Greece still faces a long hard road to end its economic depression

This morning has brought a development that many of you warned about in the comments section and it relates to Greece. So with a warning that I hope you have not just eaten let us begin.

You did it! Congratulations to Greece and its people on ending the programme of financial assistance. With huge efforts and European solidarity you seized the day. ( President Donald Tusk)

There was also this from the European Union Council.

“Greece has regained the control it fought for”, says Eurogroup President as today exits its financial assistance programme. 

There is an element of triumphalism here and that is what some of you warned about with the only caveat being that the first inkling of good news was supposed to be the cause whereas that is still in the mix. So there is an element of desperation about all of this. This is highlighted by the words of the largest creditor to Greece as the European Stability President Klaus Regling has said this and the emphasis is mine.

 We want Greece to be another success story, to be prosperous and a country trusted by investors. This can happen, provided Greece builds upon the progress achieved by continuing the reforms launched under the ESM programme.

What is the state of play?

It is important to remind ourselves as to what has happened in Greece because it is missing in the statements above and sadly the media seem to be mostly copying and pasting it. As you can imagine it made my blood boil as the business section of BBC Breakfast glibly assured us that a Grexit would have been a disaster. Meanwhile the reality is of an economy that has shrunk by around a quarter and an unemployment rate that even now is much more reminiscent of an economic disaster than a recovery.

 The seasonally adjusted unemployment rate in May 2018 was 19.5%…..

The youth (15-24)  unemployment rate is 39.7% which means that not only will many young Greeks had never had a job but they still face a future with little or no prospect of one. Yesterday the New York Times put a human face on this.

When Dimitris Zafiriou landed a coveted full-time job two months ago, the salary was only half what he earned before Greece’s debt crisis. Yet after years of struggling, it was a step up.

“Now, our family has zero money left over at the end of the month,” Mr. Zafiriou, 47, a specialist in metal building infrastructure, said with a grim laugh. “But zero is better than what we had before, when we couldn’t pay the bills at all.”

The consequence of grinding and persistent unemployment and real wage cuts for even the relatively fortunate has been this.

A wrenching downturn, combined with nearly a decade of sharp spending cuts and tax increases to repair the nation’s finances, has left over a third of the population of 10 million near poverty, according to the Organization for Economic Cooperation and Development.

Household incomes fell by over 30 percent, and more than a fifth of people are unable to pay basic expenses like rent, electricity and bank loans. A third of families have at least one unemployed member. And among those who do have a job, in-work poverty has climbed to one of the highest levels in Europe.

The concept of in work poverty is sadly not unique to Greece but some have been hit very hard.

Mrs. Pavlioti, a former supervisor at a Greek polling company, never dreamed she would need social assistance…….The longer she stays out of the formal job market, the harder it is to get back in. Recently she took a job as a babysitter with flexible hours, earning €450 a month — enough to pay the rent and bills, though not much else.

She provided quite a harsh critique of the triumphalism above.

“The end of the bailout makes no difference in our lives,” Mrs. Pavlioti said. “We are just surviving, not living.”

The end of the bailout

The ESM puts it like this.

Greece officially concludes its three-year ESM financial assistance programme today with a successful exit.

The word successful grates more than a little in the circumstances but it was possible that Greece could have been thrown out of the programme. It was never that likely along the lines of the aphorism that if you owe a bank one Euro it owns you but if you owe it a million you own it.

 As the ESM and EFSF are Greece’s largest creditors, holding 55% of total Greek government debt, our interests are aligned with those of Greece……..From 2010 to 2012, Greece received € 52.9 billion in bilateral loans under the so-called Greek Loan Facility from euro area Member States.

That is quite a lot of skin in the game to say the least. Because of that Greece is not as free as some might try to persuade you.

The ESM will continue to cooperate with the Greek authorities under the ESM’s Early Warning System, designed to ensure that beneficiary countries are able to repay the ESM as agreed. For that purpose, the ESM will receive regular reporting from Greece and will join the European Commission for its regular missions under the Enhanced Surveillance framework.

Back on February 12th I pointed out this.

 It is no coincidence that the “increased post-bailout monitoring” is expected to end in 2022, when the obligation for high primary surpluses of 3.5 percent of gross domestic product expires.

As you can see whilst the explicit bailout may be over the consequences of it remain and one of these is the continued “monitoring”. This is a confirmation of my point that whilst there has been crowing about the cheap cost of the loans in the end the size or capital burden of them will come into play.

Borrowing costs will rise

After an initial disastrous period when the objective was to punish Greece ( something from which Greece has yet to recover) the loans to Greece were made ever cheaper.

Thanks to the ESM’s and EFSF’s extremely advantageous loan conditions with long maturities and low-interest rates, Greece saves around €12 billion in debt servicing annually, 6.7% of GDP every year.  ( ESM)

So Greece is now turning down very cheap money as it borrows from the ESM at an average interest-rate of 1.62%. As I type this the ten-year yield for Greece is 4.34% which is not only much more it is a favourable comparison as the ESM has been lending very long-term to Greece. This was simultaneously good for Greece ( cheap borrowing) and for both ( otherwise everything looked completely unaffordable).

For now this may not be a big deal as with its fiscal surpluses Greece will not be in borrowing markets that much unless of course we see another economic downturn. There is a bond which matures on the 17th of April next year for example. Also the ECB did not help by ending its waiver for Greek government bonds which made it more expensive to use them as collateral with it and no doubt is a factor in the recent rise in Greek bond yields. Not a good portent for hopes of some QE purchases which of course are on the decline anyway.

Comment

The whole Greek saga was well encapsulated by Elton John back in the day.

