Germany will be the bellweather for the next stage of ECB monetary easing

Today there only is one topic and it was given a lead in late last night from Japan. There GDP growth was announced as 0.3% for the last quarter of 2018 which sounded okay on its own but meant that the economy shrank by 0.4% in the second half of 2018. Also it meant that it was the same size as a year before. So a bad omen for the economic growth news awaited from Germany.

In the fourth quarter of 2018, the gross domestic product (GDP) remained nearly at the previous quarter’s level after adjustment for price, seasonal and calendar variations.

If you want some real precision Claus Vistensen has given it a go.

German GDP up a dizzying 0.0173% in Q4.

Of course the numbers are nothing like that accurate and Germany now faces a situation where its economy shrank by 0.2% in the second half of 2018. The full year is described below.

Hence short-term economic development in Germany showed two trends in 2018. The Federal Statistical Office (Destatis) reports that, after a dynamic start into the first half of the year (+0.4% in the first quarter, +0.5% in the second quarter), a small dip (-0.2% in the third quarter, 0.0% in the fourth quarter) was recorded in the second half of the year. For the whole year of 2018, this was an increase of 1.4% (calendar adjusted: 1.5%). Hence growth was slightly smaller than reported in January.

Another way of looking at the slowdown is to compare the average annual rate of growth in 2018 of 1.5% with it now.

+0.6% on the same quarter a year earlier (price and calendar adjusted)

If we look at the quarter just gone in detail we see that it was domestic demand that stopped the situation being even worse.

The quarter-on-quarter comparison (price, seasonally and calendar adjusted) reveals that positive contributions mainly came from domestic demand. Gross fixed capital formation, especially in construction but also in machinery and equipment, increased markedly compared with the third quarter of 2018. While household final consumption expenditure increased slightly, general government final consumption expenditure was markedly up at the end of the year.

Is the pick up in government spending another recessionary signal? So far there is no clear sign of any rise in unemployment that is not normal for the time of year.

the number of persons in employment fell by 146,000, or 0.3%, in December 2018 on the previous month. The month-on-month decrease was smaller than the relevant average of the past five years (-158,000 people.

Actually we can say that it looks like there has been a fall in productivity as the year on year annual GDP growth rate of 0.6% compares with this.

Number of persons in employment in the fourth quarter of 2018 up 1.1% on the fourth quarter of 2017.

Also German industry does not seem to have lost confidence as we note the rise in investment which is the opposite of the UK where it ha been struggling. But something that traditionally helps the German economy did not.

However, development of foreign trade did not make a positive contribution to growth in the fourth quarter. According to provisional calculations, exports and imports of goods and services increased nearly at the same rate in the quarter-on-quarter comparison.

In a world sense that is not so bad news as the German trade surplus is something which is a global imbalance but for Germany right now it is a problem for economic growth.

So let us move on as we note that German economic growth peaked at 2.8% in the autumn of 2017 and is now 0.6%.

Inflation

This morning’s release on this front does not doubt have an element of new year sales but seems to suggest that inflation has faded.

 the selling prices in wholesale trade increased by 1.1% in January 2019 from the corresponding month of the preceding year. In December 2018 and in November 2018 the annual rates of change had been +2.5% and +3.5%, respectively.
From December 2018 to January 2019 the index fell by 0.7%.

Bond Yields

It is worth reminding ourselves how low the German ten-year yield is at 0.11%. That according to my chart compares to 0.77% a year ago and is certainly not what you might expect from reading either mainstream economics and media thoughts. That is because the German bond market has boomed as the ECB central bank reduced and then ended its monthly purchases of German government bonds. Let me give you some thoughts on why this is so.

  1. Those who invest their money have seen a German economic slowing and moved into bonds.
  2. Whilst monthly QE ended there are still ECB holdings of 517 billion Euros which is a tidy sum especially when you note Germany not expanding its debt and is running a fiscal surplus.
  3. The likelihood of a new ECB QE programme ( please see Tuesday’s post) has been rising and rising. Frankly the only reason it has not been restarted is the embarrassment of doing so after only just ending it.

Accordingly it would not take much more for the benchmark ten-year yield to go negative again. After all all yields out to the nine-year maturity now are. Let me point out how extraordinary that is on two counts. First that it happened at all and next the length of time for which negative bond yields have persisted.

If we look at that from another perspective we see that Germany could if it so chose respond to this slowing with fiscal policy. It can borrow for essentially nothing and in both absolute and relative terms its national debt has been falling. The awkward part is presentational after many years of telling other euro area countries ( most recently Italy) that this is a bad idea!

Comment

If you are a subscriber to the theme that Euro area monetary policy has generally been set for Germany’s benefit then there is plenty of food for thought in the above. Indeed it all started with the large devaluation it engineered for its exporters via swapping the Deutschmark for the Euro. That is currently very valuable because a mere glance at Switzerland suggests that rather than 1.13 to the US Dollar  the DM would be say 1.50 and maybe higher. Care is needed because as the Euro area’s largest economy of course it should be a major factor in monetary policy just not the only one.

Right now there will be chuntering of teeth in Frankfurt on two counts. Firstly that my theme that the timing of what you do matters nearly as much as what you do and on this front the ECB has got it wrong. Next comes the issue that it was not supposed to be the German economy that was to be a QE junkie. Yes the trade issues have not helped but it is deeper than that.

