The Italian banks and how they have contributed to a possible end to deposit protection

A regular feature of recent years has been the Italian banking saga where we are continually reassured that banks are fine and then it turns out that they are not. Many of the misrepresentations have come from Finance Minister Padoan who was in fine form in January according to Politico.

Italian Finance Minister Pier Carlo Padoan has defended the way his country dealt with its banking crisis, saying the government had “only spent €3 billion” on bailouts, in an interview with Die Welt published today.

“We are the EU country that has paid the least to save its banks,” Padoan said. Out of 600 banks, only eight “have problems,” he noted, saying the “system as a whole is not in crisis,” having “withstood the financial crisis.”

Apparently this is a mere bagatelle or the Italian equivalent.

Italy’s banking system is groaning under €360 billion in bad loans,

Such is his loose association with the truth he claimed this.

“I assure you, we have no interest in state intervention,” Padoan said

whilst doing this.

The government has set aside a €20-billion fund to save banks, and is expected to provide roughly €6.7 billion of that to prop up ailing Tuscan lender Monte dei Paschi di Siena.

Oh and he had one last go at what in modern parlance is called “misspeaking”.

Everything has been done “according to European guidelines,” the finance minister added, defending the use of bail-ins, whereby creditors and depositors take a loss on their holdings to help rescue a failing bank.

Actually what was about to come drove a Challenger tank through the rules and in my opinion has contributed to potentially ominous developments for bank depositors in the Euro area. At the moment deposits up to 100,000 Euros are covered unequivocally but on the 8th of this month the European Central Bank published an opinion piece including this and the emphasis is mine.

The general exception for covered deposits and claims
under investor compensation schemes should be replaced by limited discretionary exemptions to
be granted by the competent authority in order to retain a degree of flexibility. Under that approach,
the competent authority could, for example, allow depositors to withdraw a limited amount of
deposits on a daily basis consistent with the level of protection established under the Deposit
Guarantee Schemes Directive (DGSD)34,

That has echoes of the demonetisation shambles that took place in India a year or so ago with queues around the corner for the banks. Now let us take care as the deposit protection scheme still exists as I have seen plenty of places on social media claiming it does not but there are questions about it in the future as you can see. One of my themes is in play here as we note that the ECB is much more concerned about “the precious” than the rights and maybe losses of depositors.

The ECB cautions that prolonged periods during which depositors have no access to their deposits undermine confidence in the banking system and might ultimately create risks to financial stability.

You don’t say!

Monte Paschi

Top of the list as ever is the world’s oldest bank and in terms of the terminator it’s back. From Reuters on the 25th of October.

Shares in the bank opened on Wednesday at 4.10 euros, which became the reference price for the session, and then rose to as much as 5.26 euros, up 28 percent.

That price translates to a paper loss of 1.3 billion euros for Italian taxpayers, who are set to hold 68 percent of the Tuscan bank, which was central to public and private finances in Siena and the surrounding region.

Italy’s government paid 6.49 euros a share in August, when it pumped 3.85 billion euros into Monte dei Paschi, and is spending another 1.5 billion euros to shield some of the bank’s junior bondholders, whose debt was converted into equity.

Actually since then shareholders have had a rather familiar sinking feeling as the price as I type this is 3.95 Euros as I type this. Perhaps the former Prime Minister has suggested the shares are a good buy again as of course last time in an unfortunate mistranslation that actually meant good-bye. As I pointed out last week troubles are brewing around this issue. From Reuters.

A group of bondholders challenged Italy’s rescue of ailing bank Monte dei Paschi di Siena (MI:BMPS), suing the lender over the cancellation of their investments and calling for the bonds to be reinstated.

The Italian banking enquiry looked at the state of play yesterday and there are allegations of wrong doing pretty much everywhere as losses were hidden. Indeed Germany’s banking supervisor got dragged in as there are claims it kept back information on the derivatives contracts with Deutsche Bank.

Banca Carige

Next on the list there is this from Reuters this morning.

 Italy’s Banca Carige warned that its working capital is not sufficient to satisfy its own needs for the next 12 months, the lender said in he prospectus for its imminent capital increase.