It’s sad, so sad (so sad)
It’s a sad, sad situation
And it’s getting more and more absurd.

The big picture is that it should not have been allowed into the Euro in 2001. The boom which followed led to vanity projects like the 2004 Olympics and then was shown up by the global financial crash from which Greece received a fatal blow in economic terms. The peak was a quarterly economic output of 63.6 billion Euros in the second quarter of 2007 (2010 prices) and a claimed economic growth rate of over 5% (numbers from back then remain under a cloud). As the economy shrank doubts emerged and the Euro area debt crisis began meaning that the “shock and awe” bailout so lauded by Christine Lagarde who back then was the French Finance Minister backfired spectacularly. The promised 2.1% annual growth rate of 2012 morphed into actual annual growth rates of between -4.1% and -8.7%. Combined with the initial interest-rates applied the game was up via compound interest in spite of the private sector initiative or default.

Any claim of recovery needs to have as context that the latest quarterly GDP figure was 47.4 billion Euros. This means that even the present 2.3% annual rate of economic growth will take years and years to get back to the starting point. One way of putting this is that the promised land of 2012 looks like it may have turned up in 2018. Also after an economic collapse like this economies usually bounce back strongly in what is called a V-shaped recovery. There has been none of this here. Usually we have establishments giving us projections of how much growth has been lost by projecting 2007 forwards but not here. The reforms that were promised have at best turned up piecemeal highlighted to some extent by the dreadful fires this summer and the fear that these are deliberately started each year.

Yet the people who have created a Great Depression with all its human cost still persist in rubbishing the alternative which as regular readers know I suggested which was to default and devalue. Or what used to be IMF policy before this phase where it is led by European politicians. A lower currency has consequences but it would have helped overall.

 

 

 

 

 

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The ECB and its Italian and Turkish problems

At the moment the European Central Bank (ECB) Governing Council is on its summer break and does not formally reconvene until the 13th of September. So I raised a wry smile when Bloomberg assured us ” The ECB is staying calm amid Turkey and Italy routs” this morning! The world does not stand still during summer and is showing more than a few signs of upset for the ECB so let us take a look.

Turkey

The very volatile nature of Turkish financial markets is an issue for the ECB and one signal of this is how such a nearby country can have such a different official interest-rate. The Turkish central bank after hints of a new 19.25% interest-rate in the melee of Monday has remained at 17.75% which is an alternative universe to the -0.4% deposit rate of the ECB. It is hard to believe Greece and Turkey are neighbours when you look at that gap.

Next comes the exchange rate where at the start of 2018 some 4.55 Turkish Lira were required to buy one Euro as opposed to the 6.72 required as I type this. Even that is a fair retracement of the surge which saw it just fail to make 8 only on Monday. Apart from being a dizzying whirl recently we can see that the fall this year must have made trade difficult. As to how much trade there is we need to switch to the European Union about which we were told this in April.

  • In 2017, among the EU’s trading partners, Turkey was the fifth largest partner for exports from the EU and the sixth largest partner for imports to the EU.
  • The EU’s trade surplus with Turkey has fallen from a peak of EUR 27 billion in 2013 to EUR 15 billion in 2017.
  • Manufactured goods make up 81 % of EU exports to Turkey and 89 % of EU imports from Turkey.
  • In 2017, Germany was the EU’s largest import (EUR 14 billion) and export (EUR 22 billion) partner with Turkey.
  • Germany also had the largest trade surplus (EUR 8 billion) with Turkey while Slovenia had the largest deficit (EUR 1.5 billion).

If we just switch to exports then we see the importance of Turkey.

Germany was also the largest exporter (EUR 21.8 billion) to Turkey followed by Italy (EUR 10.1 billion) and the United Kingdom (EUR 8.4 billion). Almost a quarter of Bulgaria’s extra-EU exports (23 %) were destined for Turkey. Greece (15 %) and Romania (14 %) also had high shares while all other Member States had shares below 9 %.

Of course some of those countries are not the responsibility of the ECB but we do get an idea of vulnerabilities such as the ability of Turkish consumers to buy German cars. Also Italy with its own economic issues that I will come on to later can do without any fall in exports. Even worse for Greece.

Right in the ECB’s orbit however was this from the Financial Times last week about risks to the “precious”.

The eurozone’s chief financial watchdog has become concerned about the exposure of some of the currency area’s biggest lenders to Turkey — chiefly BBVA, UniCredit and BNP Paribas — in light of the lira’s dramatic fall…….Spanish banks are owed $82.3bn by Turkish borrowers, French banks are owed $38.4bn and Italian lenders $17bn in a mix of local and foreign currencies. Banks’ Turkish subsidiaries tend to lend in local currency.

There have been arguments since then as to exactly the size of the risk but it is clear that there is an issue. Of course if we bring the exchange-rate back in it looks much less at 6.7 to the Euro than it did at 8 but to any proper analysis that move this week may well be as dangerous as the fall. Looked at through the eyes of an ex-option trader (me) you see that a short derivative position might have been hedged in the panic ( so towards 8) but the catch is that you would be long the Euro up there just in time for it to drop! So you lose both ways. We never really find out about this sort of thing until it has really badly gone wrong.

Italy

In a way much of the problem here has been exemplified by the dreadful Autostrada bridge collapse. For a start how does that happen in a first world country? Then even worse everyone seems to be blaming everyone else. If we move to the direct beat of th ECB there is the ongoing economic growth issue.