With some of the banks in trouble too such as Deutsche Bank and Commerzbank we could see a “surprise” easing from the ECB especially if there is a no-deal Brexit. That would provide a smokescreen for a fast U-Turn.

Me on The Investing Channel

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UK GDP had a relatively good second half of 2018 but a weak December

Today brings a raft of UK economic data as we look at economic growth ( GDP), trade, production (including manufacturing) and construction data. The good news is that we now take an extra fortnight or so to produce the numbers which are therefore more soundly based on actual rather than estimated numbers especially for the last month in the quarter. The not so good news is that I think that adding monthly GDP numbers adds as much confusion as it helps. Also we get too much on this day meaning that important points can be missed, which of course may be the point Yes Prime Minister style.

The scene has been set to some extent this morning by a speech from Luis de Guindos of the ECB.

Euro area data have been weaker than expected in recent months. In fact, industrial production growth fell in the second half of 2018 and the decline was widespread across sectors and most major economies. Business investment weakened. On the external side, euro area trade disappointed, with noticeable declines in net exports.

Whilst that is of course for the Euro area the UK has been affected as well by a change in direction for production. This is especially troubling as in January we were told this.

Production and manufacturing output have risen since then but remain 6.5% and 2.0% lower, respectively, in the three months to November 2018 than the pre-downturn gross domestic product (GDP) peak in Quarter 1 (Jan to Mar) 2008.

It had looked like we might get back to the previous peak for manufacturing but like a Northern rail train things at best are delayed. Production has got nowhere near. There have been positive shifts in it as efficiencies mean we need less electricity production but even so it is not a happy picture.

Gilt Yields

Readers will be aware that I have been pointing out for a while how cheap it is for the UK government and taxpayers to borrow and a ten-year Gilt yield of 1.17% backs that up. A factor in this is the weak economic outlook and another is expectations of more bond buying from the Bank of England. The possibility of the later got more likely at the end of last week as rumours began to circulate of a U-Turn from the US Federal Reserve in this area. Or a possible firing up of what would be called QE4 and perhaps QE to infinity.

The Financial Times has caught up with this to some extent.

Investors’ waning expectations of future rises in interest rates are giving a lift to the UK government bond market.

They note that foreign buyers seem to have returned which is awkward for the FT’s cote view to say the least. Also as we look back to the retirement of Bill Gross his idea that UK Gilts were on a “bed of nitroglycerine” was about as successful as Chelsea’s defence yesterday.Anyway I think it steals the thunder from today’s Institute of Fiscal Studies report.

If the coming spending review is to end austerity Chancellor will need to find extra billions.

I am not saying we should borrow more simply that we could and that we seem keener on borrowing when it is more expensive. The IFS do refer to borrowing costs half way through their report but that relies on people reading that far. They also offered a little insight between economic growth and borrowing.

A downgrade of GDP of 0.5% would reduce annual GDP by around £10 billion and a rule-of-thumb suggests it would add between around £5 billion and £7 billion to the deficit.

Economic growth

The headline was not too bad but it did come with a worrying kicker.

UK gross domestic product (GDP) in volume terms was estimated to have increased by 0.2% between Quarter 3 (July to Sept) 2018 and Quarter 4 (Oct to Dec) 2018; the quarterly path of GDP through 2018 remains unrevised.

There were concerns about the third quarter being affected by a downwards revision to trade data but apparently not via the magic of the annual accounts. Bur even so it was far from a stellar year.

GDP growth was estimated to have slowed to 1.4% between 2017 and 2018, the weakest it has been since 2009…….Compared with the same quarter in the previous year, the UK economy is estimated to have grown by 1.3%.

We shifted even more to being a services economy as it on its own provided some 0.35% of GDP growth meaning that production and construction declined bring us back to 0.2%.

The worrying kicker was this.

Month-on-month gross domestic product (GDP) growth was 0.2% in October and November 2018. However, monthly growth contracted by 0.4% in December 2018 . The last time that services, production and construction all fell on the month was September 2012.

I have little faith in the specific accuracy of the monthly data but it does seem clear that there was a weakening in December and it was widespread. Even the services sector saw a decline ( -0.2%) and the production decline accelerated to -0.5%. Construction fell by 2.8% but that has been a series in which we have least faith of all.

Production

We learn from the monthly GDP data that steel and car production had weak December’s which helped lead to this.

Production output fell by 0.5% between November 2018 and December 2018; the manufacturing sector provided the largest downward contribution with a fall of 0.7%.

Although the detail in this section gives a different emphasis.

There is widespread weakness this month, with 9 of the 13 sub-sectors falling. Of these, pharmaceuticals, which can be highly volatile, provided the largest negative contribution, with a decrease of 4.2%. There was also a notable fall of 2.8% from the other manufacturing and repair sub-sector, where four of the five sub-industries fell due to the impact of weakness from large businesses (with employment greater than 150 persons on average).

We have learnt over time that the pharmaceutical sector swings around quite wildly ( although not as much as seemingly in Ireland last month) so that may swing back. Also production was pulled lower by the warmer weather but continuing that theme there is a chill wind blowing for this sector none the less.

If we switch to a wider perspective it seems that the worldwide economic slowing is leading to a few crutches being used.

 underpinned by strong nominal export growth of 18.9% within alcoholic beverages and tobacco products.

