and the third successive year the government has had a budget surplus.

The old argument is of course that it would help the European and world economy if Germany loosened the public purse strings. This would also presumably reduce the balance of payments surplus in a beneficial double-whammy. The catch in terms of Euro area rules is that the national debt to GDP ratio is at 69.4% above the (supposed) 60% limit although of course rather good compared to the vast majority of its peers.

Looking ahead

The immediate future certainly looks bright for German manufacturing.

The PMI rose from 56.4 in January to 56.8 in February, the highest since May 2011. The increase in the headline figure reflected the output, new orders and suppliers’ delivery times components, while employment and stocks of purchases also made positive overall contributions. The current 27-month sequence of improving manufacturing conditions is the longest observed in over eight-and-a-half years. (Markit)

This led to an improvement also in forecasts for the year as a whole.

The survey results suggest that manufacturing will contribute to a strengthening in overall economic growth in the first quarter. IHS Markit currently expects q/q growth of at least 0.6% in Q1, up from 0.4% in Q4 last year, and is forecasting a 1.9% rise in GDP over 2017 as a whole.”

This has been reinforced by the service sector survey which has just been released.

the rate of expansion in total business activity accelerated and was slightly stronger than the trend shown over 2016 as a whole. Moreover, new business rose at the fastest rate since February 2016 and employment growth was the strongest since June 2011.


Let me leave you all with a question. The US Federal Reserve is hinting ever more strongly at an interest-rate rise this month although of course we await th words of Janet Yellen later. But in 2016 the German economy grew more quickly than the US one and may well do so this year. It also has inflation above target. Where would German interest-rates be if the Bundesbank was back in charge?

If you want a real mind game then imagine where a new German Mark would be and the implications from that?!





The ECB faces a growing policy dilemma

Today I want to look at what was one of the earliest themes of this blog which is that central banks will dither and delay before they reduce their policy easing and accommodation. Or to put it another way they will be too late because they are afraid of moving too soon and being given the blame should the economy hic-cup or turn downwards. Back in the day I did not realise how far central banks would go with the Bank of Japan seemingly only limited by how many assets there are in existence in Japan as it chomps on government bonds and acts as a Tokyo whale in equity markets. Actually it has made yet more announcements today including this from Governor Kuroda according to Marketwatch.

“There is not much likelihood that we will further lower the negative rate” from the current minus 0.1%, Kuroda said in parliament, citing Japan’s accelerating growth.

Last time he said something like that he cut them 8 days later if I recall correctly!

However the focus right now is on Europe and in particular on the ECB ( European Central Bank). as it faces the policy exit question I posed on the 19th of January.

If we look at the overall picture we see that 2017 poses quite a few issues for central banks as they approach the stage which the brightest always feared. If you come off it will the economy go “cold turkey” or merely have some withdrawal systems? What if the future they have borrowed from emerges and is worse than otherwise?

What has changed?

Yesterday brought news on economic prospects which will have simultaneously cheered and worried Mario Draghi and the ECB. It started with France.

The Markit Flash France Composite Output Index, based on around 85% of normal monthly survey replies, registered 56.2, compared to January’s reading of 54.1. The latest figure pointed to the sharpest rate of growth since May 2011.

Welcome news indeed and considering the ongoing unemployment issue that I looked it only a few days ago this was a welcome feature of the service sector boom.

Staffing numbers rose for the fourth consecutive month during February. The increase was underpinned by a solid rate of growth in the service sector,

Unusually for Markit it did not provide any forecast for expected GDP (Gross Domestic Product) growth from this which is likely to have been caused by its clashes with the French establishment in the past. It has regularly reported private-sector growth slower than the official numbers so this is quite a change.

Next up was Germany and the good news theme continued.

The Markit Flash Germany Composite Output Index rose from January’s fourmonth low of 54.8 to 56.1, the highest since April 2014 and signalling strong growth in the eurozone’s largest economy. Output has risen continuously since May 2013.