In the second quarter of 2018 Italian economy slowed down, as suggested in the previous months by the leading indicator. The GDP quarterly slightly decelerated (+0.2% compared to +0.3% Q1,)

That brings Italy back to my long running theme that it struggles to have economic growth above 1%. Indeed as this still represents a period where monetary policy was very expansionary there will be fears for what will happen as it gets wound back.

On the latter subject of reducing and then an end to the QE program there was this on Monday.

The economic spokesman of Italy’s ruling League party warned on Monday that unless the European Central Bank offers a guarantee to cap yield spreads in the euro zone, the euro will collapse………….Borghi said the ECB should guarantee that yield spreads between euro zone government bonds not exceed a certain level, suggesting 150 basis points between the yields of any two sovereign bonds as a reasonable maximum. ( Reuters)

That sort of statement opens more than one can of worms. The simplest is just to compare that with where we are which is 284 basis points or 2.84%. So he is looking for the ECB to back stop the Italian bond market and his own spending plans a subject which has arisen before. No doubt this is driven by the rise in the ten-year yield of Italy which is now 3.14% which is not historically high but since then Italy’s national debt and therefore borrowing needs has risen meaning that matters tighten at lower yields than they used to.

Next comes the fact that even the ECB which in spite of calling itself a “rules based organisation” has operated at least to some extent by making them up as it goes along. But a programme just to help Italy would be even nearer to overt monetary financing than what we have seen so far. Other nations taxpayers would wonder why it was being singled out for favourable treatment. This would be especially true in Greece which only a week ago found that a waiver for its collateral at the ECB had ended.

Greek banks borrow just over 8 billion from the ECB in longer-term refinancing operations and now need to post a new type of collateral to maintain their access. ( Reuters)

Meanwhile there is the ongoing issue of the Italian banks and the irony of the Turkish situation is the way that Unicredit which was supposed to be escaping the noose may have found a way of putting its neck back in it.

Comment

Having looked at particular issues it is time to bring the analysis back to the day job which is monetary policy. This morning brought troubling news for those who are in the “pump it up” camp.

The euro area annual inflation rate was 2.1% in July 2018, up from 2.0% in June 2018. A year earlier, the rate was
1.3%.

Thus it has for now achieved its inflation objective and in fact it is a little above the 1.97% indicated by the previous President Jean-Claude Trichet. So those wanting more only have the “core” or excluding energy number at 1.4% to support them. They can also throw in the fact that economic growth has slowed in 2018 but also have to face the issue that even Mario Draghi regards this as pretty much a normal level.

Seasonally adjusted GDP rose by 0.4% in both the euro area (EA19) and the EU28……..Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.2% in both the euro area and the EU28.

Thus the ECB moves forwards with its monetary policy locked on course. It has no intention of raising interest-rates and a cut would provoke questions as after all it has told us things are going well. The QE programme is being trimmed in flow terms and it will not be long before that stops. What it has now are the boring parts of central banking such as bank supervision but in the case of Euro area banks in Turkey that would look like closing the stable door long after the horse has bolted.

Of course it could intervene against the Turkish Lira to help provide some stability and to help Euro area exporters. But I think we all know it would only do that if it thought it would help the banks. Also if we take the example of right now and the fall to 6.91 versus the Euro whilst I have been typing this it would no doubt attract the attention of the Donald and his twitter feed plunging the ECB into a political morass.  Such thoughts will have Mario Draghi reaching for another glass of Chianti on his summer break.

 

 

The economy of Italy returns to its former coma status

We are in a spell where there has been a burst of economic news about Italy and the headline brings back memories of my main theme. So let us take a look at why the idea of it being like a “girlfriend in a coma” is back.

In the second quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross
Domestic Product (GDP) increased by 0.2 per cent with respect to the first quarter of 2018 and by 1.1 per
cent in comparison with the second quarter of 2017. ( ISTAT)

Along the way I note that the statement below from only last week of European Central Bank President Mario Draghi does not seem to apply that well to his home country.

 the euro area economy is proceeding along a solid and broad-based growth path.

For newer readers my “girlfriend in a coma” theme comes from the fact that for quite some time now Italy has struggled to grow its economy at more than 1% per annum. So a fall to 1.1% reminds us of that especially as we note that annual growth only got as high as 1.7% in the “Euroboom” and since then has gone 1.6%,1.4% and now 1.1%. If we switch to the quarterly numbers then the trend is clearly not our friend as the peak of 0.5% at the end of 2016 was held in the opening quarter of 2017 but has since gone 0.4%, 0.3%,0.3%,0.3% and now 0.2%. Indeed there has also been a downgrade of the past as we had two 0.4% previously.

Perspective

The tweet below sums up the overall theme where Italy is not only still well below its pre credit crunch peak but has grown so little this century or if you prefer in the Euro era.

Also Italy has seen a fair bit of population growth meaning that the numbers on an individual or per capita basis are even worse and I have been waiting for them to rise back to where they were at the beginning of this century. Unfortunately growth has slowed to a crawl but they should be somewhere around them now.

Labour Market

We have seen in the credit crunch era that employment trends can be a leading indicator for an economy but get little solace here either.

In June 2018, 23.320 million persons were employed, -0.2% over May

The picture had been improving as the 330000 jobs gain over the past year illustrates but now the picture is not so clear. If we switch to unemployment we see that the sense of unease increases.

Unemployed were 2.866 million, +2.1% over the previous month.

This meant that the annual picture here was of only a fall of 8000 in the ranks of the unemployed. Also I have pointed out before that the unemployment rate falls below 11% to media cheers and then climbs back up to it as if it is on repeat. Well it has not yet gone back to 11% but not far off it.

unemployment rate was 10.9%, +0.2 percentage points over May 2018

The disappointing picture continues when we look at the bugbear which is youth unemployment.

