Christine Lagarde and the ECB have switched from monetary to fiscal policy

The Corona Virus pandemic has really rather caught the European Central Bank (ECB) on the hop. You see it was not supposed to be like this on several counts. Firstly the “Euro Boom” was supposed to continue but we now know via various revisions that things had turned down in Germany in early 2018 and then the Trumpian trade war hit as well. So the claims of former ECB President Mario Draghi that a combination of negative interest-rates and QE bond buying had boosted both Gross Domestic Product ( GDP) and inflation by around 1.5% morphed into this.

First, as regards the key ECB interest rates, we decided to lower the interest rate on the deposit facility by 10 basis points to -0.50%……..Second, the Governing Council decided to restart net purchases under its asset purchase programme (APP) at a monthly pace of €20 billion as from 1 November. We expect them to run for as long as necessary to reinforce the accommodative impact of our policy rates, and to end shortly before we start raising the key ECB interest rates.

As you can see the situation was quite problematic. For all the rhetoric who really believed that a cut in interest-rates of 0.1% would make a difference when much larger ones had not? Next comes the issue of having to restart sovereign bond purchases and QE only 9 months or so after stopping it. As a collective then there is the issue of what all the monetary easing has achieved? That leads to my critique that it is always a case of “More! More! More” or if you prefer QE to Infinity.

Next comes the issue of personnel. For all the talk about the ECB being independent the reclaiming of it by the political class was in process via the appointment of the former French Finance Minister Christine Lagarde as President. This of course added to the fact that the Vice President Luis de Guindos had been the Spanish Finance Minister. Combined with this comes the issue of competence as I recall Mario Draghi pointing out he would give Luis de Guindos a specific job when he found one he could do, thereby clearly implying he lacked the required knowledge and skill set. It is hard to know where to start with Christine Lagarde on this subject after her failures involving Greece and Argentina ( which sadly is in the mire again) and her conviction for negligence. Of course she has added to that more recently with her statement about “bond spreads” which saw the ten-year yield in Italy impersonate a Space-X rocket until somebody persuaded her to issue a correction. Although as the last press conference highlighted you never really escape a faux pas like that.

Do you now believe that it is the ECB’s role to control the spreads on government debt?

The Present Situation

This was supposed to be one where monetary policy had been set for the next year or so and President Lagarde could get her Hermes slippers under the table before having to do anything. Life sometimes comes at you quite fast though as this morning has already highlighted. From Eurostat.

In April 2020, the COVID-19 containment measures widely introduced by Member States again had a significant
impact on retail trade, as the seasonally adjusted volume of retail trade decreased by 11.7% in the euro area and
by 11.1% in the EU, compared with March 2020, according to estimates from Eurostat, the statistical office of
the European Union. In March 2020, the retail trade volume decreased by 11.1% in the euro area and by 10.1%
in the EU.
In April 2020 compared with April 2019, the calendar adjusted retail sales index decreased by 19.6% in the euro
area and by 18.0% in the EU.

As you can see Retail Sales have fallen by a fifth as far as we can tell ( normal measuring will be impossible right now and the numbers are erratic in normal times). Also there were large structural shifts with clothing and footwear down 63.5% on a year ago and online up 20.9%. Much of this is due to shops being closed and will be reversed but there is a loss for taxes and GDP which is an issue for ECB policy. Other news points out that May has its troubles as well.

Germany May New Car Registrations Total 168,148 -49.5% Y/Y – KBA ( @LiveSquawk)

Policy Response

For all the claims and rhetoric is that the ECB has prioritised the banks and government’s. So let us start with The Precious! The Precious!

Accordingly, the Governing Council decided today to further ease the conditions on our targeted longer-term refinancing operations (TLTRO III)……. Moreover, for counterparties whose eligible net lending reaches the lending performance threshold, the interest rate over the period from June 2020 to June 2021 will now be 50 basis points below the average deposit facility rate prevailing over the same period.

For newer readers this means that the banks will be facing what is both the lowest interest-rate seen so far anywhere at -1% and also a fix for the problems they have dealing with a -0.5% interest-rate more generally. It also means that whilst the bit below is not an outright lie it is also not true.

In addition, we decided to keep the key ECB interest rates unchanged.

In fact for those who regard the interest-rate for banks as key it is an untruth. Estimates for the gains to the banking sector from this are of the order of 3 billion Euros. Yet another subsidy or if you prefer we are getting the Vapors.

I’m turning Japanese, I think I’m turning Japanese, I really think so
Turning Japanese, I think I’m turning Japanese, I really think so

Fiscal Policy

This is what monetary policy has now morphed into. There is an irony here because one of the reasons the ECB has pursued such expansionary policy is the nature of fiscal policy in the Euro area. That has been highlighted in three main ways. the surpluses of Germany, the Stability and Growth Pact and the depressive policy applied to Greece. But that was then and this is now.

Chancellor Angela Merkel said Wednesday that Germany was set to plow 130 billion euros ($146 billion) into rebooting an economy severely hit by the coronavirus pandemic.

The measures include temporarily cutting value-added tax form 19% to 16%, providing families with an additional €300 per child and doubling a government-supported rebate on electric car purchases.

The package also establishes a €50 billion fund for addressing climate change, innovation and digitization within the German economy. ( )

Even Italy is being allowed to spend.

Fiat To Use State-Backed Loan To Pay Italy Staff, Suppliers ( @LiveSquawk)

This is the real reason for the QE and is highlighted below.

FRANKFURT (Reuters) – The European Central Bank scooped up all of Italy’s new debt in April and May but merely managed to keep borrowing costs for the indebted, virus-stricken country from rising, data showed on Tuesday.

The ECB bought 51.1 billion euros worth of Italian government bonds in the last two months compared with a net supply, as calculated by analysts at UniCredit, of 49 billion euros.


Thus President Lagarde will be mulling the words of Boz Scaggs.

(What can I do?)
Ooh, show me that I care
(What can I say?)
Hmmm, got to have your number baby
(What can I do?)

Plainly the ECB needs the flexibility of being able to expand its QE bond buying so that Euro area governments can borrow cheaply as highlighted by Italy or be paid to borrow like Germany. We could see the PEPP plan which is the latest emergency one expanded as it will run out in late September on present trends, also the German Constitutional Court has conveniently given it a bye. But she could do that next time. So finally we have a decision appropriate for a politician!

As to interest-rates we see that the banks have as usual been taken care of. That only leaves the rest of us so it is unlikely. We will only see another cut if they decide that like a First World War general that a futile gesture is needed.

The ECB hints at buying equities and replacing bank intermediation

A feature of this virus pandemic is the way that it seems to have infected central bankers with the impact of them becoming power mad as well as acting if they are on speed. Also they often seen lost in a land of confusion as this from yesterday from the Governor of the Bank of France highlights.

Naturally, there is a huge amount of uncertainty over how the economic environment will evolve, but this is probably less true for inflation.

Okay so the picture for inflation is clearer, how so?

 In the short term, the public health crisis is disinflationary, as exemplified by the drop in oil prices. Inflation is currently very low, at 0.3% in the euro area and 0.4% in France in April; granted, it is particularly tricky to measure prices in the wake of the lockdown, due to the low volume of data reporting and transactions, and the shift in consumer habits, temporary or otherwise.

This is not the best of starts as we see in fact that one price has fallen ( oil) but many others are much less clear due to the inability to measure them.Of course having applied so much monetary easing Francois Villeroy is desperate to justify it.

The medium-term consequences are more open to debate, due notably to uncertainties over production costs, linked for example to health and environmental standards and the potential onshoring of certain production lines; the differences between sectors could be significant, leading to variations in relative prices rather than a general upward path.

As you can see he moves from not being able to measure it to being very unsure although he later points out it is expected to be 1% next year which in his mind justifies his actions. There is the usual psychobabble about price stability being an inflation rate of 2% per annum which if course it isn’t.  #


It is probably best if you live in a glass house not to throw stones but nobody seems to have told Francois that.

