The UK public finances are seeing outright austerity

The UK Public Finances are something that have been quietly improving over the past year or two. This has been taking place mostly outside the news headlines partly because the numbers are much smaller than they were. From the Office of National Statistics or ONS.

Over the next 12 months (April 2018 to March 2019), the Office for Budget Responsibility, which produces the official government forecasts, expects the public sector to borrow £37.1 billion; around one-quarter of what it borrowed in the financial year ending March 2010 (April 2009 to March 2010), at the peak of the financial crisis.

Another reason why this has been in the shade rather than daylight is that it has to some extent come in spite of our economic performance. If we look back regular readers will recall times when UK economic growth was a fair bit stronger than now but the public finances were slow to respond whereas now we are seeing some catch-up. Of course an alternative view is that maybe we were not doing quite so well back then and perhaps are doing better now than we are told.

In terms of economic growth the position looks as though it has improved slightly with the NIESR suggesting this.

Building on the official data, our monthly GDP Tracker suggests that growth is set to nudge higher to 0.5 per cent in the third quarter.Recent survey evidence suggests that the manufacturing and construction sectors are recovering after a particularly weak start to the year and the dominant services sector is set to maintain a similar rate of growth in the third quarter.

Should this turn out to be true it will provide a more favourable back drop for the public finances than the first half of this year. Tucked away in the detail was something else which in terms of economic theory and to some extent practice was hopeful.

Growth is now close to our estimate of potential.

They think the economy can grow at 0.6% per quarter which is a fair bit higher than the 1.5% per annum “speed limit” produced by the Bank of England Ivory Tower. It would be helped considerably if any of this came true. From the BBC.

Britain can be a “21st Century exporting superpower”, Liam Fox is expected to say in a speech detailing the government’s post-Brexit ambitions.

The international trade secretary will say he wants exports as a proportion of UK GDP to rise from 30% to 35%.

Of course we all want lots of things and the real issue is what plan there is to achieve this.

A Helping Hand

I have pointed out before how the policies of the Bank of England and QE (Quantitative Easing) in particular have been very government friendly. This issue was taken up by Toby Nangle yesterday.

Back in 2010 it was thought that UK debt service costs would soar, but lower rate rates (Gilt & BoE) have meant massive undershoot while debt level overshot big time.

It will come as no surprise that it was the Office for Budget Responsibility was completely wrong but the difference in the numbers is stunning. Using Toby’s projections we can estimate debt costs per annum at around £80 billion whereas in reality it is in the low forty billions. Also per unit the move has been even larger because we have borrowed much more than the OBR projected.

So we have two factors here the first is the impact of lower Gilt yields due to the low official interest-rates and QE sovereign bond purchases and the second is the fact that the Bank of England owns around 22% of the Gilt market and refunds the money ( minus costs) to the government.

Whilst we looking at Gilt yields they have been falling again recently with the ten-year yield down from 1.4% when the Bank of England raised Bank Rate to 1.24% now. This seems set to reduce debt costs further as well as meaning that Governor Carney’s bazooka looks reduced to one of those potato guns I used to play with as a child.

Today’s data

The good news keeps on coming to coin a phrase. From the ONS.

Public sector net borrowing (excluding public sector banks) was in surplus by £2.0 billion in July 2018, a £1.0 billion greater surplus than in July 2017; this is the largest July surplus for 18 years (2000).

For those wondering about the surplus this is because July is a month for Self Assessment payments and therefore has a favourable wind behind it. But if we move to the financial year so far the picture remains good.

Public sector net borrowing (excluding public sector banks) in the current financial year-to-date (April 2018 to July 2018) was £12.8 billion; that is, £8.5 billion less than in the same period in 2017; this is the lowest year-to-date (April to July) net borrowing for 16 years (2002).

As you can see this is quite a drop and moves us into a zone where we can for once dream ( or for some as I will discuss later have nightmares) about an actual surplus. If we look into what is driving this we see that revenues are strong rising by 5% and in particular income tax is up by 6.1% perhaps hinting the economy has been stronger than we thought. On the other side of the coin we get an insight into cooling in the housing market in the way that Stamp Duty receipts are down by just under £400 million to £4.3 billion.

Austerity

We have often debated how much of this we have seen but the year to date figures show one of the clearest signals of it we have had.

Over the same period, central government spent £246.9 billion, around 1% less than in the same period in 2017.

After all we have found ourselves mostly discussing austerity allowing for inflation whereas at the moment we have outright austerity. Also those looking at the problems various councils are facing ( e.g Northamptonshire) will find their eyes alighting on this.

 while local government borrowing was in surplus by £4.9 billion.

National Debt

We can expect an aggressive headline today from the London Evening Standard once its editor spots that the current Chancellor is achieving one of his great hopes. The emphasis is mine.