Youth unemployment rate (aged 15-24) was 32.6%, +0.5 percentage points over the previous month and
youth unemployment ratio in the same age group was 8.6%, +0.2 percentage points over May 2018.

Inflation

If we switch to the other component of what used to be called the Misery Index ( where the annual rate of inflation was added to the unemployment rate) we see this.

In July 2018, according to preliminary estimates, the Italian harmonised index of consumer prices (HICP) decreased by 1.4% compared with the previous month and increased by 1.9% with respect to July 2017 (from +1.4% in June).

So the Misery Index rose to 12.8% if we use the latest figures albeit that unemployment is for June and not July. Just for clarity the HICP above is the measure we use in the UK as Italy kept the CPI moniker for its own measure. Some of the inflation rise was due to the summer sales starting a week later than in 2017.

Wages

There was better news here but it comes with a bit of a kicker. So let us start with the good news.

In June 2018 the hourly index and the per employee index increased by 0.9 per cent from last month.

Compared with June 2017 both indices increased by 2.0 per cent.

That was something of a burst and meant that there was some real wage growth and the numbers cover a lot of the economy.

At the end of June 2018 the coverage rate (share of national collective agreements in force for the wage setting aspects) was 86.8 per cent in terms of employees and 87.4 per cent in terms of the total amount of wages.

In fact wage growth for most changed very little but it rose to an annual rate of 4% in the public administration sector driven by a 6.4% rise for the military and 6.1% for the police. Well I suppose that is one way of boosting defence spending to please President Trump! But returning to the economics we see that whilst higher wages in that sector should boost areas such as retail sales the ordinary Italian taxpayer may be nervous of higher taxes to pay for it. Also is it ominous that the government is seemingly getting the police and military onside?

Looking Ahead

This mornings private-sector survey or PMI for the manufacturing sector did not start well.

Manufacturing growth eases in July to lowest since October 2016

The detail in fact questioned whether there was any growth at all.

Growth rates of both output and new orders
weakened during July to near standstills amid
reports of an ongoing slowdown in underlying
market activity. There were reports that both
domestic and external market conditions were
faltering. Indeed, new export orders rose to the
weakest degree since August 2016 according to the
latest data.

Indeed the conclusion was downbeat when we try to add this report to the overall picture.

Based on the latest set of PMI survey data, and
with worries mounting over any escalation of global
trade tensions on export trade, Italy’s industrial
base may well struggle to meaningfully contribute to
wider economic growth in the second half of 2018

Comment

There is a familiar drumbeat about all of this as we see Italy slipping back into what is normal for it. For a start there is the still very expansionary monetary policy of the ECB with its -0.4% deposit rate although the monthly QE purchases are reducing which drives the thought that even at its height Italy gained only a little. Economic growth since the beginning of 2014 totals a mere 4.5%.

Next comes the issue of Italy’s high national debt which has risen above 2.3 trillion Euros and of course now faces higher bond yields  (ten-year is 2.76%) as it looks to refinance maturing debt and raise new finance. The essential issue here has not been one of overspending but much more one of lack of economic growth.

Italy is in many ways a delightful country so let us end with something more positive which I note from the purchase of Ronaldo by the grand old club Juventus. Like all football transfers it starts not so well as it the fee is an import and subtracts from GDP but more positively the hope is that he provides a boost via Champions League success. But I spotted something else. From CNBC.

Ronaldo fans can purchase children’s jerseys with his name for €84.95 ($98.90), women’s jerseys for €94.95 ($110.60), men’s jerseys for €104.95 ($122.20) and an authentic replica of the gear worn by Juventus playersfor €137.45 ($160.10).

There is a lot of poor analysis on this sort of thing as much of the money goes nowhere near Juve but my point is there must be money in Italy if Juve can charge that much for a football shirt. Of course there will be international fans buying but also plenty of Italian ones.

 

 

 

 

What just happened to the GDP and economy of France?

Sometimes reality catches up with you quite quickly so this morning Mario Draghi may not want a copy of any French newspapers on holiday. This is because on the way to one of the shorter and maybe shortest policy meeting press conferences we were told this.

The latest economic indicators and survey results have stabilised and continue to point to ongoing solid and broad-based economic growth, in line with the June 2018 Eurosystem staff macroeconomic projections for the euro area.

As you can see below Mario did drift away from this at one point but then returned to it in the next sentence.

Some sluggishness in the first quarter is continuing in the second quarter. But I would say almost all indicators have now stabilised at levels that are above historical averages.

Then we got what in these times was perhaps the most bullish perspective of all.

Now, one positive development is the nominal wage performance where, you remember, we’ve seen a pickup in nominal wage growth across the eurozone. Until recently this pickup was mostly produced by wage drift, while now we are seeing that there is a component, which is the negotiated wage component, which is now – right now the main driver of the growth in nominal wages.

Most countries have a sustained pick up in wage growth as a sort of economic Holy Grail right now. So we were presented with a bright picture overall and as I pointed out yesterday Mario is the master of these events as he was even able to make a mistake about economic reforms by saying there had been some, realise he had just contradicted what is his core message and engage reverse  gear apparently unnoticed by the press corps.

France

This morning brought us to the economic growth news from France which we might have been expecting to be solid and broad-based and this is what we got.

In Q2 2018, GDP in volume terms* rose at the same pace as in Q1: +0.2%

Now that is not really solid especially if we recall it is supposed to be above historical averages so let us also investigate if it is broad-based?

Household consumption expenditure faltered slightly in Q1 2018 (−0.1% after +0.2%): consumption of goods declined again (−0.3% after −0.1%) and that of services slowed down sharply (+0.1% after +0.4%).