Comment

The theme here is of the good, the bad and the ugly. Where the good is the way that the UK outperformed its European peers in the second half of 2018 after underperforming in the first half. The bad is the decline in the quarterly economic growth rate from 0.6% to 0.2%. Lastly the ugly is the plunge in December assuming that the data is reliable. We were never likely to escape the chill economic winds blowing in the production sector and need to cross our fingers about the impact on services. My theme that we are ever more rebalancing towards services continues in spite of the rhetoric of former Bank of England Governor Baron King of Lothbury.

Meanwhile we continue to have a balance of payment deficit.

The total trade deficit widened £8.4 billion to £32.3 billion between 2017 and 2018, due mainly to a £7.2 billion increase in services imports.

Exactly how much is hard to say as I have little faith in the services estimates. But with economic growth as it is let me leave you with some presumably unintentional humour from the Bank of England.

The Committee judges that, were the economy to develop broadly in line with its Inflation Report projections, 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.

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Oh Italia!

Sometimes events just seem to gather their own momentum in the way that a rolling stone gathers moss so let me take you straight to the Italian Prime Minister this morning.

Italy Dep PM Di Maio: Low Growth Views `Theater Of The Absurd’: Messaggero ( @LiveSquawk )

I have to confess that after the way that the Italian economy has struggled for the last couple of decades this brought the Doobie Brothers to mind.

What a fool believes he sees
No wise man has the power to reason away
What seems to be
Is always better than nothing
And nothing at all

Then the Italian statistics office produced something of a tour de force.

In December 2018 the seasonally adjusted industrial production index decreased by 0.8% compared with
the previous month. The percentage change of the average of the last three months with respect to the
previous three months was -1.1.

As you can see these numbers are in fact worse than being just weak as they show a monthly and a quarterly fall. But they are in fact much better than the next one which is really rather shocking.

The calendar adjusted industrial production index decreased by 5.5% compared with December 2017
(calendar working days being 19 versus 18 days in December 2017); for the whole year 2018 the
percentage change was +0.8 compared with 2017.
The unadjusted industrial production index decreased by 2.5% compared with December 2017.

Just for clarity output was 2.5% lower but as there was an extra working day this year then on a like for like basis it was some 5.5% lower. I would say that was a depressionary type number except of course Italy has been in a long-standing depression.

Digging deeper into the numbers we see that on a seasonally adjusted basis there was a rally in industrial production as the 100 of 2015 nearly made 110 in November 2017, but now it has fallen back to 103.9. But even that pales compared to the calendar adjusted index which is now at 93.3. So whilst the different indices can cause some confusion the overall picture is clear. We do not get a lot of detail on manufacturing except that on a seasonally adjusted basis output was 5.5% lower in December than a year ago.

The drop is such that we could see a downwards revision to the Italian GDP data for the fourth quarter of last year which was -0.2% as it is. Actually the annual number at 0.1% looks vulnerable and might make more impact if the annual rate of growth falls back to 0%. Production in a modern economy does not have the impact it once did and Italy’s statisticians were expecting a fall but not one on this scale.

Monthly Economic Report

After the above we advance on this with trepidation.

World economic deceleration has spilled over into Q4, particularly in the industrial sector, which has
experienced a broad-based loss of momentum in many economies and a further slowing in global trade growth.
In November, according to CPB data the merchandise World trade in volume decreased 1.6%.

So it is everyone else’s fault in a familiar refrain, what is Italian for Johnny Foreigner? This is rather amusingly immediately contradicted by the data.

In Italy, real GDP fell by 0.2% in Q4 2018, following a 0.1% drop in the previous quarter. The negative result is
mainly attributable to domestic demand while the contribution of net export was positive.

So in fact it was the domestic economy causing the slow down. This thought is added to by the trade data where the fall in exports is dwarfed by the fall in imports at least in November as we only have partial data for December.

As for foreign trade, in November 2018 seasonally-adjusted data, compared to October 2018, decreased both
for exports (-0.4%) and for imports (-2.2%). Exports drop for EU countries (-1.3%) and rose for non EU
countries (+0.6%). However, according to preliminary estimates in December also exports to non-EU
countries decreased by 5.0%.

Now let me give an example of how economics can be the dismal science. Because whilst in isolation the numbers below are welcome with falling output they suggest falling productivity.

In the same month, the labour market, employment stabilized and the unemployment rate decreased only
marginally.

The future looks none too bright either,

In January 2019, the consumer confidence improved while the composite business climate
indicator decreased further. The leading indicator experienced a sharp fall suggesting a
worsening of the Italian cyclical position in the coming months.

Indeed and thank you for @liukzilla for pointing this out the Italian version does hint at some possible downgrades, Via Google Translate.

The data of industrial production amplify the tendency to reduce the rhythms of
activity started in the first few months of 2018 (-1.1% the economic variation in T4).

Also a none too bright future.

Data on industry orders also showed a negative trend, with a decrease for both markets in the September-November quarter (-1.3% and -1.0% respectively on the market).
internal and foreign).

The Consumer

Yesterday’s data provided no cheer either.

In December 2018, both value and volume of retail trade contracted by 0.7% when compared with the previous month. Year-on-year growth rate fell by 0.6% in value terms, while the quantity sold decreased by 0.5%.