Our choice at the ECB is more pragmatic: since March, we, like the Fed and the Bank of England, have greatly expanded and strengthened our armoury of instruments and in so doing refuted all those – and remember there were a lot of them only a few months ago – who feared that the central banks were “running out of ammunition”.

I will return to that later but let us move onto what Francois regards as longer-term policies.

First, in September 2019, we amended our use of negative rates with a tiering system to mitigate their adverse impacts on bank intermediation. I see no reason to change these rates now.

Actually it has not taken long for Francois to contradict himself on the ammunition point as “see no reason” means he feels he cannot go further into negative interest-rates for the general population. You may also note that he starts with “My Precious! My Precious!” which is revealing. Oh and he has cut the TLTRO interest-rate for banks to -1% more recently.


Meanwhile, asset purchases, in operation since mid-2014, reached a total of EUR 2,800 billion in April 2020 and will continue at a monthly average pace of more than EUR 30 billion.

Make of this what you will.

We can also add forward guidance to this arsenal,….. This forward guidance provides considerable leeway to adapt to economic changes thanks to its self-stabilising endogenous component.

New Policy

Suddenly he did cut interest-rates and we are back to “My Precious! My Precious!”

The supply of liquidity to banks has been reinforced in terms of quantity and, above all, through an incentivising price structure. Interest rates on TLTROIII operations were cut dramatically on 12 March and again on 30 April and are now, at -1%

There is also this.

Above all, we have created the EUR 750 billion Pandemic Emergency Purchase Programme (PEPP)…….First, flexibility in terms of time. We are not bound by a monthly allocation…….Second, flexibility in terms of volume. Unlike the PSPP, we are not committed to a fixed amount – today, the PEPP can go “up to EUR 750 million”, and we stated on 30 April that we were prepared to go further if need be.

If we look at the weekly updates which have settled at around 30 billion Euros per week the original 750 billion will run out as September moves into October if that pace is maintained. So it looks likely that there will be more although as the summer progresses things will of course change quite a bit.

Then Francois displays even more of what we might call intellectual flexibility. You see he is not targeting spreads or “yield curve control” or a “spread control” but he is….

While there is a risk that the effects of the crisis may in some cases be asymmetric, we will not allow adverse market dynamics to lead to unwarranted interest rate hikes in some countries.

So he is trying to have his cake and eat it here.


This word is a bit of a poisoned chalice as those have followed the Irish banking crisis will know. But let me switch to this subject and open with a big deal for the ECB especially since the sleeping giant known as the German Constitutional Court has shown signs of opening one eye, maybe.

And this brings me to my third point, flexibility in terms of allocation between countries.

He means Italy of course.

Next up is one of the sillier ideas around.

Allow me to say a final word on another development under discussion: the possibility of “going direct” to finance businesses without going through the bank channel. The truth is that we do this already, and have done since 2016, by being among the first central banks to buy corporate bonds.

He is probably keen because of this.

The NEU-CP market in Paris is by far the most active in the euro area, with outstandings of EUR 72 billion in mid-May, and the Banque de France’s most recent involvement since the end of March has been very effective and widely acknowledged by industry professionals.

Ah even better he has been able to give himself a slap on the back as well.

He is eyeing even more.

With its new Main Street Lending Program, the Fed recently went a step further by giving itself the possibility to fund the purchases of bank loans to businesses, via a special-purpose vehicle created with a US Treasury Department guarantee

If banks are bad, why are we subsidising them so much? Also why would central banks full of banks be any better?

After sillier let us have silliest.

ECB’s Villeroy: Would Not Put At Forefront Likelihood Of Buying Up Equities ( @LiveSquawk )


There is a familiar feel to this as we observe central bankers twisting and turning to justify where they find themselves. Let me start with something which in their own terms has been a basic failure.

This sluggishness in prices comes after a decade of persistently below-target inflation, which has averaged 1.3%.

This provides a range of contexts as of course the inflation picture would look very different if they made any real effort to measure  the one third or so of expenditure that goes on housing costs. In other areas this would be a scandal as imagine how ignoring a third of Covid-19 cases would be received? Also you might think that such failure after negative interest-rates and 2.8 billion Euros of QE might lead to a deeper rethink. This policy effort has in fact ended up really being about what was denied in this speech which is reducing bond yields so governments can borrow more cheaply. The hints in it have helped the ten-year yield in Italy fall to 1.55% as I type this.

Oh the subject of the ECB buying equities I am reminded that I suggested on the 2nd of March it would be next to make that leap of faith. I still think it is in the running however the German Constitutional Court may have slowed it up. The hint has helped the Euro Stoxx 50 go above 3000 today as equity markets continue to be pumped up on liquidity and promises. But more deeply we see that if we look at Japan what has been achieved by the equity buying? The rich have got richer but the economy has not seen any boost and in fact pre this crisis was in fact doing worse. So he is singing along with Bonnie Tyler.

I was lost in France
In the fields the birds were singing
I was lost in France
And the day was just beginning
As I stood there in the morning rain
I had a feeling I can’t explain
I was lost in France in love


The central banking parade continues

The last 24 hours have seen a flurry of open mouth operations from the world’s central bankers. There are a couple of reasons for this of which the first is that having burst into action with the speed of Usain Bolt they now have little to do. The second is that they have become like politicians as they bask centre stage in the media spotlight. The third is that their policies require a lot of explaining because they never achieve what they claim so we see long words like “counterfactual” employed to confuse the unwary.

The land of the rising sun

Let us go in a type of reverse order as Governor Kuroda of the Bank of Japan has been speaking this morning and as usual has uttered some gems.

BoJ Gov Kuroda: Repeats BoJ Would Not Hesitate To Add Additional Easing If Needed -BoJ Has Several Tools And Measures To Deploy If Required ( @LiveSquawk )

This is something of a hardy perennial from him the catch though comes with the “if required” bit. You see the April Economic Report from the Ministry of Finance told us this.

The Japanese economy is getting worse rapidly in an extremely severe situation, due to the Novel Coronavirus…….Concerning short-term prospects, an extremely severe situation is expected to remain due to the influence of the infectious disease. Moreover, full attention should be given to the further downside risks to the domestic and foreign economy which are affected by the influence of the infectious disease.

So if not now when? After all the Japanese economy was already in trouble at the end if 2019 as it shrank by 1.8% in the final quarter. Actually he did kind of admit that.

BoJ’s Kuroda: Japan’s Economy To Be Substantially Depressed In Q2

Then looking at his speech another warning Klaxon was triggered.

In the meantime, it expects short- and long-term policy interest rates to remain at their present
or lower levels.

This raises a wry smile because in many ways the Bank of Japan is the central bank that likes negative interest-rates the least. Yes it has one of -0.1% but it tiptoed into it with the minimum it felt it could and stopped, unlike in other easing areas where it has been happy to be the leader of the pack. Why? Well after nearly 30 years of the lost decade it still worries about the banking sector and whether it could survive them and gives them subsidies back as it is. Frankly it has been an utter disaster and shows one of the weaknesses of the Japanese face culture.

Oh and as we mull the couple of decades of easing we got this as well.


This morning there was just over another 100 billion Yen of equity ETF purchases as we mull another refinement of the definition of temporary in my financial lexicon for these times. It appears to mean something which keeps being increased and never ends.

The Bank of England

The new Governor Andrew Bailey gave an interview to Robert Peston of ITV last night which begged a few questions. The first was how its diversity plans seem to involve so much dealing with the children of peers of the realm and Barons in particular? This of course went disastrously wrong with Deputy Governor Charlotte Hogg who seemed to know as little about monetary policy as she did about the conflict of interest issue which led to her departure. During the interview Robert Peston seemed to be exhibiting a similar degree of competence as I pointed out on social media.