The latter slowdown is concerning as we note that estimates put the services sector at just under 79% of the French economy. We also might expect better consumption data as whilst it may be a bit early for Mario’s wages growth claims to be at play household disposable income rose by 2.7% in 2017. However such metrics seem to have dropped a fair bit so far this year as household purchasing power was estimated to have fallen by 0.6% in the opening quarter of this year. So if anything is broad-based here it is the warning about a slowdown we got a few months ago and not the newer more upbeat version.

Trade

This was a drag on growth but not in the way you might expect. The easy view would be that French car exports would have been affected by the trade wars developments. But whilst there nay be elements of that it was not exports which were the problem.

Imports recovered sharply in Q2 2018 (+1.7% after −0.3%) after the decrease observed in Q1. Exports also bounced back but to a lesser extent (+0.6% after −0.4%). All in all, foreign trade balance contributed negatively to GDP growth: −0.3 points after a neutral contribution in the previous quarter.

That is a bit like the UK in the first quarter and we await developments as even quarterly trade figures can be unreliable.

Production

Production in goods and services barely accelerated in Q2 2018 (+0.2% after +0.1%)………….Output in manufactured goods fell back again (−0.2% after −1.0%). Production in refinery stepped back (−9.9% after −1.6%) due to technical maintenance; production in electricity and gas dropped too (−1.7% after +1.9%). However, construction bounced back (+0.6% after −0.3%).

As you can see there is not a lot to cheer here as construction may just be correcting the weather effect in the first quarter. There was better news from investment though.

In Q2 2018, total GFCF recovered sharply (+0.7% after +0.1% in Q1 2018), especially because of the upsurge in corporate investment (+1.1% after +0.1%). It was mainly due to the upswing in manufactured goods (+1.2% after −1.1%)

As there was not much of a sign of a manufacturing upswing lets us hope that the optimism ends up being fulfilled as other wise we seem set to see more of this.

Conversely, changes in inventories drove GDP on (+0.3 points after 0.0 points).

The Outlook

We of course are now keen to know how the third quarter has started and what we can expect next? From the official survey published on Tuesday.

The balances of industrialists’ opinion on overall and
foreign demand in the last three months have dropped
again sharply in July – they had reached at the beginning of the year their highest level in seven years, before dropping back in the April survey. Business managers are also less optimistic about overall and foreign demand over the next three months;

If we look at the survey index level the number remains positive overall but the direction of travel is south, not as bad as the credit crunch impact but more like how the Euro area crisis impacted which is odd. Let us now switch to the services sector.

According to business managers surveyed in July
2018, the business climate remains stable in services.
The composite indicator which measures it has stood at
104 since May 2018, above its long-term average
(100).

Is stable the new contraction? Perhaps if we allow for the rail strikes in the second quarter but the direction of travel has again been south. If we step back and look at the overall survey which has a long record we see that it recorded a pick up early in 2013 which had some ebbs and flows but the trend was higher and now we are seeing the first turn and indeed sustained fall.

I cannot find anything from the Markit PMI business surveys on this today as presumably they are mulling how they seem now to be a lagging indicator as opposed to a leading one.

Comment

The rhetoric of only yesterday has faded quite a bit as we mull these numbers from France. It is the second biggest economy in the Euro area and the story that if we use a rowing metaphor it caught a crab at the beginning of the year now seems untrue. It may even have under performed the UK which is supposed to be on a troubled trajectory of its own. Under the new structure we do not have the official numbers for June in the UK. The surveys quoted above do not seem especially optimistic apart from the Markit ones which of course have been through this phase.

A more optimistic view comes from the monetary data which as I analysed on Wednesday has stopped getting worse and strengthened in terms of broad money and credit. Let me give a nod to the masterful way Mario Draghi presented the narrow money numbers.

The narrow monetary aggregate M1 remained the main contributor to broad money growth. ( It fell…)

So the outlook should be a little better and the year on course for the 1.3% suggested by the average number calculated today. But 0.7%,0.7% to 0.2%,0.2% is quite a lurch.

In other news let me congratulate France on being the football World Cup winners. Frankly they have quite a team there. But in the language world cup there is only one winner as Mario Draghi went to some pains to point out yesterday.

Let me clear: the only version that conveys the policy message is the English version. We conduct our Governing Council in English and agree on an English text, so that’s what we have to look at.

Or as someone amusingly replied to me Irish……

What can we expect next from the ECB?

Today the European Central Bank starts its latest policy meeting and tomorrow lunchtime we will be told the outcome. To my mind there are three certainties. The first is that ECB President Mario Draghi will call for more economic reforms in his introductory statement. The next is that he will wish everyone a happy holiday season at the end. The third is that he will find a way to point out that in its own terms the ECB has had a Eureka moment.From Eurostat.

Euro area annual inflation rate was 2.0% in June 2018, up from 1.9% in May 2018. A year earlier, the rate was
1.3%

So the 2% target has been hit and if you take the average of those 2 months you end up pretty near to the 1.97% specified back in the day in the valedictory speech of Mario’s predecessor Jean-Claude Trichet. Next comes this.

Seasonally adjusted GDP rose by 0.4% in the euro area (EA19) (and the EU28 during the first quarter of 2018),
compared with the previous quarter……..Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.5% in the euro area.

So economic growth and inflation on target as Mario readies us for the last leg of his triple play.