The situation is different here because of course Germany has performed better than France in recent times illustrated by its very different unemployment rate. I note that manufacturing is doing well as it benefits from the much lower exchange rate the Euro provides compared to where any prospective German mark would be priced. Markit is much more willing to project forwards from this.

The latest PMI adds to our expectations that economic growth will strengthen in the first quarter to around 0.6% q-o-q, marking a strong start to 2017.

Whilst these are the two largest Eurozone economies there are others so let us add them into the mix.

“The eurozone economy moved up a gear in February. The rise in the flash PMI to its highest since April 2011 means that GDP growth of 0.6% could be seen in the first quarter if this pace of expansion is sustained into March.

There are actually two cautionary notes here. The first is that these indices rely on sentiment as well as numbers and as they point out March is yet to come. But the surveys indicate potential for a very good start to 2017 for the Eurozone.

As the objectives of central banks have moved towards economic growth there is an obvious issue when they look good and it is to coin a phrase “pumping up the volume”.

Also there was a hopeful sign for a chronic Euro area problem which is persistent unemployment in many countries.

February saw the largest monthly rise in employment since August 2007. Service sector jobs were created at a rate not seen for nine years and factory headcounts showed the second-largest rise in almost six years.

What about inflation?

Just like it fell more quickly and further than the ECB expected it has rather caught it on the hop with its rise. The move from 1.1% in December to 1.8% in January means it is just below 2% or where the “rules based” ECB wants it. There is an update later but even if it nudges the number slightly the song has the same drum and bass lines. Indeed yesterday’s surveys pointed to concerns that more inflation is coming over the horizon.

Inflationary pressures meanwhile continued to intensify. Firms’ average input costs rose at the steepest rate since May 2011, with rates accelerating in both services and manufacturing. The latter once again recorded the steeper rise, linked to higher global commodity prices, the weak euro and suppliers regaining some pricing power amid stronger demand.

In the past such news would have the ECB rushing to raise interest-rates which leaves it in an awkward position. The only leg it has left to stand on in this area is weak wage growth.

Asset prices

Mario Draghi’s espresso will taste better this morning as he notes this.


Although even the espresso may provide food for thought.

Oh I don’t know…Robusta coffee futures creeping back towards 5-1/2 year highs

That pesky inflation again. Oh sorry I mean the temporary or transient phase!

As to house prices there is a wide variation but central bankers always want more don’t they?

House prices, as measured by the House Price Index, rose by 3.4% in the euro area and by 4.3% in the EU in the third quarter of 2016 compared with the same quarter of the previous year.

Of course should any boom turn to bust then the rhetoric switches to it was not possible to forecast this and therefore it was a “surprise” and nobody’s fault. The Bank of England was plugging that particular line for all it’s worth only yesterday.

The Euro

Much is going on here and it has been singing along to “Down, Down” by Status Quo again. For example it has moved very near to crossing 1.05 versus the US Dollar this morning which makes us wonder if economists might be right and it will reach parity. Such forecasts are rarely right so it would be its own type of Black Swan but more seriously we are seeing a weaker phase for the Euro as it has fallen from just over 96 in early November 2016 to 93.4 now. Here economists return to their usual form as this has seen the UK Pound £ nudge 1.19 this morning or further away from the parity so enthusiastically forecast by some.

A factor in this brings us back to QE and ECB action. A problem I have reported on has got worse and as ever it involves Germany. The two-year Schatz yield has fallen as low as -0.87% as investors continue to demand German paper even if they have to pay to get it. This is creating quite a differential ( for these times anyway) with US Dollar rates and thereby pushing the Euro lower.


There are obvious issues here for the ECB as it faces a period where economic growth could pick-up which is of course good but inflation will be doing the same which is not only far from good it is against its official mandate. It does plan to trim its monthly rate of bond buying to 60 billion Euros a month from 80 billion but of course it still has a deposit rate of -0.4%. Thus the accelerator is still being pressed hard. But as we note that the lags of monetary policy are around 18 months then it may well find itself doing that as both growth and inflation rise. Should that lead to trouble then a so-called stimulus will end up having exactly the reverse effect. Yet the consensus remains along the lines of this from Markit yesterday.