Carige also said it had not yet received the final SREP assessment by the European Central Bank, adding it could not rule out a request by the authority for additional capital strengthening measures.

The bank secured backing from core shareholders and underwriters for a vital 560 million euro cash call in a last-minute agreement signed on Friday.

Creval

Here is IlSole from Sunday via Google Translate on this subject.

A 70% collapse in less than two weeks had not been taken into account by anyone in Sondrio. Yet that is what is happening in the title of Credito Valtellinese. The Lombard bank has seen its capitalization deflating from 280 million to 95 million in a dozen sessions. And triggering sales was the announcement of the same bank to raise a 700 million capital increase.

There are obvious issues in wanting an extra 700 million Euros when your value is 280 million let alone 95 million! Anyway the share price has seen better days as it has fallen by just under 6% to 1.38 Euros as I type this.

Banca Popolare di Bari.

In a former life I used to deal with quite a few Italian banks on behalf of Deutsche Bank and am straining my memory to recall if my trip to Bari included this one. Anyway times were seemingly much better than now if this letter quoted in i due punti in September is any guide.

An important letter sent by Federconsumatori Italia to the Minister of the Economy, to the Governor of Banca d’Italia and to the President of Consob ….
It reads on the Republic signing of Antonello Cassano ” The bank has ruined our lives, we want to go back our savings. ” It is a climate of anger and despair that one breathes in the headquarters of the Banca Popolare di Bari shareholder protection committee………Investigations by the Bari Public Prosecutor’s Office describe years of irregular management, loss accounts and abnormal loans. Heavy offenses challenged at the top of Bpb, by the association for delinquency and fraud until false statements in the prospectus.

Comment

There is much to consider here as this is happening at the wrong stage in the cycle as the Italian economy has improved ( 0.5% GDP growth in the third quarter) which should be supporting the banks. Some of the non performing loans will be improving. However contrary to the boasting of Finance Minister Padoan the low bailout figure for Italy was a form of denial as problems were hidden and then ignored meaning that they got worse. A factor in this has been Italy’s problem with the size of its national debt and an aversion to adding to it.So now we find ongoing troubles instead of improvement.

Also the ongoing crisis and subversion of Euro area rules has in my view contributed to the way that the ECB is now considering changes to deposit protection. There is an irony here as its President has a past deeply entwined with all this as not only was he Governor of the Bank of Italy but there is a clue in the way that the banking regulations are called the “Draghi Laws”! Here is how he sums up the current state of play.

The other trend is the growing resilience of the financial sector.

Just for clarity in officialese banks are always resilient up to the day they collapse. But Mario is bright enough to cover himself.

Clearly this trend hides some variation among banks, which is largely driven by differences in their business models.

Can anybody think of who he might mean?

 

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The ECB has it successes but also plenty of problems

Let is continue the central banking season which allows us to end the week with some good news. As this week has developed there has been good news about economic growth in the Euro area.

The Federal Statistical Office (Destatis) reports that, in the third quarter of 2017, the gross domestic product (GDP) rose 0.8% on the second quarter of 2017 after adjustment for price, seasonal and calendar variations. In the first half of 2017, the GDP had also increased markedly, by 0.6% in the second quarter and 0.9% in the first quarter.

It has been a strong 2017 so far for the German economy but of course whilst analogies about it being the engine of the Euro area economy might be a bitter thinner on the ground due to dieselgate there are still elements of truth about it. But we know that a rising tide does not float all economic boats so ECB President Mario Draghi will have been pleased to see this about a perennial struggler.

In the third quarter of 2017 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.5 per cent with respect to the second quarter of 2017 and by 1.8 per cent in comparison with the third quarter of 2016.

Of course Mario will be especially pleased to see better news from his home country of Italy especially at a time when more issues about the treatment of non-performing loans at its banks are emerging. Also this bank seems to be running its own version of the never-ending story, from the Financial Times.

A group of investors in the world’s oldest bank, Italy’s Monte dei Paschi di Siena, have filed a lawsuit in Luxembourg after it announced bonds would be annulled as part of a state-backed recapitalisation.