The number of persons employed increased by 0.4% in both the euro area (EA19) and the EU28 in the first
quarter of 2018 compared with the previous quarter…….Compared with the same quarter of the previous year, employment increased by 1.4% in both the euro area and the EU28 in the first quarter of 2018……Eurostat estimates that, in the first quarter of 2018, 237.9 million men and women were employed in the EU28, of which 157.2 million were in the euro area. These are the highest levels ever recorded in both areas.

So as you can see even the perennial bugbear which is the employment situation in the Euro area has improved. This brings me to another certainty these days which is that Mario will run rings around the journalists at the press conference. The only danger to that is overconfidence as he sings along to Flo and her Machine.

The dog days are over
The dog days are done

A nagging problem

The catch to the scenario above is that the punch bowl at this particular party is still pretty full. No longer right up to the brim but there is still a -0.4% deposit rate and this.

would reduce the monthly pace of net asset purchases to €15 billion until the end of December 2018 and then end net asset purchases.

Lest we forget it will be twisting by the pool this summer and beyond.

Third, it intended to maintain its policy of reinvesting the principal payments from maturing securities purchased under the APP for an extended period of time after ending net purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

One of the biggest beneficiaries does not seem to merit a mention so let me help out. The various Euro area governments will be grateful for the help to fiscal policy via lower borrowing costs especially Mario’s home country because after the election result the bond market there has looked more vulnerable ( 10 year yield 2.65%). Some may think that the new Vice President the ex Spanish Finance Minister was appointed to keep the ECB reminded about this but whatever it does pose questions about the claimed independence. After all it was only at the last press conference that we were told the ECB was struggling to find him a specific role implying he lacked the skills required.

But looking ahead the sovereign bond book will head towards 2.1 trillion Euros and then stay there. So we move on with the nagging worry that people are still drinking from the punch bowl with the band at full volume.

What happens next?

This morning’s monetary data provided some food for thought.

The annual growth rate of the broad monetary aggregate M3 increased to 4.4% in June 2018 from 4.0% in
May, averaging 4.1% in the three months up to June. The components of M3 showed the following
developments. The annual growth rate of the narrower aggregate M1, which comprises currency in
circulation and overnight deposits, stood at 7.4% in June, compared with 7.5% in May

In terms of economic outlook we see that the narrow money supply has stabilised overall at a lower level confirming a weaker economic trajectory. Looking further ahead broad money growth has improved but against that inflation has risen.

The ECB will be pleased to see an improvement in credit provided to businesses but I think that is more of a lagging ( from the period of growth seen last year) than a leading indicator.

A Space Oddity

Strangely perhaps the biggest challenge to the shiny happy people economic view in the Euro area has come from the ECB itself.

The view was also reiterated that the observed slowdown could, to some extent, be seen as a natural development in a maturing expansion after many years of growth above potential.  ( ECB July Minutes )

Er haven’t we just seen many years of growth below potential? I know recently things improved but have the credit crunch and the Euro area crisis just been redacted? Also as so often for central bankers we see such thoughts are driven by a rather downbeat outlook.

An increasing number of countries and sectors were starting to run into capacity constraints and labour shortages, implying a “structural” levelling-off of growth,

If true that is a bit grim.

Banks

Problems here never really go away and claiming “many years of growth above potential” trims the list of possible excuses quite drastically. There is the ongoing issue of money laundering and corruption in the Baltic nations and of course there is the Italian version.

The ECB appears to have lost patience with Carige, which although worth a mere 500 million euros is one of Italy’s top 10 biggest lenders by assets. It has rejected the Genoa-based bank’s current capital plan, and given it until year end to raise its total capital ratio to 13.1 percent, almost 90 basis points above the current level.  ( Reuters )

Comment

As you can see the picture on the surface looks good for the ECB and it is true there have been improvements. I expect Mario to defend the ongoing QE and negative interest-rates by pointing out that what he considers to be core inflation is at 1.2% below target. But the old punch bowl argument does pose questions especially as the man who made the original case could not have been aware of how large a modern punch bowl actually is. The vulnerability is to any combination of a further slowing in the economy and pick up in inflation. That will be there for a while as the ECB intends to maintain the size of its stock of QE  as well as having no plans to raise interest-rates.

This entailed the expectation that policy rates would remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remained aligned with the Governing Council’s current expectations of a sustained adjustment path. ( ECB July Minutes)

Putting this another way I note that the Taylor Rule would according to the Wall Street Journal have interest-rates at 2.5%. I am no great fan of automatic rules but that is quite a gap and widens if you note the -0.4% deposit rate rather than the 0% rate some like to emphasise. Which returns to the question of why if things are so good we remain enmeshed in zero and indeed negative interest-rates?

 

 

 

 

 

 

 

The economic impact of the King Dollar in the summer of 2018

One of the problems of currency analysis is the way that when you are in the melee it is hard to tell the short-term fluctuation from the longer-term trend. It gets worse should you run into a crisis as Argentina found earlier this year as it raised interest-rates to 40% and still found itself calling for help from the International Monetary Fund. The reality was that it found itself caught out by a change in trend as the US Dollar stopped falling and began to rally. If we switch to the DXY index we see that the 88.6 of the middle of February has been replaced by 95.38 as I type this. At first it mostly trod water but since the middle of April it has been on the up.

Why?

If we ask the same question as Carly Simon did some years back then a partial answer comes from this from the testimony of Federal Reserve Chair Jerome Powell yesterday.

Over the first half of 2018 the FOMC has continued to gradually reduce monetary policy accommodation. In other words, we have continued to dial back the extra boost that was needed to help the economy recover from the financial crisis and recession. Specifically, we raised the target range for the federal funds rate by 1/4 percentage point at both our March and June meetings, bringing the target to its current range of 1-3/4 to 2 percent.