Although on a quarterly basis there was a little bit assuming you think the numbers are that accurate,

In the three months to December (Quarter 4), the value of retail trade rose by 0.1%, showing a slowdown
to growth in comparison with the previous quarter (+0.4%), while the volume remained unchanged at
+0.3%.

Actually there was never much of a recovery here as the index only briefing rose to 102 if we take 2015 as 100 and now is at 101.5 according to the chart provided. Odd because you might reasonably have expected all the monetary stimulus to have impacted on consumer spending.

Population

This is now declining in spite of a fair bit of immigration.

On 1 st January 2019, the population was estimated to be 60,391,000 and the decrease on the previous year was
around 90,000 units (-1.5 per thousand)………The net international migration amounted to +190 thousand, recording a slight increase on the previous year (+188
thousand). Both immigration (349 thousand) and emigration (160 thousand) increased (+1.7% and +3.1%
respecitvely).

Bond Markets

I have pointed out many times that Italian bond yields have risen for Italy in both absolute and relative terms. Let me present another perspective on this from the thirty-year bond it issued earlier this week.

Today Italy issued 8bln 30yr BTPs. Had it issued the same bond last April, it would have received around 1.3 bilion more cash from the market. ( @gusbaratta ).

Comment

This is quite a mess in a lovely country. Also the ironies abound as for example expanding fiscal policy into an economic decline was only recently rejected by the Euro area authorities. They also have just ended some of the monetary stimulus by ending monthly QE at what appears to be exactly the wrong time. So whilst the Italian government deserves some criticism so do the Euro area authorities. For example if the ECB has the powers it claims why is it not using them?

Of course I don’t want to speculate about what contingency would call for a specific instrument but if you look at the number of instruments we have in place now, we can conclude that it’s not true that the ECB has run out of fuel or has run out of instruments. We have all our toolbox still available. ( Mario Draghi )

But just when you might have thought it cannot get any worse it has.

Me on The Investing Channel

The Bank of England is not “paralysed” on interest-rates

From time to time we have the opportunity to observe the spinning efforts of the house journal of the Bank of England. So without further ado let me hand you over to the Financial Times.

Bank of England ‘paralysed’ on rates by Brexit uncertainty.

The first thought is which way?But then we get filled in.

Turmoil of EU departure constrains policymakers despite tight labour market.

So up it is then, but of course that brings us to territory which is rather well trodden. You see the Bank of England has raised Bank Rate a mere two times in the last eleven years! Thus the concept of it being paralysed by Brexit prospects is a little hard to take. Whereas on the other side of the coin it was able to cut interest-rates from the 5.75% of the summer of 2007 to the emergency rate of 0.5% very quickly including a reduction of 1.5%. That reduction was twice the current Bank Rate and six times the size of the 0.5% rises. Also we note that the panic rate cut of August 2016 not only happened quickly but means that the net interest-rate increase since the comment below has been a mere 0.25%.

This has implications for the timing, pace and degree of Bank Rate increases.
There’s already great speculation about the exact timing of the first rate hike and this decision is becoming
more balanced.
It could happen sooner than markets currently expect.

That was Governor Mark Carney at Mansion House in June 2014 and we now know that “sooner than markets expect” turned out to be more than four years before Bank Rate rose above the 0.5% it was then. But I do not recall the FT telling us about paralysis then about our “rock star” central banker.

The case for an interest-rate rise

There is one relief as we do not get a mention of the woefully wrong output gap concept. But we do get this.

Unless the UK’s sub-par productivity improves, the BoE has argued, unemployment cannot remain at current lows without wage growth feeding consumer prices. The latest data showed the labour market tightening again with employment at a record high and wage growth back to pre-crisis levels. “If they further home in on labour market trends, it will be a clear steer that they have a bias to tighten,” said David Owen, chief European economist at Jefferies, who thinks market pricing currently underestimates the likelihood of UK interest rates rising.

There are two main issues with the argument presented. The first is the productivity assumption where the Bank of England now assumes it has a cap based on a “speed limit” for the economy of an annual rate of growth of 1.5%. It’s assumptions are more likely to be wrong that right. Next is that wage growth is back to pre-crisis levels which is simply wrong. It is around 1% per annum short in nominal terms and simply nowhere near in real terms.

According to Kallum Pickering at Berenberg the Bank of England has really,really,really,really,really,really ( Carly Rae Jepsen)  wanted to raise interest-rates.

“The BoE would be close to the Fed on rate profile if it weren’t for Brexit . . . The Fed wants to pause, but the BoE has gone slower than otherwise,” he said, adding that barring a hard Brexit, the MPC would need to increase rates for a couple of years to catch up.

Sooner of later someone will turn up with the silliest example of all.

Although the BoE maintains it has plenty of firepower to fight any downturn, some outsiders believe one motive to raise interest rates is to gain space to inject stimulus if needed.

A type of Grand Old Duke of York strategy where you march interest-rates to the top of a hill just so that you can march them down again.

Some Reality

The water gets rather choppy as we find a mention of the inflation target.

Similarly, the BoE is likely to cut its near-term forecast for inflation — already close to target, at 2.1 per cent in December, and set to fall further after a drop in energy prices.

If you were serious about raising interest-rates then the period since February 2017 when inflation went over target would be an opportunity to do so except we only got a reversal of the August 2016 mistake and one other. If you go at that pace when inflation is above target it would be really rather odd to do much more when it is trending lower.