Public sector net debt (excluding public sector banks) was £1,777.5 billion at the end of July 2018, equivalent to 84.3% of gross domestic product (GDP), an increase of £17.5 billion (or a decrease of 1.7 percentage points as a ratio of GDP) on July 2017.

Comment

The situation we find ourselves in is one which we were promised for 2015/16 so it has come Network Rail style. Also there is a space oddity element about it as the previous chancellor was supposed to be the man for austerity and Phillip Hammond was one for a more relaxed view yet reality looks the opposite. An alternative view is that the numbers are much less under their control than they would like us to think. But such as they are and judging them on their own basis they now look pretty good. As ever they depend a lot on economic growth but should that continue the trajectory is for a surplus and a declining debt to GDP ratio and maybe even some falls in the national debt.

There are three challenges to this. The first is the most basic which is the inability of politicians to keep their hands out of the cookie jar. That brings us to the second which is to some extent related which is that some areas such as local councils seem to have an especially tight noose around their neck at the moment highlighted by the fact they are in surplus so far this year by £4.9 billion. Something odd is going on there. We can take this forward more generally as to whether tight now we want or need outright austerity? Even without the impact of lower inflation on debt interest we would be spending the same as last year.

Next comes the issue of the reliability of official statistics which has been raised recently by the Resolution Foundation.

When we first looked at the data, back in 2012, we came up with a clear answer: the corporate sector had been sitting on too much cash for too long……..By June 2017, a series of data revisions had lowered the scale of the corporate surplus across the entirety of the period, by a relatively uniform average of 2.4 per cent of GDP per year.

That is quite a lot but it was not the end of the story.

But a change of 4 per cent of GDP in both 2015 and 2016 – worth roughly £80 billion a year – is huge. At the very least, it might better be considered a correction rather than a revision.

Impacts on the public finances are usually from a different route in terms of how you define things but for example if you added up the impact of the Housing Associations and the Term Funding Scheme of the Bank of England you end up debating around £190 billion in national debt terms.

 

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

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

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

There was also this from the European Union Council.

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

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

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

What is the state of play?

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

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

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

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

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

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

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

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

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

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

She provided quite a harsh critique of the triumphalism above.

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

The end of the bailout

The ESM puts it like this.

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

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

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

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

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

Back on February 12th I pointed out this.

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

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

Borrowing costs will rise

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

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

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

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

Comment

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

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

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

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

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

 

 

 

 

 

The ECB and its Italian and Turkish problems

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

Turkey

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

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

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

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

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

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

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

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

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

Italy

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

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

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

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

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

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

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

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

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

Comment

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

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

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

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

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

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

 

 

UK GDP growth accelerates past France and Italy

Today brings us the latest data on the UK economy or to be more specific the economic growth or Gross Domestic Product number for the second quarter of this year. If you are thinking that this is later than usual you are correct. The system changed this summer such that we now get monthly updates as well as quarterly ones. So a month ago we were told this.

The monthly GDP growth rate was flat in March, followed by a growth of 0.2% in April. Overall GDP growth was 0.3% in May.

So we knew the position for April and May earlier than normal (~17 days) but missing from that was June. We get the data for June today which completes the second quarter. As it happens extra attention has been attracted by the fact that the UK economy has appeared to be picking-up extra momentum. The monthly GDP numbers showed a rising trend but since then other data has suggested an improved picture too. For example the monetary trends seem to have stabilised a bit after falls and the Markit PMI business survey told us this.

UK points to a 0.4% rise in Q2 tomorrow, but that still makes the Bank of England’s recent rate rise look odd, even with the supposed reduced speed limit for the economy. Prior to the GFC, 56.5 was the all-sector PMI ‘trigger’ for rate hikes. July 2018 PMI was just 53.8 ( @WilliamsonChris _

As you can see they are a bit bemused by the behaviour of the Bank of England as well. If we look ahead then the next issue to face is the weaker level of the UK Pound £ against the US Dollar as we have dipped below US $1.28 today. This time it is dollar strength which has done this as the Euro has gone below 1.15 (1.145) but from the point of view of inflation prospects this does not matter as many commodities are priced in US Dollars. I do not expect the impact to be as strong as last time as some prices did not fall but via the impact of higher inflation on real wages this will be a brake on the UK economy as we head forwards.

Looking Ahead

Yesterday evening the Guardian published this.

Interest rates will stay low for 20 years, says Bank of England expert

Outgoing MPC member Ian McCafferty predicts rates below 5% and wages up 4%

The bubble was rather punctured though by simpleeconomics in the comments section.

Considering the BoE track record on forecasting I think we should take this with a massive pinch of salt. They often get the next quarter wrong so no hope for 20 years time.

The data

As ever we should not place too much importance on each 0.1% but the number was welcome news.

UK GDP grew by 0.4% in Quarter 2 (April to June) 2018.The rate of quarterly GDP growth picked up from growth of 0.2% in Quarter 1 (Jan to Mar) 2018.