@Peston  now says that buying hundreds of billions of debt is different to a decade ago when the Bank of England bought er hundreds of billions of debt. It is frightening that this man was once BBC economics editor.

There was a policy element although it was not news to us I am sure it was to some.

Governor of the Bank of England Andrew Bailey has told ITV’s Peston show that one of the main purposes of the Bank buying £200bn of government debt – and probably more over the course of the Covid-19 crisis – is to “spread the cost of this thing to society” and help the government avoid a return to austerity. ( ITV)

To the extent that there was a policy announcement the whole interview was very wrong as it should be on the Bank of England website for all to see rather than boosting the career of one journalist and network. As I note how that person’s career had been under pressure we see the UK establishment in action. I also note that two subjects were not mentioned.

  1. The apparent dirty protest at the FCA on Andrew Bailey’s watch
  2. The doubling of overdraft interest-rates after a botched intervention by the FCA on Andrew Bailey’s watch.

The United States

Something rather ominous happened last night as The Hill reports.

“He has done a very good job over the last couple of months, I have to tell you that,” Trump told reporters during a meeting with the governors of Colorado and North Dakota. “Because I have been critical, but in many ways I call him my ‘MIP.’ Do you know what an MIP is? Most improved player. It’s called the Most Improved Player award.”

We noted back in November 2018 that The Donald was taking charge of US monetary policy and that Jerome Powell had become something of a toy. Indeed there was more.

The president said he still is at odds with Powell over his stance on negative interest rates. Trump has for months pushed negative interest rates, arguing the U.S. is on an unfair playing field if other countries have negative rates.

Whilst I disagree with The Donald on negative interest-rates he is at least honest and we know where he stands. Whereas Chair Powell said this.

Speaking to the Peterson Institute for International Economics, Powell said negative interest rates are “not something that we’re looking at,” ( Forbes)

Is that an official denial? Anyway it does not go that well with this.

The economic toll has taken an outsized toll on lower-income households, Powell said, with 40% of those employed in February and living in a household that makes less than $40,000 a year losing their job in March.

Conceptually this is a real issue for the US Federal Reserve as such people are unlikely to have many holdings ( or indeed any…) of the assets it keeps pumping up the price of.


As we survey the scene some of it is surreal. I noted on Tuesday that the US had already seen two examples of negative interest-rates and one has deepened in the meantime. US Feds Funds futures have moved as high as 100.025 for the summer of 2021 and 100.05 for the autumn. Now -0.05% is not a lot but these things have a habit of being like a balloon that is about to be inflated.

You may also note that those who have claimed central banks are independent of government have been silent recently.Perhaps they are busy redacting past comments?

Missing for today’s update so far has been the European Central Bank or ECB. This is because it is involved in something of an internal turf war.

The shock at the ruling is palpable in the corridors of power in Berlin as Karlsruhe’s three-month deadline runs down.

Officials are trying to work out a way of satisfying the court without eroding the independence of the ECB, which has kept the euro zone intact through a decade of crises.

One lawmaker described feeling like a bomb disposal expert, “because the Constitutional Court has put an explosive charge under the euro and the EU”. ( Reuters)

Hang on! Someone still thinks central banks are independent…….

What use is Forward Guidance that keeps being wrong?

Last night brought one of the most anticipated U-Turns in monetary policy as the US Federal Reserve announced this.

In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent.

Thus we saw the expected interest-rate cut of 0.25% and there was also an accelerated end to the era of QT ( Quantitative Tightening).

The Committee will conclude the reduction of its aggregate securities holdings in the System Open Market Account in August, two months earlier than previously indicated.

Whilst we are on the subject let us use the words of the Clash as we may not see QT again and we certainly will not be seeing it for a while.

Yeah, wave bye, bye

At this point on a superficial level this looks like a success for Forward Guidance as the Treasury Note ten-year yield around the 2.04% level where it had started. But there are two big catches with this. The first revolves around when economic agents were making plans for 2019 because back then the Federal Reserve was talking of “normalisation” which involved 4 then 3 then 2 interest-rate increases in 2019. Now we have a cut and as I will discuss later am expecting another.

Last Night

The response of observers to the effort to provide new Forward Guidance by Chair Jerome Powell was to sing  along with The Strokes.

And say, people, they don’t understand
Your girlfriends, they can’t understand
Your grandsons, they won’t understand
On top of this, I ain’t ever gonna understand

Here via CNBC was his opening effort.

Looking at the history of the Fed, Powell cautioned against assuming that this week’s cut is the beginning of the cycles that happened in the past.

“That refers back to other times when the FOMC has cut rates in the middle of a cycle and I’m contrasting it there with the beginning of a lengthy cutting cycle,” he said. “That is not what we’re seeing now, that’s not our perspective now.”

So it was “one and done” was it? I doubt anyone including Chair Powell actually believed that especially if they looked at the knee-jerk response which was for a stronger US Dollar. Indeed in the same press conference he seemed to correct himself.

“Let me be clear: What I said was it’s not the beginning of a long series of rate cuts,” Powell said. “I didn’t say it’s just one or anything like that. ( CNBC )

He also managed to talk about interest-rate rises for a while as things got even more out of control. So you could have pretty much any view you like as we had guidance towards no more cuts,more cuts and perhaps rises too. That is quite a fail when the scale of your operations which already are the elephant in the room are about to get larger.

Oh and did I mention an elephant in the room?

What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world……..As usual, Powell let us down, but at least he is ending quantitative tightening, which shouldn’t have started in the first place – no inflation. We are winning anyway, but I am certainly not getting much help from the Federal Reserve!

That was of course President Trump who may tweet excitedly but so far has given us better forward guidance than the Fed. Who will bet against the US Federal Reserve making another interest-rate cut this year?

European Central Bank

The ECB has been on a not dissimilar road to the Federal Reserve. I am sure the “ECB Watchers” would like us to forget that they were predicting an increase in the Deposit Rate this year as a result of their inside knowledge. They of course ended up scuttling away into the dark but the ECB kept this up until the 18th of June.

We now expect them to remain at their present levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

The informal hint that a change was on it way provided by Mario Draghi on the 18th of June became formal a week ago.

We expect them to remain at their present or lower levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to our aim over the medium term.

So not as grand a scale as the Federal Reserve but up has become the new down here too, or to be more precise is on its way in September. Assuming of course this guidance is correct.

Bank of England

Governor Carney has been even slower on the uptake than his international colleagues. As 2019 has progressed and we have seen interest-rate cuts proliferate he has cut an increasingly isolated figure.

The Committee continues to judge that, were the economy to develop broadly in line with its May Inflation Report projections that included an assumption of a smooth Brexit, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate to return inflation sustainably to the 2% target at a conventional horizon.

It is revealing that the sentence needs to be so long but the message is that the plan is to tighten monetary policy and apparently ignore the rush in the other direction. More realistically of course the reality is that we should be prepared for the return of the Unreliable Boyfriend as he has a track record of cutting interest-rates after promising rises.

Also this is revealing.

Mark Carney, Governor of the Bank of England says “there will be great fortunes made” for companies preparing for and tackling climate change. ( Channel 4 News)

These days he seems to spend much of his time discussing climate change. If we skip the issue of him having both no mandate and indeed no qualifications in this area we find that he is deflecting us from his troubles with monetary policy. From his personal point of view discussing it is also part of his application for the IMF job.

Meanwhile as we move through the “Super Thursday” procedure he constructed I hope the media will concentrate on how he is forecasting interest-rate increases in the current economic environment.


It is more than six years ago that Michael Woodford told us this.

Greater clarity within the policy committee itself about the way in which policy is expected to be conducted in the future is likely to lead to more coherent policy decisions, and greater clarity on the part of the public as to how policy will be conducted is likely to improve the degree to which the central bank can count on achieving the effects that it intends through its policy.