The next issue is the economic outlook where we have been recording economic slow downs in both China and Europe. Some of this is related to the automotive sector which has always affected the UK via Jaguar Land Rover and more recently Nissan. On its own that would make this an odd time to raise interest-rates. If we move to the UK outlook then this mornings Markit Purchasing Manager’s Index or PMI tells us this.

January data indicated a renewed loss of momentum for
the UK service sector, with a decline in incoming new work
reported for the first time since July 2016. Subdued demand
conditions meant that business activity was broadly flat
at the start of 2019, while concerns about the economic
outlook weighed more heavily on staff recruitment. Latest
data pointed to an overall reduction in payroll numbers for
the first time in just over six years.

Some care is needed here as the Markit PMI misfired in July 2016 but we need to recall that the Bank of England relied on it. We know this because that October Deputy Governor Broadbent went out of his way to deny it.

All that said, there’s little doubt that the economy has performed better than surveys suggested immediately
after the referendum and, although we aimed off those significantly, somewhat more strongly than our near term forecasts as well.

So in spite of it being an unreliable indicator at times of uncertainty like now I expect the Bank of England to be watching it like a hawk. If so they will be looking at this bit.

Adjusted for seasonal influences, the All Sector Output Index posted 50.3 in January, down from 51.5 in December. The index has posted above the crucial 50.0 no-change mark in each month since August 2016, but the latest reading signalled the slowest pace of expansion over this period and the second-lowest since December 2012.

If accurate that is in Bank Rate cut territory rather than a raise.

Comment

There is a fair bit to consider here so let us start with the “paralysis” point and let me use the words of the absent-minded professor Ben Broadbent from October 2016.

Before August, the UK’s official interest rate had been held at ½% for over seven years, the longest period of
unchanged rates since 1950. No-one on the current MPC was on the Committee when rates were previously
changed, in early 2009; indeed there are children now at primary school who weren’t even alive at the time.

Oh well as Fleetwood Mac would put it. Next comes the issue of why the Bank of England is encouraging what is effectively false propaganda about raising interest-rates? Personally I believe it is a type of expectations management as they increasingly fear that they will have to cut them again. So we are being guided towards the view that events are out of their control. This is awkward as we note the scale of their interventions ( for example some £435 billion of QE) and the way that positive news is always presented as being the result of their actions. Yet they also claim when convenient that lower interest-rates are nothing to do with them at all.

As to my view I am still of the view that we need higher interest-rates but that now is not the time. The boat sailed in the period 2014-16 when the rhetoric of Forward Guidance was not matched by any action. It is hard not to have a wry smile at us being guided towards a 7% unemployment rate then 6.5% and so on to the current 4%.

Italy may be in a recession but more importantly its depression never ended

The last 24 hours have brought the economic problems and travails of Italy into a little sharper focus. More news has arrived this morning but before we get there I would like to take you back to early last October when the Italian government produced this.

Politics economy, reform action, good management of the PA and dialogue with businesses and citizens will therefore be directed towards achieving GDP growth of
at least 1.5 percent in 2019 and 1.6 percent in 2020, as indicated in new programmatic framework. On a longer horizon, Italy will have to grow faster than the rest of Europe, in order to recover the ground lost in the last
twenty years.

This was part of the presentation over the planned fiscal deficit increase and on the 26th of October I pointed out this.

If we look back we see that GDP growth has been on a quarterly basis 0.3% and then 0.2% so far this year and the Monthly Economic Report tells us this.

The leading indicator is going down slightly suggesting a moderate pace for the next months.

They mean moderate for Italy.So we could easily see 0% growth or even a contraction looking ahead as opposed some of the latest rhetoric suggesting 3%  per year is possible. Perhaps they meant in the next decade as you see that would be an improvement.

Political rhetoric suggesting 3% economic growth is a regular feature of fiscal debates because growth at that rate fixes most fiscal ills. The catch is that in line with the “Girlfriend in a Coma” theme Italy has struggled to maintain a growth rate above 1% for decades now. Also as we look back I recall pointing out that we have seen quarterly economic growth of 0.5% twice, 0.4% twice, then 0.3% twice in a clear trend. So we on here were doubtful to say the least about the fiscal forecasts and were already fearing a contraction.

Yesterday

All Italy’s troubles were not so far away as the statistics office produced this.

In the fourth quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross
Domestic Product (GDP) decreased by 0.2 per cent with respect to the previous quarter and increased by
0.1 per cent over the same quarter of previous year.

Whilst much of the news concentrates on Italy now being in a recession the real truth is the way that growth of a mere 0.1% over the past year reminds us that it has never broken out of an ongoing depression. If we look at the chart provided we see that in 2008 GDP was a bit over 102 at 2010 prices but now it has fallen below 97. So a decade has passed in fact more like eleven years and the economy has shrunk. Also I see the Financial Times has caught onto a point I have been making for a while.

Brunello Rosa, chief executive of the consultancy Rosa and Roubini, has pointed out that, on a per capita basis, Italy’s real gross domestic product is lower than when the country adopted the euro in 1999. Over the same period Germany’s per capita real GDP has increased by more than 25 per cent, while even recession-ravaged Greece has performed better than Italy on the same basis.