No change in policy
therefore looks likely until at least after the German
elections in September.



Inflation is back!

Regular readers will be aware that as 2016 progressed and the price of crude oil did not fall like it did in the latter part of 2015 that a rise in consumer inflation was on the cards pretty much across the world. This would of course be exacerbated in countries with a weak currency against the US Dollar and ameliorated by those with a strong currency. This morning has brought an example of this from a country which I gave some praise to only on Monday so let us investigate.

An inflationary surge in Spain

This mornings data release from the statistics institute INE was eye-catching indeed. Via Google Translate

The estimated annual inflation of the CPI in January 2017 is 3.0%, according to the An advance indicator prepared by INE.This indicator provides an advance of the CPI which, if confirmed, would increase of 1.4 points in its annual rate, since in December this variation was of 1.6%.

Okay and the reason why was no great surprise to us on here.

This increase is mainly explained by the rise in the prices of electricity and The fuels (gasoil and gasoline) in front of the drop that they experienced last year.

So as David Bowie put it they have been putting out fire with gasoline. As we investigate further I note that El Pais labels it as an Ultimate Hora and gives us some more detail.

The agency blames the acceleration of inflation to the rise in electricity prices, which this month has exploded, affecting mainly consumers in the regulated market of light, 46.5% of households, Which pay according to the hourly evolution of electricity prices in the wholesale market.

Actually that sounds ominous in the UK as the National Grid was effectively promising no blackouts yesterday but at the cost of more volatile ( which of course means higher) domestic energy prices. The actual numbers for Spanish consumers are eye-watering.

The average price of the megawatt hour (MWh) in the wholesale electricity market was on January 1, 51.9 euros. This Tuesday, the last day of January, the average price stands at 73.27 euros, 43.4% more. On Wednesday 25, the average stood at 91.88 euros (78.9% more than January 1), with maximums of more than 100 euros for the time stretches with more demand. Consumers receiving the regulated tariff (Voluntary Price for the Small Consumer, PVPC) will see those increases already reflected in their next receipt of light and have already been noted in the CPI, which has registered the highest level for more than four Years,

I guess they must be grateful that this has not been a long cold winter as such prices would have appeared earlier and maybe gone higher. The push higher in the inflation measure was exacerbated by the fact that fuel prices fell this time last year.

Thus, in January 2016, electricity fell by 13% compared to the same month in 2015. The gas price fell at a rate of 15%, while other fuels (diesel for heating, butane …) went down To 19.9%. Finally, the fuel and lubricants registered a year-on-year decrease of 7.1%.

It would seem that El Pais has cottoned onto one of my themes.

 The evolution of oil prices largely explained the behavior of the CPI in Spain. In January of 2016, the oil marked minimums in less than 30 dollars. Now, with the price of a barrel of brent upwards (around 55 dollars), fuels are rising and expenses related to housing are rising: gas, of course, a byproduct, and electricity, which is generated Partly by burning gas.

So far we have looked at Spain’s own CPI but the situation was the same for the official Euro area measure called HICP ( which confusingly is called CPI in the UK) as it rose to an annual rate of 3% as well. This poses an issue for the ECB as El Pais points out.

In any case, inflation is already at levels above the ECB’s target of 2%

Also it points out that Spain will see a reduction in real purchasing power as wage growth is now much lower than inflation.

already at levels that imply a loss of purchasing power for pensioners – the government will only update pensions by 0.25 %, The minimum that marks the law, for officials, whose salaries will not rise above 1%, and the vast majority of wage earners, since the average wage increase agreed in the agreements remained at 1, 06%.

There are also other concerns as to how it may affect Spain’s economic recovery.