As you can see the initial point failed last night as Chair Powell was pretty incoherent. Whilst Mario Draghi of the ECB is a much more professional operator he too struggled at his last press conference on the subject of the inflation target. It is about to be Governor Carney’s turn to face the music and he is usually the most incoherent. This means that they cannot give the public “greater clarity” and in fact have misled them which means they are undermining their own policies.

Of course there is also the Riksbank of Sweden to make the others feel better.

Me on The Investing Channel





The Open Mouth Operations of Mario Draghi have a shorter and shorter half-life

There is much to consider in the current financial market turmoil and as central banks are such major players today there is much to consider for them too. They have slashed interest-rates and many have expanded their balance sheets considerably via the use of QE (Quantitative Easing) yet we are where we are. Many will be wondering if the current indigestion in financial markets has been caused by a single 0.25% interest-rate hike by the US Federal Reserve. Only a couple of weeks or so ago the Open Mouth Operations of the US Fed were promising another four of those in 2016 but that looks like another mirage right now. This returns us to the long-running junkie culture theme of this blog where the continual interventions of central banks have left financial markets and to some extent economies dependent on them. On that subject let me address the words ( yes more OMO! ) from Mario Draghi of the ECB last night.

What did Mario Draghi say?

In what is becoming a familiar theme for central banking speeches Mario opened by blaming foreigners. There is an obvious catch with that if everyone does it.

The euro area has started the New Year facing two opposing forces: a strengthening domestic economy and a weakening global one.

What is Italian for “Johnny Foreigner” please? The detail was interesting as well.

At home, the recovery is proceeding, with consumption as the main driver. That is being supported by our accommodative monetary policy, falling energy prices and a neutral fiscal policy. Employment is rising, up by over 2 million people compared with the trough in 2013.

There is good news for the Euro area economy which has improved as we have regularly discussed and there are 2 million clear reasons to welcome that. However Mario has contradicted himself as  the “falling energy prices” have been driven by the foreign events he has just blamed. Also you may note what is a savaging of the Euro area political class and establishment in “a neutral fiscal policy”. Or you can look at it as Mario taking all the credit for himself.

Inflation Inflation

President Draghi opens fire here with a misrepresentation and an odd connection.

The ECB has a central role to play in supporting confidence. We do that by fulfilling our price stability mandate: an inflation rate of below, but close, to 2%.

The misrepresentation is the use of a 2% annual inflation rate as plainly 0% would be price stability as language gets twisted again. Also there is the rather odd idea that a number which was picked out of thin air in some way gives “confidence”! Next came an attempt to hide a rather awkward confession.

With inflation already low for some time, we saw a danger that a continued period of low inflation – even if oil-driven – might destabilise inflation expectations and become persistent.

That is a description of failure by the ECB and yet we are told this.

And we chose to respond by recalibrating the APP because we have ample evidence that it works.

He means the Asset Purchase Program by APP and he continues with the emphasis being mine.

Since the middle of 2014, when we launched our credit easing package, bank lending rates have fallen by 80 basis points for the euro area, and by between 100 and 140 basis points in the countries hit hardest by the crisis. To put that in perspective, to have a similar impact on lending rates with conventional policy would’ve required a one-off rate cut of 100 basis points.

The problem with in effect singing along with last summers hit cheerleader is that you immediately hit trouble. After all Mario Draghi has just confessed that the perceived inflation problem has just got worse! If you re-read his quote he has just told you that not only has 60 billion Euros not worked in that regard but a 1% interest-rate cuts would not have worked either. This poses two sorts of problems. Firstly if he has effectively cut interest-rates by 1% what was he doing cutting them by 0.1% in December? Secondly he is confessing that interest-rate cuts are unlikely to meet the inflation target. This sits very uncomfortably with this bit.

Overall, it’s clear that the impact of the APP on confidence, credit and the economy has been substantial.

Also let’s face it the sentence below is a description of what has not happened in the Euro area since its inception.

Confidence comes from every party fulfilling its mandate.

What is the real problem?

Mario is desperate to tell us that low inflation is a bad idea presumably hoping we will forget the other parts of his speech where it has helped the economy. But as we progress we get to the true issue and it is the worst four letter word in the economic landscape right now, debt.

For example, if euro area inflation were to undershoot our baseline by just 1 percentage point each year for the next five years, it would increase the private debt ratio by around 6 percentage points. That might not sound like a big figure. But, over five years, it’s equivalent to €700 billion in extra debt for firms and households at a time when we should be aiming to reduce debt.

So at the current speed that is nearly a years worth of QE or APP or more than it has done so far as the total is 530 billion Euros.

The banks

The subject of debt and the banks is an intertwined one of course. Mario Draghi assures us that things can only get better.

And thanks to the creation of the Single Supervisory Mechanism (SSM) and the comprehensive assessment of banks’ balance sheets, banks are actually stronger now than they were a few years ago. Capital ratios for euro area banks have risen from around 8% in 2007 to close to 14% today. In other words, the risks are currently falling, not rising.

This has already led to some discussion about the problems of Deutsche Bank whose share price fell by over 5% yesterday after previous falls. Also there is the problem of banking in Mario’s home country Italy where we see this so far today.



But apparently that is not a sign of instability.

What’s more, though low-interest rates can encourage risk-taking, there are no warning signs of serious financial instability.

Many might say look at home Mario as the subject analysed in the article linked to below was the hot topic on Bloomberg television this morning.

Yet in other areas there are opposite signs of trouble.

That’s not to say we don’t see pockets of exuberance, for example in some housing markets.

However in a complete reversal of economic history up to this point we will apparently see this.

And let me also add that if we did at some point see a generalised overheating in the economy, it’s never a problem for central banks to withdraw excess liquidity.

Never a problem?

A Space Oddity

Mario Draghi tells us that criticisms I have expressed are false.

Others warned that we were exposing ourselves to heavy losses from expanding our balance sheet and accepting lower-quality collateral. In fact we haven’t had a single loss.

He seems to have forgotten that by buying ever more so far he has enforced this by doubling down! The Greek debt either has gone to the ESM (European Stability Mechanism) or is on its way there and 60 billion Euros per month of other Euro area debt is being bought by him apparently for an ever longer period! How could he have a loss as he is preventing it?

Market problems

Yesterday and today have highlighted that the beneficial half-life of Open Mouth Operations for equity markets has shrunk. Mario had a go last Thursday and last night yet markets have fallen yesterday and today. Yet if we move to government bond markets we have seen more signs of safe haven buying. The two-year yield of Germany has fallen to -0.46% and the five-year yield to -0.24% which are both records. Just as a reminder this means that investors are paying to hold German sovereign debt and by a record amount which gives us a different song to the “things can only get better” of Mario Draghi.

There is also the issue of the Euro exchange rate which is not following the hints of President Draghi. He would like it to fall further but it has got rather becalmed in spite of his moves in December and his current hints teases and promises. Some of that is due to the weaker path of the UK Pound £ but the Euro has in general stopped falling.


President Draghi has lost himself in a land of confusion as he alternates between describing his policies as a success and a failure. If they are working so well why has he added more and then so quickly making even more promises. He has become like Agent Smith in The Matrix series of films. The monetary taps are open interest-rates have been slashed to negative territory and yet if we move from price to quantity there must be clear issues with how much Italian banks for example are willing to lend.

Yet if we step back we see that employment has risen and the Euro area is seeing economic growth which of course are interrelated. This is a clear improvement but if we look at the latest business surveys the famous quote from Muhammed Ali comes to mind “Is that all you’ve got (George)” as we note the extraordinary monetary effort.

The survey data are consistent with GDP rising at a steady quarterly rate of 0.3-0.4% at the start of the year.