But in Mario’s terms he is likely to consider the overall numbers below to be a delivery on his “whatever it takes” speech and promise.

Seasonally adjusted GDP rose by 0.6% in the euro area…….Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.5% in the euro
area.

Inflation

This is a more problematic area for Mario Draghi as this from his speech in this morning indicates.

According to a broad range of measures, underlying inflation has ticked up moderately since the start of this year, but it still lacks clear upward momentum.

This matters because unlike the Bank of England the ECB takes inflation targeting seriously and a past President established a rather precise estimate of it at 1.97% per annum. We seem unlikely now to ever find out how Mario Draghi would deal with above target inflation but he finds himself in what for him maybe a sort of dream. Economic growth has recovered with inflation below target so he can say this.

This recalibration of our asset purchases, supported by the sizeable stock of acquired assets and the forthcoming reinvestments, and by our forward guidance on interest rates, helps to maintain the necessary degree of accommodation and thereby to accompany the economic recovery in an appropriate way.

So we will get negative interest-rates ( -0.4%) for quite a while yet as he has hinted in the past that they may persist past the end of his term. Also of course whilst at a slower rate ( 30 billion Euros a month) the QE ( Quantitative Easing) programme continues. Even that has worked out pretty well for Mario as continuing at the previous pace seemed set to run out of German bonds to buy.

Consequences

However continuing with monetary expansion into a boom is either a new frontier or something which later will have us singing along with Lyndsey Buckingham.

(I think I’m in)(Yes) I think I’m in trouble
(I think I’m in) I think I’m in trouble

Corporate Bonds

When you buy 124 billion Euros of corporate bonds in a year and a few months there are bound to be consequences.

“Tequila Tequila” indeed. What could go wrong with this.?

OK, we are officially in la la land. A BBB rated company just borrowed 500 million EUR for 3 years with a negative yield of -0.026 %. A first..  ( h/t @S_Mikhailovich )

You can take your pick whether you think that Veolia is able to issue debt at a negative interest-rate or at only 0.05% above the swaps rate is worse.

Mario Draghi explained this sort of thing earlier in a way that the Alan Parsons Project would have described as psychobabble.

By accumulating a portfolio of long-duration assets, the central bank can compress term premia by extracting duration risk from private investors. Via this “duration extraction” effect, the central bank frees up risk bearing capacity in markets, spurs a rebalancing of private portfolios toward the remaining securities, and thus lowers term premia and yields across a range of financial assets.

Moral hazard anyone?

The dangers of this sort of thing have been highlighted by what has happened to Carillion this morning.

The wages problem

It is sometimes argued in the UK that weak wage growth is a consequence of high employment and low unemployment. But we see that there are issues too in the Euro area where the latter situations whilst improved are still poorer.

A key issue here is wage growth.Since the trough in mid-2016, growth in compensation per employee has risen, recovering around half of the gap towards its historical average. But overall trends remain subdued and are not broad-based.

Indeed if we look back to late May Mario gave us a rather similar reason to what we often here in the UK as an explanation of weak wages growth.From the Financial Times.

Mr Draghi also acknowledged concerns that sinking unemployment was not leading to a recovery in well-paid permanent jobs………….Mr Draghi said he agreed. “What you say is true,” he said. “Some of this job creation is not of good quality.”

The Italian Job

As I hinted earlier in this piece there are ever more signs of trouble in the Italian banking sector. There have been many cases of can kicking in the credit crunch era but this has been something of a classic with of course a dash of Italian style and finesse. From the FT.

Mid-sized Genoan bank Carige’s future looked uncertain this week after a banking consortium pulled its support for a €560m capital increase demanded by European regulators. Shares in another mid-sized bank Credito Valtellinese fell 8.5 per cent to a market value of €144m after it announced a larger than anticipated €700m capital raising to shore up its balance sheet.

There are issues with banks elsewhere as investors holding bonds which were wiped out insist on their day in court.

Comment

As you can see there is indeed good news for Mario Draghi to celebrate as not only is the Euro area seeing solid economic growth it is expected to continue.

From the ECB’s perspective, we have increasing confidence that the recovery is robust and that this momentum will continue going forward.