So the heat is on and looks set to be turned up a notch or two further.

 the FOMC believes that–for now–the best way forward is to keep gradually raising the federal funds rate.

One nuance of this is the way that it has impacted at the shorter end of the US yield curve. For example the two-year Treasury Bond yield has more than doubled since early last September and is now 2.61%. This means two things. Firstly if we stay in the US it is approaching the ten-year Treasury Note yield which is 2.89%. If you read about a flat yield curve that is what is meant although not yet literally as the word relatively is invariably omitted. Also that there is now a very wide gap at this maturity with other nations with Japan at -0.13% and Germany at -0.64% for example.

At this point you may be wondering why two-year yields matter so much? I think that the financial media is still reflecting a consequence of the policies of the ECB which pushed things in that direction as the impact of the Securities Markets Programme for example and negative interest-rates.

QT

QT or quantitative tightening is also likely to be a factor in the renewed Dollar strength but it represents something unusual. What I mean by that is we lack any sort of benchmark here for a quantity rather than a price change. Also attempts in the past were invariably implicit rather than explicit as interest-rates were raised to get banks to lend less to reduce the supply of Dollars or more realistically reduce the rate of growth of the supply. Now we have an explicit reduction and it has shifted to narrow ( the central banks balance sheet) money from broad money.

 In addition, last October we started gradually reducing the Federal Reserve’s holdings of Treasury and mortgage-backed securities. That process has been running smoothly.  ( Jerome Powell).

You can’t always get what you want

It may also be true that you can’t get what you need either which brings us to my article from March the 22nd on the apparent shortage of US Dollars. This is an awkward one as of course market liquidity in the US Dollar is very high but it is not stretching things to say that it is not enough for this.

Non-US banks collectively hold $12.6 trillion of dollar-denominated assets – almost as much as US banks…….Dollar funding stress of non-US banks was at the center of the GFC. ( GFC= Global Financial Crisis). ( BIS)

The issue faded for a bit but seems to be on the rise again as the Libor-OIS spread dipped but more recently has risen to 0.52 according to Morgan Stanley. What measure you use is a moving target especially as the Federal Reserve shifts the way it operates in interest-rate markets but they kept these for a reason.

In October 2013, the Federal Reserve and these central banks announced that their liquidity swap arrangements would be converted to standing arrangements that will remain in place until further notice.

Impact on the US economy

The situation here was explained by Federal Reserve Vice-Chair Stanley Fischer back in November 2015.

To gauge the quantitative effects on exports, the thick blue line in figure 2 shows the response of U.S. real exports to a 10 percent dollar appreciation that is derived from a large econometric model of U.S. trade maintained by the Federal Reserve Board staff. Real exports fall about 3 percent after a year and more than 7 percent after three years.

Imports are affected but by less.

The low exchange rate pass-through helps account for the more modest estimated response of U.S. real imports to a 10 percent exchange rate appreciation shown by the thin red line in figure 2, which indicates that real imports rise only about 3-3/4 percent after three years.

And via both routes GDP

The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years.

The impact is slow to arrive meaning we are likely to be seeing the impact of a currency fall when it is rising and vice versa raising the danger of tripping over our own feet in analysis terms.

What happens to everyone else?

As the US Dollar remains the reserve currency if it rises everyone else will fall and so they will experience inflation in the price of commodities and oil. This is likely to have a recessionary effect via for example the impact on real wages especially as nominal wage growth seems to be even more sticky than it used to be.

Comment

Responses to the situation above will vary for example the Bank of Japan will no doubt be saying the equivalent of “Party on” as it will welcome the weakening of the Yen to around 113 to the US Dollar. The ECB is probably neutral as a weakening for the Euro offsets some of its past rise as it celebrates actually hitting its 2% inflation target which will send it off for its summer break in good spirits. The unreliable boyfriend at the Bank of England is however rather typically likely to be unsure. Whilst all Governors seem to morph into lower Pound mode of course it also means that people do not believe his interest-rate hints and promises. Meanwhile many emerging economies have been hit hard such as Argentina and Turkey.

In terms of headlines the UK Pound £ is generating some as it gyrates around US $1.30 which it dipped below earlier. In some ways it is remarkably stable as we observe all the political shenanigans. I think a human emotion is at play and foreign exchange markets have got bored with it all.

Another factor here is that events can happen before the reasons for them. What I mean by that was that the main US Dollar rise was in late 2014 which anticipated I think a shift in US monetary policy that of course was yet to come. As adjustments to that view have developed we have seen all sorts of phases and we need to remember it was only on January 25th we were noting this.

The recent peak was at just over 103 as 2016 ended so we have seen a fall of a bit under 14%

Back then the status quo was

Down down deeper and down

Whereas the summer song so far is from Aloe Blacc

I need a dollar, dollar
Dollar that’s what I need
Well I need a dollar, dollar
Dollar that’s what I need

Me on Core Finance

 

 

 

Can the Portuguese economy rely on the Lisbon house price boom?

It is time to head south again and touch base with what is happening in sunny Portugal. In the short-term the UK weather may be competitive but of course in general Portugal wins hands down which is why so many holidaymakers do their bit and indeed best for retail sales and the tourism industry over there. No doubt they helped cushion things when the economy was hit by the double whammy of the credit crunch followed by the Euro area crisis but now the Bank of Portugal was able to report his in its May Bulletin.

In 2017 GDP grew by 2.7%, in real terms, after increasing by 1.6% in the previous year.

This is significant on several levels. The most basic is that growth is happening. Next comes the fact that for Portugal this is a performance quite a bit above par. This is because as regular readers will be aware the background is of an economy that has struggled to maintain economic growth above 1% per annum. It is also means that the statement below has been rather rare.