As normal if there was any major rebalancing it was towards the services sector.

Services industries had robust growth of 0.5% in Quarter 2 (Apr to June) 2018, which contributed 0.42 percentage points to overall gross domestic product (GDP) growth.

The areas which did particularly low are shown below.

 Retail and wholesale trade were the largest contributors to growth, at 0.11 percentage points and 0.05 percentage points respectively. Computer programming had a growth of 1.9%, contributing 0.05 percentage points to headline gross domestic product (GDP).

There was also some much better news from the construction sector and even some rebalancing towards it.

Growth of 0.9% in construction also contributed positively to GDP growth.

Although of course these numbers have been in disarray demonstrated by the fact that the latest set of “improvements” are replacing the “improvements” of a couple of years or so ago. Perhaps they have switched a business from the services sector to construction again ( sorry that;s now 3 improvements).So Definitely Maybe. Anyway I can tell you that there are now 40 cranes between Battersea Dogs Home and Vauxhall replacing the 25 when I first counted them.

Today’s sort of humour for the weekend comes from the area to which according to Baron King of Lothbury we have been rebalancing towards.

However, contraction of 0.8% in the production industries contributed negatively to headline GDP growth…….

Manufacturing fell by 0.9% although there is more to this as I will come to in a moment.

Monthly GDP

You might have assumed that the June number would be a good one but in fact it was not.

GDP increased by 0.1% in June 2018

If we look into the detail we see that contrary to expectations there was no services growth at all in June. Such growth as there was come from the other sectors and construction had a good month increasing by 1.4%. I did say I would look at manufacturing again and it increased by 0.4% in June which follows a 0.6% increase in May. So we have an apparent pick-up in the monthly data as the quarterly ones show that it is in a recession with two drops in a row. Thus it looks as if the dog days of earlier this year may be over,

This leaves us with the problem of recording zero services growth in June. The sectors responsible for pulling the number lower are shown below.

The professional, scientific and technical activities sector decreased by 1.0% and contributed negative 0.10 percentage points. ……The other notable sector fall was wholesale, retail and motor trades, which decreased by 0.6% and contributed negative 0.08 percentage points.

The decline of the retail trade whilst the football world cup was on seems odd. Also there overall number completely contradicts the PMI survey for June which at 55.1 was strong. So only time will tell except Bank of England Governor Mark Carney may need its barman to mix his Martini early today as he mulls the possibility that he has just raised interest-rates into a service-sector slow down.

One consistent strong point in the numbers in recent times has carried on at least.

There was also a rise in motion pictures, increasing by 5.8% and contributing 0.05 percentage points.

So we should all do our best to be nice to any luvvies we come across.

Comment

We should welcome the improved quarterly numbers as GDP growth of 0.4% is double that of both France and Italy and is double the previous quarter. However whilst the monthly numbers do provide some extra insight into manufacturing as the recessionary quarterly data looks like a dip which is already recovering the services numbers are odd. I fear that one of my warnings about monthly GDP numbers are coming true as it seems inconsistent with other numbers to say we picked up well in May but slowed down in June. If we look at the services sector alone and go back to February 2017 we are told this happened in the subsequent months, -0.1%,0.3%-0.1%,0.3% which I think speaks for itself.

We also got an update on the trade figures which have a good and a bad component so here is the good.

The total UK trade deficit (goods and services) narrowed £6.2 billion to £25.0 billion in the 12 months to June 2018. The improvement was driven by both exports of goods and services increasing by more than their respective imports.

Next the bad.

The total UK trade deficit widened £4.7 billion to £8.6 billion in the three months to June 2018, due mainly to falling goods exports and rising goods imports.

If you want a one word summary of out recorded trade position then it is simply deficit. Although currently we are looking rather like France in terms of patterns as a reminder that some trends are more than domestic.

 

The economy of Italy returns to its former coma status

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

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

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

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

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

Perspective

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

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

Labour Market

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

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

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

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

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

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

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

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

Inflation

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

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

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

Wages

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

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

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

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

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

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

Looking Ahead

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

Manufacturing growth eases in July to lowest since October 2016

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

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

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

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

Comment

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

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

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

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

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

 

 

 

 

What just happened to the GDP and economy of France?

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

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

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

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

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

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

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

France

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

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

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

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

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

Trade

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

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

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

Production

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

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

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

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

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

The Outlook

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

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

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

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

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

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

Comment

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

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

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

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

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

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

Or as someone amusingly replied to me Irish……

What can we expect next from the ECB?

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

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

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

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

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

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

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

The dog days are over
The dog days are done

A nagging problem

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

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

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

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

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

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

What happens next?

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

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

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

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

A Space Oddity

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

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

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

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

If true that is a bit grim.

Banks

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

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

Comment

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

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

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