The problem though is where does it go from here? Even Mario himself worries about the consequences of monetary policy which has been so easy for so long and is now pro cyclical rather than anti cyclical before of course dismissing them. But unless you believe that growth will continue forever and recessions have been banished there is the issue of how do you deal with the latter when you already have negative interest-rates and ongoing QE?

Also the inflation target problem is covered up by describing it is price stability when of course it is anything but.

Ensuring price stability is a precondition for the economy to be able to grow along a balanced path that can be sustained in the long run.

Wage growth would be improved in real terms if inflation was lower and not higher.

Also Mario has changed his tune on the fiscal situation which he used to regularly compare favourably to elsewhere.

This means actively putting our fiscal houses in order and building up buffers for the future – not just waiting for growth to gradually reduce debt. It means implementing structural reforms that will allow our economies to converge and grow at higher speeds over the long-term.

Number Crunching

This from Bloomberg seemed way too high to me.

Italy’s failure to qualify for the soccer World Cup finals for the first time in 60 years may cost the country about 1 billion euros ($1.2 billion), the former chairman of the national federation said.

Me on Core Finance

http://www.corelondon.tv/2-uk-growth-cap-unreliable-predictive-bodies-bad/

 

 

 

 

 

What are the consequences of a parallel currency for Italy?

This week has seen the revival of talk about a subject which has done the rounds before. It would also appear that you cannot keep Silvio Berlusconi down as he was the person bringing it back into the news! Here is what was put forwards according to the Financial Times.

Berlusconi said the right-wing Lega Nord’s proposal of introducing the so-called ‘mini-BoT’ (short-term, interest-free, small-sized government securities, a sort of ‘IOUs’ to be used as internal currency to pay government suppliers, taxes, social security contributions, etc) would not be too far from his idea of a parallel currency.

There are quite a few issues here but let us stick to the obvious question which is could it happen? The FT again.

Berlusconi’s point then is that a parallel currency could be launched entirely legally within the constructs of European treaties, with the ECB potentially powerless to intervene once the decision has been taken.

Either way, regardless of whether Italy goes down the path of an explicit parallel currency or the introduction of small-sized Italian government securities, it’s clear the will to break up the euro’s monopoly in Italy is growing.

According to Citi’s analysts more than two thirds of Italian voters currently support parties with an anti-euro stance.

An interesting view although of course likely to cause something of an Italian turf war as the current President of the ECB Mario Draghi told us this in July 2012.

And so we view this, and I do not think we are unbiased observers, we think the euro is irreversible. And it’s not an empty word now, because I preceded saying exactly what actions have been made, are being made to make it irreversible.

Of course the speech went further with the by now famous phrase below.

Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.

So there would be an especial irony should it be that Mario’s home country ends up torpedoing the whole project. Perhaps that is why his speech this morning refers back to 2012.

Investors had begun pricing redenomination risk into sovereign debt and interbank markets, as they worried about the possible break-up of the euro area.

And reminds us of his “Jedi Mind Trick” from back then.

This is why we announced Outright Monetary Transactions (OMTs) as an instrument that can support our monetary policy. The idea was for the ECB to purchase the sovereign bonds of countries affected by panic-based redenomination risk.

This brings us back to this week where Italian bond yields rose in response to such risk but only to 2.1% for the ten-year as I type this. So some 5% lower than the time of the Euro crisis and those selling Italian bonds would most likely be selling them to the bond buyers of the ECB. So in that sense Mario has played something of a blinder here especially if we allow for the fact that going forwards the ECB may purchase such bonds disproportionately ( partly because it is running out of German bonds to buy).

Some care is needed as on the face of it there is only one winner which is the “whatever it takes” ECB. But take care because if we dive a little deeper there is the issue of the ECB being backed by 19 different treasuries including the Italian one. What if people started to believe it would no longer be one of them? What would the other treasuries think about owning lots of Italian government bonds ( 283.7 billion Euros)? It would make the discussions with the UK look like a tea party.

How did this begin?

In essence the parallel currency thoughts came out of this summarised by Roubini’s Economonitor in July 2014.