As Spanish inflation is above European, the Spanish economy may lose competitiveness, not only because it may affect exports, but also because it may lead to a rise in wages.


A little more prosaic and also for December and not January but we saw this from Germany yesterday.

The inflation rate in Germany as measured by the consumer price index is expected to be +1.9% in January 2017. A similarly high rate of inflation was last measured in July 2013 (+1.9%).

German consumers will be particularly disappointed to note that the inflation was in essential items such as energy (5.8%) and food (3.2%). Of course central bankers and their media acolytes will rush to call these non-core as we wonder if they sit in the cold and dark without food themselves?!

This poses another problem for the ECB as Germany is now pretty much on its inflation target ( just below 2%) and this morning has also posted good news on unemployment where the rate has fallen to 5.9%.

Euro area

This morning’s headline is this.

Euro area annual inflation is expected to be 1.8% in January 2017, up from 1.1% in December 2016, according to a flash estimate from Eurostat, the statistical office of the European Union.

So a by now familiar surge as we note that it is now in the zone where the ECB can say it is achieving its inflation target. Of course it will look for excuses.

energy is expected to have the highest annual rate in January (8.1%, compared with 2.6% in December), followed by food, alcohol & tobacco (1.7%, compared with 1.2% in December),

Accordingly if you take out the things people really need ( energy and food) the “core” inflation rate falls to 0.9%. But the heat is on now as Glenn Frey would say.


The Financial Times reported this yesterday.

Giles Turrell, chief executive of Weetabix, said on Monday that the company was absorbing the higher cost of dollar denominated wheat but that Weetabix prices were likely to go up later this year by “mid-single digits”.

Sadly the decline of the FT continues as the “may” is reported in the headline as “Weetabix prices hiked” . The Guardian was much fairer although this bit raised a smile.

Although the company harvests wheat in Northamptonshire, it is sold in US dollars on global markets, meaning the cost in pounds to buy wheat in the UK has gone up.


It is hard not to have a wry smile as it was not that long ago in 2016 that the consensus was that inflation is dead and of course before that the “deflation nutters” were in full cry. Any news from them today? Of course the official mantra will be on the lines of this as reported by DailyFX.

ECB’s Villeroy says concerns about rising inflation are exaggerated.

What was that about never believing anything until it is officially denied? It was only yesterday that another ECB board member was informing us that there would be no change in monetary policy for 6 months when today’s inflation and GDP data suggests it is already behind the curve, as I pointed out on the 19th of this month. Although as ever Italy ( unemployment rising to 12%) is lagging behind. As Livesquawk points out not everyone has got the memo.

Spanish EconMin deGuindos: Inflationary Trend In Europe Could Lead To Tightening Of MonPol, Higher Interest Rates

So we see a problem and whilst some of the move in Spain is particular to one month it is also true that the pattern has changed now and so should the response of the ECB as it looks forwards.

UK National Statistician

Thank you to John Pullinger for meeting a group of inflation specialists including me at the Royal Statistical Society last Wednesday. I was pleased to point out that his letter to the Guardian of a week ago made in my opinion a case for using real numbers for owner-occupied housing such as house prices and mortgage-rates as opposed to the intended use of an imputed number such as Rental Equivalence. This will be more important when the UK makes the changes planned for March. Here is the section of his letter which I quoted.

And there is a real yearning for trustworthy analysis that deals with both the inherent biases in many data sources and also the vested interests of many who try to cloak their own opinions and prejudices as “killer facts”.






Rising bond yields are feeding into the real economy

Once upon a time most people saw central banks as organisations which raised interest-rates to slow inflation and/or an economy and cut them to have the reverse effect. Such simple times! Well for those who were not actually working in bond markets anyway. The credit crunch changed things in various ways firstly because we saw so many interest-rate cuts ( approximately 700 I believe now) but also because central bankers ran out of road. What I mean by that is the advent of ZIRP or near 0% interest-rates was not enough for some who plunged into the icy cold waters of negative interest-rates. This has posed all sorts of problems of which one is credibility as for example Bank of England Governor Mark Carney told us the “lower bound” for UK Bank Rate was 0.5% then later cut to 0.25%!

