The ECB faces the problem of what to do next?

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

The Euro

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

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

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

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

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

Monetary policy

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

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

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

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

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

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

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

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

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

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

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

 

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

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

QE and the exchange rate

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

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

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

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

Comment

There is plenty of good news around for the ECB.

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

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

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

 

What is happening with the Swiss Franc?

One of the features of the credit crunch era has been the strength of the Swiss Franc. This has been for two interrelated reasons. The first is simply that Switzerland has been seen as something of a safe haven in these troubled times. The second as we have looked at many times comes from what was called the Carry Trade. This involved people and companies from other parts of the world borrowing in Swiss Francs because in something getting ever harder to believe interest-rates were much higher in their own domestic currencies than they were in the Swissy. In particular those taking out mortgages in some parts of eastern Europe with Hungary and Poland to the fore and also in places like Cyprus took out Swiss Franc mortgages to take advantage of the lower “carry” or interest-rate. The catch was the fact that there was an exchange rate risk which was obscured by the fact that the size of the trade put downwards pressure on the Swiss Franc ( and the Japanese Yen which was its currency twin in this regard). Accordingly it looked as if a financial triumph was on its way where interest-rate gains came with exchange-rate benefits. What could go wrong?

As the credit crunch hit there was a safe haven demand for Swiss Francs accompanied by some beginning to reverse their carry trades and the two reinforced each other. This meant that those who had taken Swiss Franc mortgages in eastern Europe found that the amount owed headed higher in their own currency and as the monthly repayments depended on the amount owed they headed higher too. The same happened to business borrowers. As more cut their losses the pressure was built up even more on those who remained. Meanwhile Switzerland was left feeling like a tennis ball bouncing around on a foreign currency ocean with consequences described the summer of 2011 by the Swiss National Bank like this.

The massive overvaluation of the Swiss franc poses a threat to the development of the economy in Switzerland and has further increased the downside risks to price stability.

It was afraid of a pricing out of the Swiss economy as it became less competitive. In September of that year it made something of a ground breaking announcement.

The Swiss National Bank (SNB) is therefore aiming for a substantial and sustained weakening of the Swiss franc. With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities.

On that road the SNB became an enormous hedge fund with at the time of writing some 724.4 billion Swiss Francs in its foreign currency reserves. An odd consequence of this is that it would have welcomed this news overnight. From Reuters.

Shares in the world’s most valuable company surged 6 percent after-hours to a record of more than $159, taking its market capitalization above $830 billion.

As 20% of its assets are in equities the SNB will be happy and the last number I saw had it holding some 15 million shares in Apple. However even “utmost determination” apparently has its bounds as this told us in January 2015.

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%.

So the full set had been deployed in terms of monetary policy of foreign exchange intervention and negative interest-rates. But it was not enough and the retreat by the SNB was followed by another Swiss Franc surge causing worries for not only Switzerland but more losses for those who had borrowed in it.

Ch-ch-changes

More recently there has been signs and hints of a possible crack in the dam of Swiss Franc strength. At the end of last week Bloomberg was pointing out that it was at its weakest since the January 2015 announcement and that this was driven by stop-loss buying from Japanese banks. Whilst my career has seen regular episodes of stop-loss buying by Japanese banks across many instruments which begs the question of whether they ever make profits this is an interesting connection between what were the two currency twins. CNBC summarised the situation like this.

The franc fell sharply against the euro in morning deals, trading at 1.13 Swiss francs, a three percent drop on the week. Against the dollar, it hit a month low of 0.9724 Swiss francs.

This morning has seen the Euro rise to 1.143 Swiss Francs as the new beat goes on.

Swiss Cheese

The Financial Times notes that the hole in Swiss cheese production may be in the process of being fixed.

 

Its competitiveness wounded by the strong Swiss franc, Switzerland has imported more cheese than it has exported in some recent months — an unhappy state of affairs for producers of Gruyère and Emmental. “It would be great to get back to a reasonable exchange rate,” says Manuela Sonderegger, of Switzerland Cheese Marketing.

A real world impact of the exchange rate moves although of course it will take a while for the weaker level of the Swiss Franc to have any significant impact.