Since 2008, Italy’s industrial production has shrunk 25 per cent. In the last quarter of 2013, while exports reached back to almost the same level as in 2007, household consumption was down by about 8 per cent and investment by 26 per cent, with a capacity loss in manufacturing hovering around 15 per cent. Between 2007-2013 employment fell by more than a million, and the unemployment rate more than doubled (Banca d’Italia 2014a).

So we have the issue of Italian economic underperformance which regular readers will be well aware of. Not only was economic output below that below the credit crunch peak it went below the level of the year 2000. On an individual level the position was in fact even worse as the population has grown in the Euro area and I recall calculating that economic output ( GDP) per head was in fact 7% lower than in 2000.

What about now?

Whilst the specific numbers this morning were for France and Germany the Markit PMI business survey hinted at more growth for Italy.

The rest of the eurozone saw a slightly weaker increase in output during the month, albeit one that was still marked. A slower rise in services activity outweighed stronger growth of manufacturing output.

This adds to last weeks official release.

In the second quarter of 2017 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.4 per cent with respect to the first quarter of 2017 and by 1.5 per cent in comparison with the second quarter of 2016.

So we find an irony in that the parallel currency has been revived when Italy is doing better economically. The catch is that if we move to the individual experience and look at GDP per inhabitant we see the underling issue. In 2007 GDP per individual was 28.699 Euros and in 2016 it was 25876 Euros in 2010 prices.

Comment

There is a fair bit to consider here and the first is that parallel currencies are usually not approved by the government and may even be restricted or made illegal. Usually it is the US Dollar being used due to a loss of faith in the national currency although in an irony some places could use the Euro. We saw an example of the US Dollar being used in Ukraine for example. So the crux of the matter in many ways would be what would be legal tender in Italy going forwards and as someone observed when we looked at Bitcoin can it be used to pay taxes? Presumably this time the answer to the latter would be yes.

Next comes the interrelated issues of capital flight and currency depreciation or devaluation. I think that it is clear that large sums would leave Italy which poses the issue of whether a 1:1 exchange-rate could be maintained and for how long? I see no mention for example of what the official interest-rate would be? Moving onto debts such as bank debt and Italian government bonds or BTPs in theory the ECB could insist on repayment in Euros but in practice we come to the famous quote from Joseph Stalin.

“How many divisions does the Pope of Rome have?”

In the end it comes down to the words fiat and and faith. The first is easy as the government can make a law but will people not only have faith but really believe? Also in a way it is something of a side show ( Bob) because both pre and during the Euro what Italy has needed is reform and of course neither has delivered it. Mario Draghi reminds us of this at every ECB press conference.

 

 

 

 

The ECB faces the problem of what to do next?

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

The Euro

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

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

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

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

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

Monetary policy

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

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

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

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

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

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

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

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

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

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

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

 

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

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

QE and the exchange rate

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

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

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

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

Comment

There is plenty of good news around for the ECB.

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

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

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

 

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

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

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

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

Mario Draghi

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Market Movements

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

Comment

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

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

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

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

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

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

 

The problems of the banks of Italy part 101

It is time to look again at a topic which is a saga of rinse and repeat. Okay I am not sure it is part 101 but it certainly feels like a never-ending story. Let us remind ourselves that the hands of the current President of the ECB ( European Central Bank) Mario Draghi are all over this situation. Why? Well let me hand you over to the ECB itself on his career so far.

1997-1998: Chair of the Committee set up to revise Italy’s corporate and financial legislation and to draft the law that governs Italian financial markets (also known as the “Draghi Law”)

It is a bit awkward to deny responsibility for the set of laws which bear you name! This happened during the period ( 1991-2001) that Mario was Director General of the Italian Treasury. After a period at the Vampire Squid ( Goldman Sachs) there was further career progression.

2006-October 2011Governor, Banca d’Italia

There were also questions about the close relationship and dealings between the Italian Treasury and the Vampire Squid over currency swaps.

https://ftalphaville.ft.com/2010/02/09/145201/goldmans-trojan-greek-currency-swap/?mhq5j=e2

But with Mario linking the Bank of Italy and the ECB via his various roles the latest spat in the banking crisis saga must be more than an embarrassment.