Why I welcome the fact that ECB QE has been a failure in its main objective

It is now nearly a year since Mario Draghi and the European Central Bank fired the starting gun on a large-scale move into Quantitative Easing. After its Christmas break it has this week resumed its 60 billion Euro’s per month of bond purchases as it chomps away on Euro area debt like a Pac-Man. In the meantime the period for which it will exist has been extended from September this year to March 2017. So it is time for us to take a look back over this period and see what has been achieved. For those wondering why I defined it as the beginning of large-scale QE it is because the purchases of Greek,Irish and Portuguese debt fitted the bill on a smaller scale as did the two efforts at covered bond purchases. As an aside it is an irony of sorts to see complaints that Greece is not part of the new program as of course there is so little left to buy as around 80% of it is in official hands.

Economic activity

The position here is one that this morning has received some good news. The latest Purchasing Managers Index survey is optimistic looking forwards.

The eurozone economy ended 2015 on a positive note, with the rate of expansion in output rising to a four-month high and growth over the final quarter as a whole the quickest in four-and-a-half years. The expansion was broad-based, with December seeing activity rise across Germany, France, Italy, Spain and Ireland.

So you can see that the survey was bullish for a good 4th quarter which is in stark comparison to the United States where expectations for the same time period have fallen. It is also nice for once to see Italy have some genuine hopes of an improvement. But as the results of the survey progress some of the optimism disappears.

However, despite the improvement, the survey data signal a modest 0.4% increase in GDP in the fourth quarter, which would mean the eurozone grew 1.5% in 2015.

If correct this poses something of a problem for the ECB and let me illustrate this with quarterly economic growth since the beginning of 2014. It goes 0.2%,0.1%,0.3%,0.4%,0.5%,0.4% and 0.3%. The uplift began some 6 months before QE began and you could easily argue that it has made little or no difference so far. That would be not so dissimilar to the UK experience, as for all the hype about Bank of England QE the boost to the housing market via the Funding for Lending Scheme would never have happened if QE was working as advertised.

The crude oil effect

If we look at the improvement in the Euro area economic growth trajectory then it fits much more neatly with the fall or if you prefer plummet in the price of crude oil and other commodities which has taken place. Brent Crude Oil nearly touched US $116 in late June 2014 but was below US $50 at the year-end. I have argued before that this boosts consumption via such factors as higher real wages as it cuts consumer inflation so let us take a look.

In October 2014 compared with September 2014, the seasonally adjusted volume of retail trade rose by 0.4% in the euro area…….In October 2015 compared with October 2014 the retail sales index increased by 2.5% in the euro area

Whilst correlation does not prove causation the improvement in retail sales and consumption in the Euro area fits a lower oil price pretty well as much happens before QE was even a twinkle in Mario Draghi’s eye. Also I note that if we look back to January 2015 Mario Draghi agreed with me.

Looking ahead, recent declines in oil prices have strengthened the basis for the economic recovery to gain momentum. Lower oil prices should support households’ real disposable income and corporate profitability.

The Euro exchange-rate

This is awkward because if we look back we see that after the QE announcement the effective or trade-weighted Euro exchange-rate fell to 92.2 late last January and it is now ahem, 92.2! Okay so we return to my theory that exchange-rates fall in anticipation of QE and we see that the Euro effective exchange-rate was falling anyway in 2014 but from mid-December fell from a convenient 100 to 92.2.

There are issues with this as of course the exchange-rate is falling in anticipation of monetary easing and cannot have known – in spite of the hedge fund briefings – exactly what was going to happen. For example the ECB could have dipped its foot rather than its toe into the world of negative interest-rates.


Yesterday provided yet another disappointment for the ECB as the consumer inflation data was released.

Euro area annual inflation is expected to be 0.2% in December 2015, stable compared to November 2015,

This compares to the objective stated by Peter Praet of the Executive Board only this morning.

You may label that ECB policy a success if inflation, the rise in the cost of living, stays below, but close to, 2% over the medium term. That is our mandate.

Consequently Peter thinks this about the state of play.

I admit that our policy has not yet been successful enough: inflation rates in Europe have been at the very low level of almost 0% for quite some time now.

Accordingly he hints at “More,More,More”

That is why we are continuing to take the necessary measures to drive inflation up to 2% over the medium term.

Here is where I completely depart from the ECB view and indeed much of the analysis you will find in the media and elsewhere. I welcome the “failure” of the ECB in this area as lower consumer inflation driven by the falls in the price of commodities and oil has pushed real wages higher in the Euro area. This has boosted consumption as I highlighted earlier by looking at retail sales data. Once you think of it like that the ECB has in fact acted against the interests of ordinary consumers and workers by trying to drive inflation higher and make things more expensive. Accordingly its failure in this regard has boosted the economy in 2015 and looks likely to do so further in early 2016.

If we move to the exchange-rate impact which will have been the main driver here we see that it will have had a very mixed and potentially adverse overall impact. In simple terms a lower effective exchange rate is expected to generate more net exports although in the credit crunch era less so than in the past. But against that we have the way that it has raised material costs (or more specifically they have fallen by less than otherwise). Also we have the way that it has offset the beneficial falls in consumer inflation and rise in real wages.


This morning Peter Praet has tried to muddy the waters on the issue of QE.

If the ECB had not taken the measures that it did, we would be in a depression; I’m convinced of that. And a depression would be much worse than what we are experiencing today and worse than what we went through over the past decade.

He is deliberately obfuscating by combining all the ECB monetary easing measures rather than just discussing the QE ” €1.5 trillion (i.e. €1,500,000,000,000),” . Although I can agree with him on this.

The ECB’s policy undoubtedly has unintended consequences.

My view is that the “unintended” here has been the beneficial oil price fall which completely changed changed late 2014 and 2015 and will run into early 2016. But Peter’s QE policies have offset that to some extent in a failure which has attempted to undermine an economic success.

Another way of looking at this is we move from the “deflation” mantra of these times -although they usually fail to understand they mean disinflation – is that there is a clear sign of inflation. Today we find it in the case of where deploying €1,500,000,000,000 has so little effect. We have moved from billions to trillions as we wonder whether quadrillions will be along soon?

We also have an addition to my financial lexicon for these times.

In some countries, there is a risk that real estate prices or some equity and other financial markets are increasing in a way that is too rapid or artificial. We are keeping a close watch on that.

Close watch means do nothing.

Oh and I did not realise that Peter and the ECB have imported tactics from England’s Rugby World Cup campaign.

There is no plan B, there is only one plan.






How and when can the Greek banks support a Grecovery?

Yesterday saw something of a misfire for the monetary policy Bazooka of Mario Draghi and the European Central Bank. It was also a misfire for the Financial Times which put out an incorrect announcement five minutes early which begs a question as you see the ECB has repeated the mistake on its website.

the deposit facility will remain unchanged…… -0.2%

It sort of symbolised the day and something must have been in the air as agency after agency made mistakes. I have not seen anything like it since the 1990s when one news agency declared a German interest rate rise as another declared a cut and bedlam ensued! Just for clarity the deposit rate was reduced to -0.3% from December 9th. In terms of consequences well the Euro shot higher to 1.09, Euro area bond markets plummeted just as Mario was giving himself the credit for them rising, and equity markets fell too for a financial market clean sweep.

However there was quite a bit of news relating to the relationship between the ECB and Greece that slipped to some extent under the radar. Indeed Deputy Governor Vitor Constancio was woken up to give us some of the news which is a sign of the times. I use the number of times his afternoon nap is disturbed at ECB press conferences as a signal of trouble. If there is credit to be taken and easy results Mario holds sway if not what is often a hospital pass is swept out.

The Greek banks

The ECB has been supplying an extraordinary level of support for the Greek banking industry most publicly shown by the amount of Emergency Liquidity Assistance or ELA. From the Bank of Greece.

On 3 December 2015 the Governing Council of the ECB did not object to an ELA-ceiling for Greek banks of €77.9 billion, up to and including Wednesday, 16 December 2015, following a request by the Bank of Greece.

The reduction of €7.8 billion in the ceiling reflects an improvement of the liquidity situation of Greek banks amid a reduction of uncertainty and the stabilization of private sector deposits flows, as well as the progress achieved in the recapitalisation process of Greek banks.