On that basis Italy has been in a depression this century if not before. Indeed if you look at the detail it comes with something that challenges modern economic orthodoxy, so let me explain. In 1999 the Italian population was 56,909,000 whereas now it is just under 60.5 million. Much of the difference has been from net migration which we are so often told brings with it a list of benefits such as a more dynamic economic structure and higher economic growth. Except of course, sadly nothing like that has happened in Italy. As output has struggled it has been divided amongst a larger population and thus per head things have got worse.

Meanwhile this seems unlikely to help much.

Italy’s statistical institute will soon have a new president, the demographer Gian Carlo Blangiardo. He has recommended calculating life expectancy from conception – rather than birth – so as to include unborn babies. ()

Also population statistics in general have taken something of a knock this week.

Pretty interesting – New Zealand just found it has 45,000 fewer people than it thought. In a population of 4.9 million (maybe), that means economists might have to start revising things like productivity and GDP growth per capita. ( Tracy Alloway of Bloomberg).

Can I just say chapeau to whoever described it as Not So Crowded House.

The banks

I regularly point out the struggles of the Italian banks and say that this is a factor as they cannot be supporting the economy via business lending so thank you to the author of the Tweet below who has illustrated this.

As you can see whilst various Italian government’s have stuck their heads in the sand over the problems with so many of the Italian banks there has been a real cost in terms of supporting business and industry. This has become a vicious circle where businesses have also struggled creating more non-performing loans which weakens the banks as we see a doom loop in action.

What about now?

The GDP numbers gave us an idea of the areas involved on the contraction.

The quarter on quarter change is the result of a decrease of value added in agriculture, forestry and fishing
as well as in industry and a substantial stability in services. From the demand side, there is a negative
contribution by the domestic component (gross of change in inventories) and a positive one by the net
export component.

The latter part is a bit awkward for Prime Minister Conte who has taken the politically easy way out and blamed foreigners this morning. As to the industrial picture this morning;s PMI business survey suggests things got worse rather than better last month.

“January’s PMI data signalled another deterioration in Italian manufacturing conditions, with firms struggling in the face of a sixth consecutive monthly fall in new business. Decreases in output, purchasing activity and employment (the first in over four years) were recorded, marking a weak start to 2019.”

The spot number of 47.8 was another decline and is firmly in contraction territory.

Comment

This is as Elton John put it.

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

Italy has been in an economic depression for quite some time now but nothing ever seems to get done about it. Going back in time its political leadership were keen to lock it into monetary union with France and Germany but the hoped for convergence has merely led to yet more divergence.

One of the hopes is that the unofficial or what used to be called the black economy is helping out. I hope so in many ways but sadly even that is linked to the corruption problem which never seems to get sorted out either. Oh and whilst many blame the current government some of that is a cheap shot whilst it has had its faults so has pretty much every Italian government.

 

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A bond issue does little for the problem of plunging investment in Greece

Today brings a development which will no doubt be trumpeted across the media and it is explained by this from Reuters yesterday,

Greece will return to bond markets with a five-year issue “in the near future, subject to market conditions”, authorities said on Monday.

The sovereign has mandated BofA Merrill Lynch, Goldman Sachs International Bank, HSBC, J.P. Morgan, Morgan Stanley and SG CIB as joint lead managers for the transaction, according to a regulatory filing to the stock exchange.

The near future is today as we mull that in spite of its role in the Greek economic crisis Goldman Sachs is like the Barnacles in the writings of Charles Dickens as it is always on the scene where money is involved. As to why this is happening the Wall Street Journal explains.

Greece‘s borrowing costs have dropped to a four-month low, and Athens plans to raise up to $3.4 billion in a bond sale.

Although it is not turning out to be quite as cheap as the 3.5% hoped for.

Greece Opens Books For New 5 Year Bond, Initial Guidance For Yield 3.75-3.875% – RTRS Source ( @LiveSquawk)

Why are investors buying this?

The obvious objection is the default history of Greece but in these times of ultra low yields ~3.8% is not be sniffed at. This is added to by the Euro area slow down which could provoke more ECB QE and whilst Greece does not currently qualify it might as time passes. In the mean time you collect 3.8% per annum.

Why is Greece offering it?

This is much more awkward for the politicians and media who trumpet the deal because it is a bad deal in terms of financing for Greece. It has been able to borrow off the European Stability Mechanism at not much more than 1% yield for some time now. Actually its website suggests it has been even cheaper than that.

0.9992% Average interest rate charged by ESM on loans (Q1 2018)

Past borrowing was more expensive so the overall ESM average is according to it 1.62%. So Greece is paying a bit more than 2% on the average cost of borrowing from the ESM which is hardly a triumph. Even worse the money will have to be borrowed again in five years time whereas the average ESM maturity is 32 years ( and may yet be an example of To Infinity! And Beyond!).

So there is some grandstanding about this but the real reason is escaping from what used to be called the Troika and is now called the Institutions. The fact the name had to be changed is revealing in itself and I can understand why Greece would want to step away from that episode.
As we move on let me remind you that Greece has borrowed some 203.8 billion Euros from the ESM and its predecessor the EFSF.

The economy

We can see why the Greek government wants to establish its ability to issue debt and stay out of the grasp of the institutions as we note this from Kathimerini.