Comment

There is quite a bit to consider here so let us look at what is in play. We cannot rule out that this is a consequence of thin summer markets but it is also true that a weakening has been in play for a few months. One initial driver may have been the strong phase of the US Dollar offering an alternative but the main player now is the Euro area. The better phase for it economically is now being accompanied by a stronger Euro signalled by the way it has moved above 1.18 versus the US Dollar and in a lesser way by the UK Pound £ being just under 1.12.

Thus the SNB will be hoping for a continuation of the stronger Euro and thus has a vested interest in the next move of Mario Draghi and the ECB. It will be hoping that it will withdraw more of its stimulus measures once the summer and indeed elections are over. Of course now the web gets increasingly tangled as the ECB will not be that keen on further rises in the Euro as it moves it reduces its “price stability” target. This particular currency war is now in the world of strength rather than weakness which of course sends another Ivory Tower or two collapsing as we note there is still 60 billion Euros a month of QE from the ECB.

Also if we look wider there will be implications. For example we may hear a sigh of relief from eastern Europe but also what if the rally continues and the SNB gets the chance to trim its reserves. As it has been a factor in driving equity markets higher would it be a sign of a turn? That is a fair way away from here but much more nearby has been the recent disarray in the claimed safe haven of Bitcoin. It makes me wonder if this has impacted the Swiss Franc but am struggling to think of a causal link.

Let me finish with another potential consequence which would be quite a change which would be an interest-rate rise in Switzerland. Could it get away from negative interest-rates before the next downturn strikes or is it trapped there?

 

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

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

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

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

Mario Draghi

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Market Movements

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

Comment

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

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

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

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

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

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

 

Of Denmark its banks and negative interest-rates

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

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

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

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

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

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

A Problem

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

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

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

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

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

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

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

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

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

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

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

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

The banks

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

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

What does the DNB think?

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

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

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

What about house prices?

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

Although the DNB is keen to emphasise a difference.

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

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

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

A Space Oddity

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

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

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

Comment

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

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

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

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

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

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

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

Portugal

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

Germany the currency manipulator?

Today gives us an opportunity to look again at the German economy. As we do so we see yet another situation where conventional analysis and media reporting is flawed. So often we read that Germany has in some way been defeated in its efforts to direct the policies of the ECB ( European Central Bank). The evidence for that are the regular bursts of rhetoric from the German Bundesbank against the policies of negative interest-rates and a balance sheet of the order of 4.5 trillion Euros. However this to my mind ignores a much larger victory Germany gained when it joined the Euro because it has achieved for itself a much lower and therefore more competitive exchange rate. It did so in a way which has avoided the barrage of “currency manipulator” allegations that have been fired at others because it was a type of stealth effort.

Also the impact of this move has been heightened by the credit crunch era. We find evidence for this if we look at Switzerland and the Swiss Franc which of the currencies we have is the most similar. How is it doing? Well let me hand you over to the Swiss National Bank. From Reuters yesterday.

The Swiss National Bank’s (SNB) policy of negative interest rates is not ideal but is nevertheless necessary in order to weaken Switzerland’s “significantly overvalued” currency, Chairman Thomas Jordan said on Thursday…………Jordan said negative interest rates, along with the central bank’s willingness to intervene in the currency were absolutely necessary in order to protect exporters from a stronger Swiss franc, which is a safe-haven currency in times of market stress.

So if the Swiss Franc is a safe haven currency what would a German Deutschmark be if it existed? I think we can be sure that its value would have soared in recent times which leads me back to the competitive advantage point. There is also an irony as we note that on Switzerland’s road Germany would have had negative interest-rates anyway and maybe more negative than now. Ouch! We find ourselves in some strange places these days. Also would it now be a hedge fund manager as it tried to find somewhere to put its currency reserves? This week raised a wry smile as Apple passed the US $150 mark as I thought that the Swiss National Bank would be one of those most pleased via its holdings. I guess if you have 695.9 billion Swiss Francs they burn a hole in your pocket or something like that.

The trade surplus

The opening paragraph of Tuesday’s trade figures hammer home a consequence of this.

Germany exported goods to the value of 118.2 billion euros and imported goods to the value of 92.9 billion euros in March 2017. These are the highest monthly figures ever reported for both exports and imports. Based on provisional data, the Federal Statistical Office (Destatis) also reports that German exports increased by 10.8% and imports by 14.7% in March 2017 year on year.