Quite a chunky reduction in something which the ECB had been reducing in thin slivers up to then. Also we have learnt to take care with gifts being given to Greeks so let us investigate further as after all “stabilization of private sector deposits flows” is not a great vote of confidence if you think about it.


This for the Greek banks has been rather like London buses. Do not worry if you miss one as another will be along in a minute. The latest one has been particularly problematic as after all there are only so many times you can tell people that a corner has been turned! Yesterday saw one in particular hit hard. From Kathimerini.

with National Bank (of Greece) suffering a widely anticipated 30 percent limit-down upon its return to the market with its new shares after its capital increase.

All the banks required further dilution of existing shareholders and as you can see Natioanl Bank of Greece shareholders were hit heavily again. Also Piraeus bank needed the help of the European Stability Mechanism.

Piraeus Bank requires additional state aid through the Hellenic Financial Stability Fund (HFSF), which is funded by the ESM. The first disbursement of €2.72 billion on 1 December 2015 covers such capital needs.

This consequence of this lead to this at the ECB press conference yesterday.

some politicians in Greece say that the shareholdings of the Greek State and the pension funds in Greek banks have become worthless because of the recapitalisation method imposed by the institutions. What is your view?

Ouch! Here is Vitor’s reply.

So there is in that respect not a problem of valuation of those public shares.

As Greek banking shares fell by another 10% yesterday shareholders will not think that! But apparently.

So the statement, that those public investments are worthless, is not correct.

Why is that Vitor?

(Because they) will benefit from any profits or dividends that the banks will get in the future.

These profits will have to be extraordinary at National Bank of Greece were shares have just been issued at more than a 90% discount and this of course comes on top of many other falls and discounts in the Greek crisis.

Greek banking liquidity

The mainstream media has moved on as this is no longer a matter for the headlines but towards the end of last month the numbers posed a question?From Reuters.

Business and household deposits dropped by 590 million euros or 0.5 percent month-on-month to 121.08 billion euros ($129.1 billion), to their lowest level since March 2003.

Thus the overall situation if we look at 2015 so far is this.

Greece saw a 42 billion euro deposit outflow from December to July.

What we learn is that the money went but so far at least has not come back which is probably why we are seeing a barrage of rhetoric from EU officials that “haircuts” are off the agenda now.

Official Interest-Rates and Reality

You might think that is there is anywhere that the new even more negative deposit interest-rate of the ECB will apply it is Greece. After all it has so much negative GDP,prices, and wages. Yet in an echo of one of the opening themes of this blog back in 2009 take a look at reality. From the Bank of Greece.

The overall weighted average interest rate on all new loans to households and corporations increased by 29 basis points from the previous month to 5.08%.

Depositors can also get some interest albeit not much.

The overall weighted average interest rate on all new deposits decreased by 7 basis points, compared with the previous month, to 0.62%.

So what is called the transmission mechanism for monetary policy is pretty much broken if we look beneath the hype.

Another problem for Greek banks

So often and particularly in my own country I report on banks getting a back door bailout via house prices (assets against the banks loan book) rising. However in Greece things are very different. From the Bank of Greece.

According to data collected from credit institutions, nominal apartment prices are estimated to have declined on average by 6.1% year-on-year in the third quarter of 2015. According to revised data, for the first and second quarters of 2015 apartment prices fell at an annual rate of 3.9% and 5.0% respectively, whereas for 2014 as a whole the average annual decline was 7.5%.

Or as Alicia Keys would put it.

I keep on

Please do not misunderstand me I am not arguing for house prices and another bank bailout what i am saying is that under current conditions how can the Greek banking sector support the real economy?

QE for Greece

I have written before that the ECB has its finger on the trigger of approving QE for Greece, or to be more specific it is dangling it as a carrot in front of the Greek govenrment.The quid pro quo would be some economic reforms. This will be a two stage process where Greek banks return to normal liquidity operations. Yesterday it dropped another heavy hint about this.

that could even happen before the conclusion of the review, if we would be close enough to that end of the review and we would be convinced that the review would become successful.

Sadly nobody had the wit to reply with how this affects the constant proclaiming that the ECB is a “rules based organisation”. Next would come admittal to QE.

What would it be worth? Well for holders of Greek bonds quite a lot as one might expect the ten-year bond yield to halve from the current 8%. For Greece itself then issuing bonds would be cheaper than otherwise, but and here is the rub, still much more expensive than going to the ESM.


The Greek financial system remains very troubled and a lot of time has been wasted in 2015. The ECB has a very difficult job as repairing the banks will first help hedge and vulture funds more than Greek investors and taxpayers. Also in spite of the proclamations of success the deposits that left have not returned.

Meanwhile the real issue is how the banking system can support the real economy where nearly 3 years after the “Grecovery” rhetoric began we see this. From Greek Statistics.

in the 3rd quarter of 2015 the Gross Domestic Product (GDP) in volume terms decreased by 0.9% compared with the 2nd quarter of 2015


The volume of retail trade (i.e. turnover in retail trade at constant prices) in September 2015, recorded a decrease of 3.2% compared with the corresponding index of September 2014, while compared with the corresponding index of August 2015, recorded a decrease of 8.5%.

The underlying index for retail sales is stuck firmly in depression territory at 69.6 where 2010 when “shock and awe” according to Christine Lagarde began was 100. So how is the too big to fail and banking bailout strategy going?




Inflation targeting what is it good for?

Today will be one of the set piece days of economic history as we wait to see if Mario Draghi carries out his promises to ease Euro area monetary policy. Should that be the case then we can expect an increase in QE possibly in several ways ( an extension, a faster rate of purchases, and/or extra assets to be purchased) plus a reduction in the deposit rate below -0.2%. Should he not do so he will have a lot of egg on his face and his version of Forward Guidance where he has mimicked Agent Smith crying “More! More!” in the Matrix series of films will vanish in a puff of smoke. Actually the main problem of Mario and his colleagues at the European Central Bank is that they have raised the expectations bar so high.

If we look for a rationale for this then we see this.

Euro area annual inflation is expected to be 0.1% in November 2015, stable compared with October 2015,

The ECB is about as pure an inflation targeter as we have these days and this is well below the level it has established as what it aims at which is just below 2% per annum and with some spurious accuracy has pointed at 1.97%. If we take this further we see that looking further up the inflation chain is also sending a signal.

In October 2015, compared with September 2015, industrial producer prices fell by 0.3% in the euro area…..In October 2015, compared with October 2014, industrial producer prices fell by 3.1% in the euro area.

To this we can add more factors as the price of a barrel of Brent Crude Oil fell below US $43 per barrel last night and the Bloomberg Commodity Index fell to 80.31 this morning or a new low for this century.


There are several fundamental issues that have to be faced. Firstly inflation targeting under current methodologies did not stop the credit crunch did it? In fact I would argue that the influence of China pushing goods prices lower made consumer inflation mild lulling our establishments into a false sense of security whilst they tuned a blind eye to asset price inflation mostly in house prices. Whilst they stood behind a locked door the burglar climbed in through the window.

Next we have a problem which is not what one would have expected before the credit crunch era. Back then one might have expected negative interest-rates and 60 billion Euros a month of QE asset purchases to generate raging inflation whereas so far we have not seen a lot. Yes there is some in the services sector in the Euro area (1.1%) but even it is below target. If you look at the Euro area inflation figures they are not much different to nations who are no longer increasing monetary easing. What change there has been can easily be explained by the fall in the Euro exchange rate which in trade weighted terms nearly made 100 at the end of 2014 and is 90.7 now. If we look back two years we see that it is some 11.6% lower now than it was then.

Central bankers do not see it like that

Deputy Governor Per Jansson of the Swedish Riksbank has given a speech this morning and told us this.