If all that had worked we would not be where we are and we would not have seen central banks singing along with Huey Lewis and the News.

I want a new drug
One that won’t make me sick
One that won’t make me crash my car
Or make me feel three feet thick

This of course was QE (Quantitative Easing) style policies which became increasingly the policy option of choice for central banks because of a change. This is because the official interest-rate is a short-term one usually for overnight interest-rates so 24 hours if you like. As central banks mostly now meet 8 times a year you can consider it lasts for a month and a bit but in the interest-rate environment that changes little as you see there are a whole world of interest-rates unaffected by that. Pre credit crunch they mostly but not always moved with the official rate afterwards the effect faded. So central banks moved to affect them more directly as lowering longer-term interest-rates reduces the price of fixed-rate mortgages and business loans or at least it should. Also much less badged by central bankers buying sovereign bonds to do so makes government borrowing cheaper and therefore makes the “independent” central bank rather popular with politicians.

That was then and this is now

Whilst there is still a lot of QE going on we are seeing ch-ch-changes even in official policy as for example from the US Federal Reserve which has raised interest-rates twice and this morning this from China.

Chinese press reports that the PBoC have raised interest rate on one-year MLF loans by 10bps to 3.1% ( @SigmaSqwauk)

The Chinese bond market future fell a point to below 96 on the news which raised a wry smile at a bond market future below 100 ( which used to be very common) but indicated higher bond yields. These are becoming more common albeit with ebbs and flows and are on that road because of the return of inflation. So many countries got a reminder of this in December as we have noted as there were pick-ups in the level of annual inflation and projecting that forwards leaves current yields looking a bit less than thin. Or to put it another way all the central bank bond-buying has created a false market for sovereign and in other cases corporate bonds.

The UK

Back on the 14th of June last year I expressed my fears for the UK Gilt market.

There is much to consider as we note that inflation expectations and bond yields are two trains running in opposite directions on the same track.

In the meantime we have had the EU leave vote and an extra £60 billion of Bank of England QE of which we will see some £1 billion this afternoon. This drove the ten-year Gilt yield to near 0.5%. Hooray for the “Sledgehammer” of Andy Haldane and Mark Carney? Er no because in chart terms they have left UK taxpayers on an island that now looks far away as markets have concentrated more on thoughts like this one from the 14th of October last year.

Now if we add to this the extra 1.5% of annual inflation I expect as the impact of the lower UK Pound £ then even the new higher yields look rather crackpot.

In spite of the “Sledgehammer” which was designed by Bank of England lifer Andy Haldane the UK ten-year Gilt yield is at 1.44% so higher than it was before the EU leave vote whilst his ammunition locker is nearly empty. So he has driven the UK Gilt market like the Duke of York used to drill his men. I do hope he will be pressed on the economic effects of this and in the real world please not on his Ivory Tower spreadsheet.

The Grand old Duke of York he had ten thousand men
He marched them up to the top of the hill
And he marched them down again.
When they were up, they were up
And when they were down, they were down
And when they were only halfway up
They were neither up nor down.

If you look at inflation trends the Gilt yield remains too low. Oh and do not forget the £20 billion added to the National Debt  by the Term Funding Scheme of the Bank of England.

Euro area

In spite of all the efforts of Mario Draghi and his bond-buyers we have seen rising yields here too and falling prices. Even the perceived safe-haven of German bonds is feeling the winds of change.

in danger of taking out Dec spike highs in yield of 0.456% (10yr cash) ( @MontyLaw)

We of course gain some perspective but noting that even after price falls the yield feared is only 0.456%! However it is higher and as we look elsewhere in the Euro area we do start to see yield levels which are becoming material. Maybe not yet in Italy where the ten-year yield has risen to 2.06% but the 4% of Portugal will be a continuous itch for a country with such a high national debt to GDP (Gross Domestic Product) ratio. It has been around 4% for a while now which is an issue as these things take time to impact and I note this which is odd for a country that the IMF is supposed to have left.