The inspection at Banca Popolare di Vicenza that began in 2015 was launched at the request of the Bank of Italy and was conducted by Bank of Italy personnel. Any subsequent decisions were not the responsibility of the Bank of Italy but of the European Central Bank, because in November 2014 Banca Popolare di Vicenza had become a ‘significant’ institution and was subject to the European Single Supervisory Mechanism (SSM). ( h/t @FerdiGiugliano )

So we can see that the Bank of Italy is trying to shift at least some of the blame for one of the troubled Veneto banks to the ECB. At this point Shaggy should be playing on its intercom system.

It wasn’t me…….It wasn’t me

An official denial

At the end of last month the Governor of the Bank of Italy gave us its Annual Report.

At the end of 2016 Italian banks’ non-performing loans, recorded in balance sheets net of write-downs, came to €173 billion or 9.4 per cent of total loans. The €350 billion figure often cited in the press refers to the nominal value of the exposures and does not take account of the losses already entered in balance sheets and is therefore not indicative of banks’ actual credit risk.

Indeed he went further.

Those held by intermediaries experiencing difficulties, which could find themselves obliged to offload them rapidly, amount to around €20 billion.

I suppose your view on this depends on whether you think that 20 billion Euros is a lot or a mere bagatelle. It makes you wonder why the problems at the Veneto banks and Monte Paschi seem to be taking so long to solve does it not?

Meanwhile he did indicate a route to what Taylor Swift might call “Trouble, trouble,trouble”.

At the current rate of growth, GDP would return to its 2007 level in the first half of the 2020s.

An economy performing as insipidly as that is bound to cause difficulties for its banks, but not so for the finances of its central bank.

The 2016 financial year closed with a net profit of €2.7 billion; after allocations to the ordinary reserve and dividends paid to the shareholders, €2.2 billion were allocated to the State, in addition to the €1.3 billion paid in taxes.

The QE era has seen a boom in the claimed profits for central banks and as you can see they will be very popular with politician’s as they hand them over cash to spend.

The ECB is pouring money in

The obvious problem with telling us everything is okay is that Governor Visco is part of the ECB which is pouring money into the Italian banks. From the Financial Times.

According to ECB data as of the end of April, Italian banks hold just over €250bn of the total long-term loans — almost a third of the total.

There is a counter argument that the situation where the Italian banks rely so much on the ECB has in fact simply kicked that poor battered can down the road.

“Some of them [Italian banks] are unprofitable even with the ECB’s cheap funding,” adds Christian Scarafia, co-head of Western European Banks at Fitch.

Fitch also observes that the TLTRO funding is tied up with Italy’s management of the non-performing loans that beset its banks. “The weak asset quality in Italy is certainly the big issue in the country and access to cheap ECB funding has meant that banks could continue to operate without having to address the asset quality problem in a more decisive manner,” says Mr Scarafia. (FT)

It was intriguing to note that the Spanish bank BBVA declared 36 million Euros of profits in April from the -0.2% interest-rate on its loans from the ECB. A good use of taxpayer backed money?

The Veneto Banks

For something that is apparently no big deal and according to Finance Minister Padoan has been “exaggerated” this keeps returning to the news as this from Reuters today shows.

Italian banks are considering assisting in a rescue of troubled lenders Popolare di Vicenza and Veneto Banca by pumping 1.2 billion euros (1.1 billion pounds) of private capital into the two regional banks, sources familiar with the matter said.

Good money after bad?

Italian banks, which have already pumped 3.4 billion euros into the two ailing rivals, had said until now that they would not stump up more money.

As you can see the ball keeps being batted between the banks, the state , and the Atlante fund which is a mostly private hybrid of bank money with some state support. Such confusion and obfuscation is usually for a good reason. A bail in has the problem of the retail depositors who were persuaded to invest in bank bonds.

Monte Paschi

On the 2nd of this month we were told that the problem had been solved and yet the saga like so many others continues on.

HEDGE FUND SAID IN TALKS TO BUY $270 MILLION MONTEPASCHI LOANS ( h/t @lemasabachthani )

Seems odd if it has been solved don’t you think? Mind you according to the FT the European Banking Authourity may have found a way of keeping it out of the news.