One of my most important messages is: ”if it’s not broken, don’t try to fix it!”. In our eagerness to bring about change, we can often do more damage than good. The aspect I believe is not broken and therefore does not need fixing is the policy of flexible inflation targeting, which in recent decades has developed into something of an international standard.

Most people consider the credit crunch to be a big deal and many have really suffered which provides its own critique to Per’s “international standard”. There is another oddity here especially if we consider that Per and his colleagues are making an extraordinary effort with negative interest-rates and ever more QE.

I, like my colleagues, have greater sympathy for the argument in the international debate that central banks should raise their inflation targets than for the argument in the Swedish debate that the inflation target should be lowered.

What would raising the inflation target achieve when Per and his colleagues are pretty much “maxxed-out” but still failing to hit the current one? If you think it through logically they are offering a very pessimistic view of the future and giving a damning critique of the implications of their own policy actions.

What could we do?

A starting point was given by Per Jansson earlier.

In the euro area and the United Kingdom, the target is formulated in terms of the HICP index (harmonised index for consumer prices) which does not include costs for owner-occupied housing, only operating costs.

If you put house prices into the consumer inflation numbers then you have a way of addressing a situation where consumer inflation can be benign as it mostly was pre credit crunch whilst asset prices shoot higher. An example of this sort of situation if we stick to the Euro area can be found in Ireland right now. Here is consumer inflation flat-lining.

Prices on average, as measured by the EU Harmonised Index of Consumer Prices (HICP), remained unchanged compared with October 2014.

Well below the 2% annual target and a clear case for Mario to follow the Sugababes and “push the button”. But if we look deeper we see this.

In the month of October, residential property prices rose by 1.6% nationwide. Residential property prices remained up 7.6% on an annual basis.

Actually the whole housing sector is seeing plenty of inflation as in the year to October private rents were rising at an annual rate of 10.3%. Now both property buyers and renters in Ireland must laugh when they are told that there is no inflation in Ireland and even worse if we switch to its own measure (confusingly called CPI) which is at -0.2%.

Ireland is of course a small part of the Euro area but what if ever lower interest-rates fire up its property market one more time? It is of course a muddy picture as prices are now a third below the past bubble peaks but one thing we did learn was that they were unsustainable. It is hard not to wonder about Spain as well.


Today it will be easy to get caught up in the melee especially at 12.45 pm and 1.30 pm but I wanted to pose a challenge to the methodology as much is being done in its name. The whole “deflation” saga which is really a burst of disinflation would be different if we measured inflation more appropriately. As ever there are issues because adding asset prices does not fit the logical mantra of only having consumer expenditure but as I pointed out mathematical and statistical consistency has led us to where exactly?

Also if the main monetary policy mechanism is via the exchange-rate there is the issue of it being a zero-sum game. So who will the ECB export disinflation too? Will it become like a game of tennis with each player hitting the ball back over the net?

It is almost a heresy to say it these days but workers and consumers will welcome the lower good prices central bankers are “battling” and those looking to buy a property will not welcome the higher prices that central bankers call “wealth effects”

A playlist for Mario today

Push the Button by Sugababes

Pump It Up by Elvis Costello and the Attractions

More,More,More by Andrea True Connection

Money For Nothing by Dire Straits

Take the Money and Run by The Steve Miller Band

Money,Money,Money by Abba

Mo Money Mo Problems by The Notorious BIG

And for interest-rates

How low? by Ludacris






How do Negative Interest Rates affect economies and the ordinary person?

On Thursday we are expecting to see a further dip into the icy-cold world of negative interest-rates made by the European Central Bank. After all the hints and promises made by its President Mario Draghi its deposit rate is expected to fall from the current -0.2% to either -0.3% or -0.4%. Also the negativity if I may put it like that will be reinforced and backed up by an extension to the Asset Purchase Program or QE via an extension beyond next September and/or a faster rate of purchases. These expectations have seen an extension to the negative interest-rate environment already.

If we look at bond yields we see that the two-year yield in Germany has fallen to -0.42% predicting a cut to -0.4% if it is right. However more remarkable is the way that five-year yields in France are dipping in and out of negative territory and the same for the two-year yields of Spain and Italy. So we see a litany of markets where price discovery has been abandoned as a method of determining economic reality and instead they depend on the cheque book of the central bank.

On Thursday if Mario Draghi carries out his hints and promises we will see the ECB take the Euro area further into the world of negative interest-rates and I mean this in terms of amount and length of time. What impact will this have?

Is it necessary?

There is a real problem here as this morning we have seen data which suggests that the Euro area economy if not surging is doing okay. For example there was this from Germany.

In October 2015, roughly 43.4 million persons resident in Germany were in employment….. Thus employment surpassed the record high observed in September 2015 since German reunification.

Employment has been a leading indicator in the credit crunch era ( in the UK for example) but you could argue Germany is a special case. But there has also been this for the whole Euro area from the Markit PMI.

The eurozone manufacturing upturn gained further momentum during November, with rates of expansion in production and new orders the fastest for around one-and-a-half years. Growth was broad-based by country, with output and new business inflows improving in almost all of the nations covered (the exception being Greece).

As monetary policy is already very expansionary then the ECB seems set to make a policy error on Thursday. If recent speeches are any guide it will claim that the improvement is due to its policies (skipping over the oil price fall) and point us towards inflation being below target. It may even highlight the -0.4% CPI inflation reading in Italy.

Sweden is an example

If we look to see what negative interest-rates can do in an environment of falling oil and commodity prices let us look yesterday’s development in Sweden.

Sweden’s GDP increased 0.8 percent in the third quarter of 2015, seasonally adjusted and compared to the second quarter of 2015. GDP increased 3.9 percent, working-day adjusted and compared to the third quarter of 2014.

This would in the past have a central bank looking for the punchbowl so they could take it away but of course the Riksbank has its foot firmly on the accelerator as it indulges in pro rather than anti cyclical policy. If life was that easy then central bankers would be found permanently on the beach or ski slopes before we realised we could just open the taps permanently and fire them. The catch? Here is a clear example if we look at private-sector debt.

Most of the increase can be explained by housing loans, which increased by SEK 196 billion and amounted to 2 655 billion in total in October. Housing loans had an annual growth rate of 8.1 percent in October, which is an increase compared with September when the growth rate was 8.0 percent.

The consequence of this for house prices can be filed under this from the Black Eyed Peas.

Boom boom boom (Gotta get get) [x4]

Boom boom boom (now) [x2]
Boom boom boom [x2]

House prices in Sweden have risen by 2% in the quarter to October and by 10% on a year before with a few districts in Stockholm rising at over 20% annually. If we look back we see that house prices have reached “escape velocity” since the Riksbank started cutting interest-rates. The house price index of Sweden Statistics was 492 at the end of 2007 and was 668 at the end of the third quarter of 2015. What credit crunch house prices might say?!

Is that what the ECB is aiming for in the Euro area where debt both private and public sector is compared to assets (house prices) more favourably? My argument which I am sure that prospective house buyers in Sweden will agree with is that would be misrepresenting inflation and is we allow for that more accurately a lot of the recorded economic growth fades away.

How did a housing boom work out for Spain and Ireland in particular?

Interest-Rates for the ordinary person

These have not turned out to be as expected or hyped. Let me give you an example from  Statistics Sweden to illustrate this.

The average interest rate for housing loans for new agreements was 1.59 percent in October, which implies that it increased compared with September when the average interest rate was 1.58 percent.

Whilst there may be an occasional example of negative mortgage-rates, for example ones set in relation to official rates as happened in the UK, they are still a fair way away overall. So much lower but not negative is the message here.

In the world of savings and in particular bank deposits then negative interest-rates were assumed to be something that would be passed on very quickly. But in fact banks have generally avoided this. For example I have just been searching in Sweden and if the online tables are up to date you can get 0.3% for a year with Nordea Bank. Not much but also not negative.

However “the times they are a-changing”. Remember this that I pointed out on the 19th of October?