The US

The election of President Trump had an immediate effect on the US bond market as I pointed out at the time.

There has been a clear market adjustment to this which is that the 30 year ( long bond) yield has risen by 0.12% to 2.75%.


As I type this we get a clear idea of the trend this has been in play overall by noting that the long bond yield is now 3.06%.  We can now shift to an economic effect of this by noting that the US 30 year mortgage-rate is now 4.06% and has been rising since late September when in dipped into the low 3.3s%. So there will be a contractionary economic effect via higher mortgage and remortgage costs. There will be others too but this is the clearest cause and effect link and will be seen in other places around the world.


Here we have a slightly different situation as the Bank of Japan has promised to keep the ten-year yield around 0% so you can take today’s 0.07% as either success or failure. In general bond yields have nudged higher but the truth is that the Bank of Japan so dominates this market it is hard to say what it tells us apart from what The Tokyo Whale wants it too. Also the inflation situation is different as Japan remains at around 0%.


We find ourselves observing a changing landscape. Whilst not quite a return of the bond vigilantes the band does strike up an occasional tune. When it plays it is mostly humming along to the return of consumer inflation which of course has mostly be driven by the end of the fall in the crude oil price and indeed its rebound. What that has done is made inflation adjusted or real yields look very negative indeed. Whilst Ivory Tower spreadsheets may smile the problem is finding investors willing to buy this as we see markets at the wrong price and yield. Unless central banks are willing to buy bond markets in their entirety then yields will ebb and flow but the trend seems set to be higher and in some cases much higher. For example German bunds have “safe-haven” status but how does a yield of 0.44% for a ten-year bond go with a central bank expecting inflation to go above 2% as the Bundesbank informed us earlier this week?

The economic effects of this will be felt in mortgage,business and other borrowing rates. This will include governments many of whom have got used to cheap and indeed ultra-cheap credit.




The confusion around the Target2 system of the Euro

As the Euro crisis developed there were a wide range of discussions and disagreements. One of the longest lasting and most polarised was and indeed is the one over the Target2 settlement system. There has been a new outbreak of this which has been triggered by a letter published on Friday by ECB (European Central Bank) President Mario Draghi. Let us cut straight to the chase.

If a country were to leave the Eurosystem, its national central bank’s claims on or liabilities to the ECB would need to be settled in full.

Boom! This opens more than one can of worms and one rather large one is opened if we step bank in time to July 2012 and the emphasis is mine.

And so we view this, and I do not think we are unbiased observers, we think the euro is irreversible. And it’s not an empty word now, because I preceded saying exactly what actions have been made, are being made to make it irreversible.

That speech was also famous for something else which is relevant to the discussion.

Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.

So how can you leave something which is irreversible? Accordingly you will not be settling up partly because Mario will not let it happen. That July 2012 speech was a success for keeping the Euro going forwards although reading it again exposes a fair bit of hot air and boasting about relative economic success of which the clearest critic is the ECB’s 1.5 trillion Euros plus of QE (Quantitative Easing) and -0.4% deposit interest-rate.

But as I read the crucial sentence in the letter to Mr Marco Valli (MEP) and Mr Marco Zanni (MEP) my other thought was that Mario Draghi had just boosted the credibility of those who have argued that Target2 balances matter.

How has this come about?

Ironically this is another side-effect of the QE programme.

the recent increase in TARGET2 balances largely reflects liquidity flows stemming from the ECB’s asset purchase programme (APP).

Oops! Also the change is how can one put it? Geographically concentrated.

Almost 80% of bonds purchased by national central banks under the APP were sold by counterparties that are not resident in the same country as the purchasing national central bank, and roughly half of the purchases were from counterparties located outside the euro area, most of which mainly access the TARGET2 payments system via the Deutsche Bundesbank.