The EBA said it would be up to supervisors to decide whether to include any bank in restructuring within the stress tests, and European Central Bank supervisors have decided not to include Monte dei Paschi, people briefed on the matter said.

So bottom place is available again.

Comment

This has certainly been more of a marathon than a sprint and in fact maybe like a 100 or 200 mile race. The Italian establishment used to boast that only 0.2% of GDP was used to bailout Italian banks but of course it is now absolutely clear that this effort to stop its national debt rising even higher allowed the banking sector to carry on in the same not very merry way. This week the environment has changed somewhat with Santander buying Banco Popular for one Euro. Although of course the capital raising of 7 billion Euros needs to be factored into the equation. I guess Unicredit has troubles enough of its own and could not reasonably go for yet another rights issue!

Me on TipTV Finance

http://tiptv.co.uk/living-extraordinary-times-not-yes-man-economics/

 

The British and Irish Lions

I have been somewhat remiss in not wishing our players well on what is the hardest rugby tour of all which is a trip into the heart of the All Blacks. I am thoroughly enjoying it although of course we need to raise our game after a narrow win and a loss. Here’s hoping!

 

 

 

Will 2017 see an economic rennaisance for France?

This morning has opened with some better economic news for France as GDP ( Gross Domestic Product) growth was revised higher.

In Q1 2017, GDP in volume terms* rose barely less fast (+0.4%) than in Q4 2016 (+0.5%).

The French statistical service have put in it downbeat fashion and you have to read to the end to spot it as it is right at the bottom.

The GDP growth for Q1 2017 is raised from +0.3% to +0.4%.

There was also a good sign in the fact that investment was strong.

In Q1 2017, total GFCF accelerated sharply (+1.2% after +0.5%), especially that of enterprises (+1.9% after +0.9%)……Investment in manufactured goods was more dynamic (+1.6% after +0.4%), notably in equipment goods. Similarly, GFCF in market services accelerated sharply (+1.9% after +0.7%), notably in information-communication and business services.

However it was not a perfect report as there were signs of what you might call the British problem as trade problems subtracted from the growth.

Exports fell back in Q1 2017 (−0.8% after +1.0%), especially in transport equipment and “other manufactured goods”. Imports accelerated (+1.4% after +0.6%)………..All in all, foreign trade balance weighed down on GDP growth by −0.7 points, after a contribution of +0.1 points in the previous quarter.

If we look back there may be an issue building here as import growth was 4.2% in 2016 which considerably exceeded export growth at 2.1%. So it may well be true that the French are getting more like the British which is something of an irony in these times.

You may be wondering how there was any economic growth after the net trade deficit and that is because inventories swung the other way and offset it.

In Q1 2017, the contribution of changes in inventories to GDP growth amounted to +0.7 points (after −0.2 points at the end of 2016). They increased especially in transport equipment and “other industrial goods” (pharmaceuticals, metallurgy and chemicals).

The optimistic view on this is that French businesses are stocking up for a good 2017 with the danger being that any disappointment would subtract for growth later this year.

Also as feels so common in what we consider to be the first world the manufacturing industry continues to struggle.

Manufacturing output fell back (−0.2% after +0.7%), mainly due to a sharp decline in the coke and refined petroleum branch and a slowdown in transport equipment.

Looking ahead

The good news is that the private-sector business surveys are very optimistic at the moment.

The latest PMI data points to further strong growth momentum in the French private sector, with the expansion quickening to a six-year peak.

Of course France has been in a rough patch so that may not be as good as it reads or sounds so let us look further.

The service sector saw activity increase for the eleventh time in as many months. Moreover, the rate of expansion accelerated to a six-year high and was sharp overall. Manufacturing output also continued to rise markedly, albeit to a fractionally weaker extent than in April.

As you can see the service sector is pulling the economy forwards and manufacturing is growing as well according to the survey. Unusually Markit do not make a GDP prediction from this but we can if we note they think this for the Euro area which has a lower reading than France.

consistent with 0.6- 0.7% GDP growth.