From the first of January, customers of the Alternative Bank Switzerland ABS will not only get no interest, they have to pay even itself 0.125 percent interest that they may give their money to the ABS.

A small Swiss bank is dipping its toe in the water of negative interest-rates for savers and depositors. Interestingly quite a few places have been reporting this as news in the last week or so which puts them more than a month behind us and in the category of slooooow news.

What we take forwards from this is that it takes at least a year for the impact of negative interest-rates in the wholesale and money markets to reach the ordinary person. That year is only seeing a dipping toe rather than a wide scale move. Maybe that will change should we see more countries dragged into the supermassive black hole that is negative interest rates but as we muse on the subject that is the evidence so far.


There are various lessons to be learned from the negative interest-rate experience so far so let me explain them. Firstly dips into the pool seem to create the demand for further reductions as we hear Agent Smith calling for “More! More!”. Secondly no-one has yet escaped from it and I am thinking of Sweden here as you might think that an annual growth rate of nearly 4% would provide such an opportunity. Thirdly the danger is of overheating private credit and loans leading to a house price boom. Fourthly there is the oddity of such a policy being pursued when the outlook for the countries concerned was already being boosted by lower oil and commodity prices. This makes us wonder if genuine economic improvement is what is being planned or not? So in summary we turn to Coldplay.

Oh, no, I see
A spider web, and it’s me in the middle,
So I twist and turn,
Here am I in my little bubble,

For the man and women in the street then negative savings and deposit rates have in general not occured and I think the banks are afraid of what would happen. However as time passes that will change and the negative interest-rate sage will take another dark turn.

Meanwhile there is another feature which is geographical and that is that the countries afflicted are in or near to the Euro area. Even the IMF seemed to abandon its “on track” methodology yesterday as in essence adding the Chinese Renminbi to its Special Drawing Rights saw quite a reduction for the weighting of the Euro.





Is the economy of Italy still the girlfriend in a coma?

Today I wish to take a look again at the state of play in the Italian economy and see if it remains “the girlfriend in a coma” as described by Bill Emmott who used to be editor of the Economist. The documentary he made especially the interview with Silvio Berlusconi who you may not be surprised to read promised quite a bit in an interview and the delivered nothing! Was revealing and sad. As to the concept let me give you an illustration from my article on the subject from the 18th of May.

between 2001 and 2013 GDP shrank by 0.2%. (The Economist)

Very thin pickings from the Euro area and it gets worse if we move from the aggregate number to try to get an idea of the individual experience as I did back then.

That statistic gets even worse when you allow for the fact that the Italian population was expanding over that period by around 7% so per person the situation was even worse.

Once you look at it like that it is a surprise that there has not been more protests in Italy about the state of play.This is because a weak aggregate performance becomes quite a decline per person or capita. Let us bring everything up to date.

The latest economic growth

Form Istat Italy.

In the third quarter of 2015 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.2 per cent with respect to the second quarter of 2015 and by 0.9 per cent in comparison with the third quarter of 2014.

Firstly let us welcome the fact that Italy has economic growth and the fact that it has had it for each quarter of 2015 now. However there is a rather ominous pattern for 2015 so far as it has gone 0.4%,0.3% and now 0.2% which is a clear trend. Of course there is spurious accuracy at play but it is hard not to at least wonder about it.

What the economic growth in 2015 has done is wipe out the 12 year decline the Economist pointed out as the latest quarter had GDP of 387.2 billion Euros and 2013 was oddly extremely consistent with each quarter in the 385 billion Euros (these numbers are based on 2010).

Thus as we stand the Euro era has provided economic stagnation for Italy on an aggregate level and declines per person.

Shouldn’t 2015 have been better?

On Friday ECB President Mario Draghi was busy slapping himself on the back for his monetary policies but it is hard not to think of Italy reading the quotes below.

We cannot say with confidence that the process of economic repair in the euro area is complete……..this is the weakest euro area rebound since 1998; and the recovery remains very protracted in historical perspective…..If our current assessment is correct, it will take the euro area 31 quarters to return to its pre-crisis level of output – that is, in 2016 Q1.

These words echo in Mario’s home country as if we stay with the last point when will Italy return to its pre crisis level of output? If we look at it in annual terms the peak was in 2007 when annual GDP was 1.688 trillion Euros. After the initial hit Italy bounced back but sadly the Euro area crisis saw it sink again and GDP in 2014 was 1.535 trillion Euros or 9% lower which at current growth rates will take quite some time to recover. That is on the optimistic assumption that the outlook is bright and to coin a phrase “the only way is up baby”.

Also whilst Mario was slapping himself on the back and proclaiming the success of his policies Italy will have benefited from the fall in oil and commodity prices that began in the late summer of 2014. Of course around a third of that has been offset by the fall in the value of the Euro- Mario is a bit less clear on this consequence of his actions.

Thus we have a lower exchange rate, lower input prices, negative official interest-rates and as of the end of October purchases of some 61.3 billion Euros of Italian government bonds. This has led to a situation that seems unrelated to either the Italian economy or its public finances as Mario Draghi pointed out to Il Sole 24 Ore at the end of October.

The interest rate on two-year Italian securities is near zero;

Should Forward Guidance have any impact on the real economy then we are plainly being signalled a cut in the main ECB interest-rate below -0.2% plus more QE next month. With the Euro below 1.07 versus the US Dollar we can see that there has already been an impact on the financial one.

Looking Forwards

We find as we assess things that there have already been disappointments for 2015 and by that I mean that only in October the Bank of Italy told us this.

Economic activity in Italy has been expanding since the beginning of 2015, at an annualized rate of about 1.5 per cent.

Yet I note that it suggested overall economic growth would be less than 1% in 2015 which in the circumstances is not good and if we return to the recovering ground lost point means not this decade.

If we look to the business surveys then they are managing some optimism as shown below.

Italian manufacturers registered a solid start to the fourth quarter, with output and new orders both rising at robust and accelerated rates in October……Italian service sector activity rose for the eighth consecutive month in October, supported by solid and accelerated growth in inflows of new business.


A consequence of the economic difficulties has been persistently elevated unemployment.

At the same time, the unemployment rate fell to 11.8%. The drop was associated with an increase of inactive people rather than with employees.

Let us take the good news first which is that employment has risen and unemployment has fallen which is nice to see. However it remains high and is falling only slowly plus there are concerns if the recent improvement is merely a category shift from unemployed to inactive.

There has also been consistent wage growth which feeds into real wages with inflation so low. Although care is needed as these only cover formal agreements which cover about 60% of the situation.

Compared with October 2014 the hourly index and the per employee index increased by 1.2 per cent.


The Girlfriend in a Coma theme came from someone who plainly likes Italy and was sad to see that its economic growth pattern was so poor. Let me echo that as I like Italy too. A subtitle was Good Italy:Bad Italy and the former is easy to see if you visit the place with the latter shown by today’s article. Whilst it would be great to proclaim that there has been a fundamental change there it is hard to see many signs.

A consequence of this has been that the debt burden of the Italian state has risen and risen. It seemed symbolic when it rose above 2 trillion Euros in the spring of 2013 and is more like 2.2 trillion now. If the economy struggles then the ratio to GDP rises which is has done and is now 132.8% according to the Bank of Italy. Due to the exertions of the ECB with its QE purchases there is no financial crisis and Italy has the benefit of borrowing cheaply. But kicking the debt can via QE only works in the longer-term if Italy grows at a decent rate.

A more hopeful thought is that the shadow economy is helping out considerably. Back in 2013 the IEA estimated it as just under 22% of the economy although oddly they thought it had shrunk in the Euro area from 27%. This means that Italy’s Euro era performance is even worse! Of course since then some of the shadow economy (drugs and prostitution) have become formal economic agents. Is there an Italian equivalent for “hard-working families”? So we are left hoping that in recent times the Italian shadow economy has seen a boom. Otherwise it has been in quite a long lasting depression.