In Portugal, GDP growth stood close to the
euro area average.

Accordingly the nuance is a type of statement of triumph as not only has Portugal seen absolute economic problems it has been in relative decline. Tucked away in the detail was good news for issues which have plagued the Portuguese economy.

The factors behind the acceleration of the Portuguese economy in 2017 were exports and
investment. This composition of growth is particularly important in correcting a number of
structural problems persisting in the Portuguese economy. The strong performance of Portuguese
exports mostly resulted from a recovery in the pace of growth of external demand for Portuguese
goods and services, in particular from euro area partners.

So the “Euroboom” helped and one part of the story allows the central bank to do a bit of cheerleading.

These developments have a structural dimension, including the closure of firms which are more oriented towards the domestic market and the establishment
and expansion of new firms that export higher value-added goods and are oriented towards more diversified geographical markets than in the past.

However us Brits may well have done our bit for something which is also going well.

In 2017 the market share gain of Portuguese exports was also associated with extraordinary growth in tourism exports. The dynamism observed in the tourism sector in Portugal exceeds that of a number of competing
countries, namely the other countries in Southern Europe.

This issue matters because Portugal has in recent decades been something of a serial offender in terms of finding itself in the hands of the IMF ( International Monetary Fund). A familiar tale of austerity and cut backs then follows which is one of the causes of its economic malaise. The May Bulletin implicitly confirms this.

Bringing the GDP per worker in Portugal closer to the average of European Union (EU) countries is a particularly important challenge for the Portuguese economy.

Indeed and tucked away in the better news on investment is something of a warning.

Construction benefited from favourable financing conditions, an increase in demand from
non-residents and strong growth in tourism and related real estate activities……….This is particularly relevant for an economy such as Portugal, where housing has
a very high share of the capital stock and the level of capital per worker is low compared with
the other European countries.

This brings us to the background of Portugal being a low wage, low productivity and low growth economy. An issue is this way it leads this European league table.

In 2015, Portugal was the country with the largest weight of construction in the stock of fixed
assets, with 91.7% (41.5% associated with dwellings and 50.2% associated with other buildings
and structures)

Unemployment

The better economic situation has led to welcome developments in this area as you might expect. From Portugal Statistics on Friday.

The April 2018 unemployment rate was 7.2%, down 0.3 percentage points (p.p.) from the previous month’s level,
0.7 p.p. from three months before and 2.3 p.p. from the same month of 2017.

This area has been a particular positive as the unemployment rate has gone from a Euro area laggard to one improving the overall average. Whilst in Anglo-saxon and Germanic terms it still looks high for Portugal it is an achievement.

only going back to November 2002 it is
possible to find a rate lower than that.

On a deeper level we learn something from the employment trends. For newer readers in the credit crunch era rises in employment have become a leading indicator for an economy. Looked at like this then there was a change in the summer of 2013 and since then an extra half a million or so Portuguese have found work. Returning to economic theory this is a change as it used to be considered a lagging indicator whereas now we often see it being a leading one.

House Prices

The Bank of Portugal will be pleased to see this and will have its claims of wealth effects ready.

In the first quarter of 2018, the House Price Index (HPI) rose 12.2% in relation to the same quarter of the previous
year, 1.7 percentage points (p.p.) more than in the fourth quarter of 2017. This was the fifth consecutive quarter in
which dwelling prices accelerated

Perhaps this is what they meant by this.

Monetary and financial conditions contributed to this economic momentum, with the ECB’s monetary policy remaining accommodative.

A couple of areas stand out according to Reuters.

The National Statistics Institute said house prices in the Lisbon area rose 18.1 percent in the fourth quarter from a year earlier to an average of 1,262 euros per square meter. In Porto house prices rose 17.6 percent.

So Portugal now has the capital city house price disease. Just under half of recent turnover in houses by value has been in Lisbon. Yet the ordinary first-time buyer is seeing prices move out of reach.

Comment

The new better phase for Portugal is very welcome for what is a delightful country. But beneath the surface there are familiar issues. Let me start with an area that should be benefiting from the house price boom which is the banks.

Nevertheless, NPLs remain at high levels, in turn, weighing on banks’ profitability, funding and capital costs. High NPLs also hinder a more efficient allocation of resources in the corporate sector and thus weaken potential growth.

You may note that the European Central Bank prioritises the banks over the corporate sector as it reminds us that non performing loans remain an issue. Also there is the ongoing problem on how the new  bank Novo Banco went from being perceived as clean to dirty like it was a diesel.

The FT’s Rob Smith has a story today on the latest complication. Novo Banco is planning to push ahead with its bond sale, which involves tendering outstanding senior bonds, despite a new legal challenge from a London-based hedge fund, which argues that it has actually already defaulted on its senior debt. ( FT Aplhaville).

Also there is this pointed out by @WEAYL around ten days ago.

CGD, BCP and Novo Banco lent 100 million to the venture capital company ECS at the end of 2017. The next day they received the same amount in a distribution of the fund’s capital managed by ECS. (Economic Online)

Next comes the issue of demographics of which I get a reminder whenever I go to Stockwell or little Portugal.

The resident population in Portugal at 31 December 2017 was estimated at 10,291,027 persons (18,546 fewer than in
2016). This results in a negative crude rate of total population change of -0.18%, maintaining the trend of population decline, despite its attenuation in comparison to recent years.

Even worse the departed are usually the young, healthy and educated.

Should the trade wars get worse, then there will be an issue for the car industry as it is around 4% of economic output and has been doing well.