Greek Prime Minister Alexis Tsipras announced an 11 percent increase in the minimum wage during a cabinet meeting on Monday, the first such wage hike in the country in almost a decade.

Actually the sums are small.

The hike will raise the minimum wage from 586 to 650 euros and is expected to affect 600,000 employees. He also said the government will scrap the so-called subminimum wage of 518 euros paid to young employees.

There are two catches here I think. Firstly in some ways Greece is competing with the Balkan nations which have much lower average wages than we are used to. Also this reverses the so-called internal competitiveness model.

The standard mimimum monthly wage was slashed by 22 percent to 586 euros in 2012, when Greece was struggling to emerge from a recession.

A deeper cut was imposed on workers below 25 years, as part of measures prescribed by international lenders to make the labour market more flexible and the economy more competitive.

Productivity

Here we find something really rather awkward which in some ways justifies the description of economics as the dismal science. Let me start with a welcome development which is the one below.

The seasonally adjusted unemployment rate in October 2018 was 18.6% compared to 21.0% in October 2017 and 18.6% in September 2018 ( Greece Statistics Office)

But the improving labour market has not been matched by developments elsewhere as highlighted by this.

we documented that employment had started to lead output growth in the early days of the SYRIZA government. Since such a policy is unsustainable, we have to include in any consistent outlook that this process reverses and output starts leading employment again – hence restoring positive productivity growth. ( Kathimerini)

That led me to look at his numbers and productivity growth plunged to nearly -5% in 2015 and was still at an annual rate of -3% in early 2016. Whilst he says we “have to include” an improvement the reality is that it has not happened yet as this year has seen two better quarters and one weaker one. We have seen employment indicators be the first sign of a turn in an economy before but they normally take a year or so to be followed by the output indicator not three years plus. This reminds us that Greek economic growth is nothing to write home about.

The available seasonally adjusted data
indicate that in the 3rd quarter of 2018 the Gross Domestic
Product (GDP) in volume terms increased by 1.0% in comparison with the 2nd quarter of 2018, while
in comparison with the 3rd quarter of 2017, it increased by 2.2%.

If it could keep up a quarterly rate of 1% that would be something but the annual rate is in the circumstances disappointing. After all the decline was from a quarterly GDP of 62 billion Euros at the peak in 2009 whereas it is now 51.5 billion. So the depression has been followed by only a weak recovery.

More debt

I looked at the woes of the Greek banks yesterday but in terms of the nation here is the Governor of the central bank from a speech last week pointing to yet another cost on the way to repairing their balance sheets

An absolutely indicative example can assess the immediate impact of a transfer of about €40 billion of NPLs, namely all denounced loans and €7.4 billion of DTCs ( Deferred Tax Credits).

Comment

Whilst I welcome the fact that Greece has finally seen some economic growth the problem now is the outlook. The general Euro area background is not good and Greece has been helped by strong export growth currently running at 7.6%. There have to be questions about this heading forwards then there is the simply woeful investment record as shown by the latest national accounts.

Gross fixed capital formation (GFCF) decreased by 23.2% in comparison with the 3rd quarter of 2017.

The scale of the issue was explained by the Governor of the central bank in the speech I referred to earlier.

However, in order to increase the capital stock and thus the potential output of the Greek economy, positive net capital investment is indispensable. For this to happen, private investment must grow by about 50% within the next few years. In other words, the Greek economy needs an investment shock, with a focus on the most productive and extrovert business investment, to avoid output hysteresis and foster a rebalancing of the growth model in favour of tradeable goods and services.

Yet as we stand with the banks still handicapped how can that happen? Also if we return to the productivity discussion at best it will have one hand tied behind its back by as the lack of investment leads to an ageing capital stock. So whilst the annual rate of economic growth may pick up at the end of 2018 as last year quarterly growth was only 0.2% I am worried about the prospects for 2019.

It should not be this way and those who created this deserve more than a few sleepless nights in my opinion.

Argentina is counting the cost of its 60% interest-rates

In these times of ultra low interest-rates in the western world anywhere with any sort of interest-rate sticks out. In the case of Argentina an official interest-rate of 60% sticks out like a sore thumb in these times and in economic terms there is a second factor in that it has been like that for a while now. So the impact of this punishing relative level of interest-rates will be building on the domestic economy. Also the International Monetary Fund is on hand as this statement from Christine Lagarde yesterday indicates.

“I commended Minister Dujovne and Governor Sandleris on decisive policy steps and progress thus far, which have helped stabilize the economy. Strong implementation of the authorities’ stabilization plan and policy continuity have served Argentina well, and will continue to be essential to enhance the economy’s resilience to external shocks, preserve macroeconomic stability and to bolster medium-term growth.

“I would like to reiterate the IMF’s strong support for Argentina and the authorities’ economic reform plan.”

The opening issue is that sounds awfully like the sort of thing the IMF was saying about Greece when it was predicting a quick return to economic growth and we then discovered that it had created an economic depression there. Of course Christine Lagarde was involved in that debacle too although back then as Finance Minster of France rather than head of the IMF. Also the last IMF press conference repeated a phrase which ended up having dreadful connotations in the Greek economic depression.

It’s on track as of our last mission which was, you know, in December.

As the track was from AC/DC.

I’m on the highway to hell
On the highway to hell
Highway to hell
I’m on the highway to hell
No stop signs, speed limit
Nobody’s gonna slow me down

So let us investigate further.