As we note that foreign investors have been selling Euro area bonds to the ECB on a large-scale we see this as a consequence of who they have chosen to sell them too.

This, in turn, resulted in an increase in the Deutsche Bundesbank’s TARGET2 balance vis-à-vis the ECB.

With Germanic accuracy we are told that this amounted to 754,262,914,964.24 Euros as of the end of 2016. It may be hard to believe now but back in the early 2000s there were occasions when the German Bundesbank was a debtor in this system but the amounts back then were far far smaller. You will not be surprised to read it became a creditor as the credit crunch hit and at the end of 2008 that amounted to 115.3 billion Euros. At the time of Mario’s “whatever it takes” speech the balance was 727.2 billion Euros. This of course poses the problem that it we are in so much of a better place now why are we seeing a new record surplus? Here is the official reply.

However, the current increase in TARGET2 balances is not a symptom of increased stress and is therefore inherently different from the previous episodes of rising balances.

Ah, so this time is different!

What is Target2?

It is a settlement system which represents the monetary side of transactions described below by the Bundesbank.

These payment transactions can take a wide variety of forms, such as payment for a goods delivery, the purchase or sale of a security, the granting or repayment of a loan or the depositing of funds at a bank, among many others.

Now this reminds me of the case of the way changes in UK £M3 were represented some 30 years or so ago. This is because back then just because there was an accounting identity we were told there had to be a causal identity as well. Sadly that did not go so well. However the scale of Target2 leads to worries.

An average of around 350,000 payments with a value of just under €2½ trillion are processed using TARGET2 each working day, a figure which is broadly equivalent to the size of Germany’s GDP.

Other central banks have settlement systems but you see where the difference is comes from the fact that the Bank of Japan works in an environment of political and monetary union so nobody worries much about balances between Kobe and Osaka. The problem is created because the Euro is an economic concept which crosses national boundaries. Thus these cash-flows cross national boundaries. But the Target2 balances are not a causal force they are a consequence of financial actions elsewhere. For example back in 2011/12 they built up because of the banking crises seen and now they are building up ironically as part of the ECB’s response to that and the subsequent economic problems.

How could it go wrong?

There are two possibilities. The mildest would be something that cannot be settled under the current structure as described by Beate Resazt here.

in Target2 there is always a danger that one leg of a transaction is paid and the counterparty is not willing or able to fulfil its part of the business. For this eventuality banks have to provide collateral. If collateral turns out to be insufficient to realize the full amount the resulting loss is shared by the euro area NCBs in line with their capital shares.

So a risk but after so many stresses we have avoided that so far meaning it is there as a risk but the ECB has so far kept on top of it. The bigger issue is of course someone leaving the Euro as Mario Draghi stated. This poses all sorts of questions. The current fractious state of Brexit negotiations would presumably be considered to be something of a tea-party compared to this so there are genuine dangers. In such an environment the worst case scenario would be if the departing state refused to settle its deficit as after all it would likely be in deficit. Some argue that there is no deficit only claims and perhaps they have a point when everyone is still in the Euro as you can then argue that in essence this is simply a settlement system run by the ECB. But we return to what if you leave when you are now outside the system and refuse to settle up what would now be a deficit?


As I indicated earlier to my mind rather than being a problem in itself the Target2 issue indicates problems elsewhere. For example the German current account surplus or the way that ECB QE is settled mostly at the German Bundesbank. So when we see headlines like “debt” or “profit and loss” I am not convinced as it is an accounting system telling us about flows of cash. Of course cash flow leads many companies to come a cropper and indeed can do to governments as we are reminded again that this would not be a subject for debate beyond regional policy if there was fiscal and political union.

Somebody leaving seems likely to be an explosive event both politically and economically and in the turmoil lots would happen. For example a new currency for the country concerned and probably an element of default on debts too. This would bounce around the Target2 system but it would be an accounting identity rather than a cause.