So let us say 0.7% then and also remind ourselves that it has not been common in recent years for there to be an expectation that France will outperform its Euro area peers.

However this morning’s official survey on households did come with a worrying finale to the good news stream.

In May 2017, households’ confidence in the economic situation has improved anew after a four-month stability: the synthetic index has gained 2 points, reaching 102, above its long-term average and at its highest level since August 2007.

What could go wrong?

Unemployment

This has been the Achilles heel for France in the credit crunch era but this too has seen some better news.

In Q1 2017, the average ILO unemployment rate in metropolitan France and the overseas departments (excluding Mayotte) stood at 9.6% of active population, after 10.0% in Q4 2016.

The good news is that we see the unemployment rate finally fall into single digits. The bad news is that it mostly seems to be people who have given up looking for work.

The activity rate of people aged 15-64 stood at 71.4% in Q1 2017. It decreased by 0.3 percentage points compared to the previous quarter and a year earlier.

The business surveys are optimistic that employment is now improving as we see here.

Bolstered by strong client demand, French private sector firms raised their staffing numbers in May, thereby continuing a trend that has been evident since November last year. Furthermore, the rate of job creation quickened to a 69-month high.

Monetary policy

Yesterday we heard from ECB ( European Central Bank ) President Mario Draghi and he opened with some bombast.

Real GDP in the euro area has expanded for 16 consecutive quarters, growing by 1.7% year-on-year during the first quarter of 2017. Unemployment has fallen to its lowest level since 2009. Consumer and business sentiment has risen to a six-year high,

You might be wondering about monetary policy after such views being expressed but in fact we got this.

For domestic price pressures to strengthen, we still need very accommodative financing conditions, which are themselves dependent on a fairly substantial amount of monetary accommodation.

Is that a Tom Petty style full speed ahead and “Damn The Torpedoes”? For now perhaps but there are two other influences. In terms of a tactical influence Mario Draghi will have noted the rise of the Euro since it bottomed versus the US Dollar in December last year and would prefer it to be lower than the 1.12 it has risen to. Also more strategically as we have discussed on here before he will be waiting for the Euro area elections to pass before making any real change of course in my opinion. That leaves us mulling once again the concept of an independent central banker as we note that economic growth is on the upswing in election year.

Thus France finds itself benefiting from 293.7 billion Euros of sovereign bond purchases meaning it can issue and be paid for it out to around the 6 years maturity and only pay 0.74% on ten-year bonds. This is a considerable help to the fiscal situation and the government. In addition there are the corporate bond purchases and the covered bond purchases to help the banks. The latter gets so little publicity for the 232 billion Euros on the ECB’s books. Plus we have negative interest-rates and a Euro exchange rate pushed lower.

Has monetary policy ever been so expansionary at this stage of the economic cycle?

House prices

There was some further news to warm the cockles of Mario Draghi’s heart this morning.

In Q1 2017, the prices of second-hand dwellings kept increasing: +1.9% compared to the previous quarter (provisional seasonally adjusted results). The increase is virtually similar for flats (+1.9%) and for houses (+1.8%).

Over a year, the increase in prices was confirmed and strengthened: +3.0% compared to Q1 2016 after +1.5% the quarter before.

Up until now we have seen very little house price inflation in France and whilst the rate is relatively low it does look to be on the rise which represents a clear change. If you add this to the house price rises in Germany that I analysed on the 8th of this month then the ECB will be pleased if first-time buyers will not be.

Comment

It looks as though France is in a better phase of economic growth. This is certainly needed as we look at the unemployment rate issue but there is also another factor as this from French statistics indicates.

 2016 (GDP growth unchanged, at +1.1% WDA), 2015 (−0.2 points at +1.0%) and 2014 (+0.3 points at +1.0%)

As you can see the annual rate of economic growth has been essentially 1% as we note something of a reshuffle in the timing. Indeed in spite of a better couple of quarters the current annual rate of economic growth in France is you guessed it 1%! Somehow 1% became the new normal as we wait and hope for better news as 2017 develops. Should we get that then at this stage of the cycle I fear we may then be shifting to how long can it last?!