Monetary policy

The plan is to contract money supply growth so you could look at this as like one of those television programmes that take us back to the 1970s.

In particular, the BCRA undertakes not to raise the monetary base until June 2019. This target brings about a significant monetary contraction; while the monetary base increased by over 2% monthly in the past few months, it will stop rising from now onwards. Then, the monetary base will dramatically shrink in real terms in the following months.

So you can see that the central bank of Argentina is applying quite a squeeze and is doing it to the monetary base because it is a narrow measure, Actually it explains it well in a single sentence.

The BCRA has chosen the monetary base as it is the aggregate it holds a grip on.

It is doing it because it can. Although I am a little dubious about this bit.

The monetary base targeting will be seasonally adjusted in December and June, when demand for money is higher.

It is usually attempts to control broad money that end up targeting money demand rather than supply. It is being achieved with this.

the BCRA undertakes to keep the minimum rate on LELIQs at 60% until inflation deceleration becomes evident.

Also there will be foreign exchange intervention if necessary, or more realistically there has been a requirement for it.

The monetary target is supplemented with foreign exchange intervention and non-intervention measures. Initially, the BCRA would not intervene in the foreign exchange market if the exchange rate was between ARS34 and ARS44. This range is adjusted daily at a 3% monthly rate until the end of the year, and will be readjusted at the beginning of next year. The BCRA will allow free currency floating within this range, considering it to be adequate.

Finally for monetary policy then monetary financing of the government by the central bank is over.

As it has already been reported, the BCRA will no longer make transfers to the Treasury.

Fiscal Policy

Another squeeze is on here as the BCRA points out.

Finally, the new monetary policy is consistent with the targets of primary fiscal balance for 2019 and of surplus for 2020.

Yes in terms of IMF logic but the Greek experience told a different story. There a weaker economy made the fiscal targets further away and tightening them weakened the economy in a downwards spiral.

So where are we?

The squeeze is definitely as my calculations based on the daily monetary report show that the monetary base has shrunk by just under 4% in the last 30 days. If we move onto the consequences of this for the real economy then any central bankers reading this might need to take a seat as the typical mortgage rate in December was 48%. To give you an idea of other interest-rates then an overdraft cost 71% and credit card borrowing cost 61%.

If we look for the impact of such eye-watering levels we see that mortgage growth was on a tear because annually it is 54% up of which only 0.1% came in the last month. Moving to unsecured borrowing overdraft growth has been -1.2% over the past 30 days but credit card growth has been 3.5% so perhaps there has been some switching.

Economic growth

This has gone into reverse as you can see from this from the statistics office.

The provisional estimate of the gross domestic product (GDP), in the third quarter of 2018, had a fall of 3.5% in relation to the same period of the previous year.
The seasonally adjusted GDP of the third quarter of 2018, with respect to the second quarter of 2018, showed a variation of -0.7%.

So a weaker quarter following on from a 4.1% dip in the second quarter of 2018 which was mostly driven by the impact of a drought on the agricultural sector. Looking back the Argentine economy did recover from the credit crunch pretty well but the recorded dip so far takes us back to 2011 or eight years backwards.

The IMF points out this year should get the agricultural production back which is welcome.

However,
in the second quarter, a rebound in agricultural
production (expected to fully recover the 30 percent
production lost in 2018 because of the drought)
should lead to a gradual pickup in economic activity.

But if we put that to one side there has to be an impact from the credit crunch. Also whilst this is good.

The recession and peso depreciation are quickly lowering the trade deficit.

It does come with something which has a very ominous sign for domestic consumption.

The adjustment mainly reflects
lower imports, reflecting a contraction in
consumption and investment.

Moving to inflation then here it is.

The general level of the consumer price index (CPI) representative of the total number of households in the country registered in December a variation of 2.6% in relation to the previous month.

Comment

There is a fair bit to consider here as we see a monetary squeeze imposed on an economy suffering from a drought driven economic contraction. Also I have form in that I warned about the dangers of raising interest-rates to protect a currency on May 3rd.

However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one.

Interest-rates were half then what they are now and I have already pointed out what mortgage rates now are. As to what sort of a economic crunch is coming the latest from the statistics office looks rather ominous.

The statistics office’s monthly economic activity index fell 7.5% y/y in November after dropping 4.2% in the previous month.

As to the business experience this from Reuters gives us a taste of reality.

Like many small businessmen, Meloni has found himself caught in a vice. Sales from his plant in the town of Quilmes, 30 km (19 miles) outside the capital Buenos Aires, shrank by just over one third last year as Argentina’s economy sank deep into recession…..

 

Meloni said the plant, which makes fabrics, used to operate 24 hours a day from Monday to Saturday but now just operates 16 hours a day, five days a week. Like many other businesses, Meloni advanced the holidays to his roughly 100 employees with the hope that once summer ends in March, demand will pick up.

It is very expensive to make people in Argentina which keeps people in a job (good) but with lower pay from less work (bad) and if it keeps going will collapse the company (ugly).

Back in the financial world I also wonder how this is going?

About a year after emerging from default, Argentina has surprised investors by offering a 100-year bond.

The US-dollar-denominated bond is offered with a potential 8.25 per cent yield.

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Here are my answers to questions asked about the Euro area economy