So if you are looking for evidence of a lower currency leading to trade advantages it is hard to miss the persistent surpluses of Germany.

The foreign trade balance showed a surplus of 25.4 billion euros in March 2017. In March 2016, the surplus amounted to 25.8 billion euros. In calendar and seasonally adjusted terms, the foreign trade balance recorded a surplus of 19.6 billion euros in March 2017.

Indeed the statistics agency has an in focus highlight which rams this home.

According to Eurostat data, Germany had the highest export surplus among EU countries (257 billion euros) in 2016, as was the case in the previous years. Germany exported goods totalling 1,210 billion euros while the value of imports was 953 billion euros. Compared with the previous year, the export surplus rose by roughly 3% – in 2015, it had been 248 billion euros.

Interestingly we see that the idea of the Euro area having a large trade  surplus is true but that the vast majority of it is Germany as it was 257 billion out of 272 billion Euros in 2016.

Bond yields

The other gain for Germany from a combination of ECB policy and the credit crunch era is the extraordinary low level of interest it has to pay to issue new debt. Indeed this has frequently been negative in recent times meaning that Germany has been paid to issue its debt.  Some of that is still true as for example the yield on its five-year benchmark bond is -0.31% as I type this.

Even if it were to borrow for ten years then Germany would only have to pay 0.41% which I cannot say often enough is extraordinarily low. So it has clearly benefited from the 368 billion Euros of purchases of German debt by the ECB as we mull if there was a country which needed them less?

The catch is that it is mostly the German government that has benefited as it looks to run a fiscal surplus. As to the ordinary German well as I pointed out earlier this week first-time buyers will be much less keen as the easy monetary policy of recent years has led to something of a house price boom in Germany.

GDP and economic output

This morning’s official GDP data had a familiar drumbeat to it.

In addition, the development of foreign trade was more dynamic and contributed to growth as exports increased more than imports, according to provisional results.

The quarterly number was good and this impression was reinforced by the breakdown of the numbers.

. In the first quarter of 2017, the gross domestic product (GDP) rose 0.6% on the fourth quarter of 2016 after adjustment for price, seasonal and calendar variations……. Capital formation increased substantially. Due to the mild weather, fixed capital formation especially in construction, but also in machinery and equipment was markedly up compared with the fourth quarter of 2016.

Is the weather allowed to be a positive influence? Only in Germany perhaps as elsewhere its role invariably is to take the blame. There is an undercut to this though as we mull the individual experience and note that economic growth over the past year was 1.7%.

The economic performance in the first quarter of 2017 was achieved by 43.7 million persons in employment, which was an increase of 638,000 or 1.5% on a year earlier.

So whilst the employment rise is welcome we see that it very nearly matches the level of economic growth. Also if we look back to the data we are left wondering if the construction investment boom is related to the house price boom and the UK economic model is being copied to some extent.

Comment

The economic outlook remains bright for Germany if the Markit business or PMI surveys are any guide.

IHS Markit expects German economic growth to strengthen to 0.7% qr/qr in the first quarter, and the April PMI provides an early signal that expansion will remain strong in the second quarter.

So something along the lines of more of the same is expected although of course that was only one month of this quarter. If we look at the overall situation let us use a type of Good Germany: Bad Germany type of analysis that mimics Italy.

The good sees that the reforms of the past have enabled Germany to expand its economy post credit crunch such that GDP  reached 110. 02 last year compared to 101.66 in 2008. It has a substantial trade surplus and these days has an internationally rare fiscal surplus.

The trouble is that some of the latter points are also part of Bad Germany as we see how its adoption of the Euro has helped feed its trade surplus via a more competitive exchange rate. Also there is the issue that one of the problems pre credit crunch was world imbalances and the German trade surplus was one of them. Within the Euro area some will wonder if it would be helped by less fiscal austerity. Then we get to the issue of comparing the rise in employment with GDP growth, is Germany like the rest of us struggling for productivity growth with its implications for wages? Also as I pointed out earlier this week the rise in house prices will make first-time buyers wonder if they are indeed better off?

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.

Inflation

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.

Comment

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.

Japan

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”?

Germany

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.

Bitcoin

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…

Comment

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.