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.

 

 

 

 

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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?!

 

 

Will rising bond yields mean ECB QE is To Infinity! And Beyond!?

Yesterday the ECB ( European Central Bank ) President Mario Draghi spoke at the European Parliament and in his speech were some curious and intriguing phrases.

Our current monetary policy stance foresees that, if the inflation outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council is prepared to increase the asset purchase programme in terms of size and/or duration.

I say that bit was curious because it contrasted with the other rhetoric in the speech as we were told how well things are going.

Over the last two years GDP per capita has increased by 3% in the euro area, which compares well with other major advanced economies. Economic sentiment is at its highest level in five years. Unemployment has fallen to 9.6%, its lowest level since May 2009. And the ratio of public debt to GDP is declining for the second consecutive year.

The talk of what I would call “More,More,More” is also a contrast to the December policy decision which went down the road of less or more specifically slower.

We will continue to purchase assets at a monthly pace of €80 billion until March. Starting from April, our net asset purchases will run at a monthly pace of €60 billion, and we will reinvest the securities purchased earlier under our programme, as they mature. This will add to our monthly net purchases.

There was another swerve from Mario Draghi who had written to a couple of MEPs telling them that a country leaving the Euro would have to settle their Target 2 balances ( I analysed this on the  23rd of January ) whereas now we were told this.

L’euro e’ irrevocabile, the euro is irrevocable

Of course Italian is his natural language bur perhaps also there was a message to his home country which has seen the rise of political parties who are against Euro membership.

Such words do have impacts on bond markets and yields but I was particularly interested in this bit. From @macrocredit.

DRAGHI SAYS ECB POLICY DOESN’T TARGET BOND SPREADS

A rather curious observation from someone who is effectively doing just that and of course for an establishment which trumpeted the convergence of bond yield spreads back before the Euro area crisis. Just to be clear which is meant here is the gap between the bond yield of Germany and other nations such as Spain or Italy. These days Mario Draghi seems to be displaying all the consistency of Arsene Wenger.

Oh and rather like the Bank of England he seems to be preparing himself for a rise in inflation.

As I have argued before, our monetary policy strategy prescribes that we should not react to individual data points and short-lived increases in inflation.

Spanish energy consumers may not be so sanguine!

Growing divergence in bond yields

The reality has been that recently we have seen a growing divergence in Euro area bond yields. This has happened in spite of the fact that the ECB QE ( Quantitative Easing) bond buying program has continued. As of the latest update it has purchased some 1.34 trillion Euros of sovereign bonds as well as of course other types of bonds. Perhaps markets are already adjusting to the reduction in the rate of purchases planned to begin on April 1st.

France

Ch-ch-changes here are right at the core of the Euro project which is the Franco-German axis. If we look back to last autumn we see a ten-year yield which fell below 0.1% and now we see one of 1.12%. This has left it some 0.76% higher than its German equivalent.

Care is needed as these are still low levels but politicians get used to an annual windfall from ,lower bond yields and so any rise will be unwelcome. It is still true that up to the five-year maturity France can borrow at negative bond yields but it is also true that a chill wind of change seems to be blowing at the moment. The next funding auction will be much more painful than its predecessor and the number below suggests we may not have to wait too long for it.

The government borrowing requirement for 2017 is therefore forecast to reach €185.4bn.

Italy

Here in Mario’s home country the situation is more material as the ten-year yield has risen to 2.36% or 2% over that of Germany. This will be expensive for politicians in the same manner as for France except of course the yield is more expensive and as the Italian Treasury confirms below the larger national debt poses its own demands.

The redemptions over the coming year are just under 216 billion euros (excluding BOTs), or some 30 billion euros more than in 2016, including approximately 3.3 billion euros in relation to the international programme. At the same time, the redemptions of currently outstanding BOTs amount to just over 107 billion euros, which is below the comparable amount in 2016 (115 billion euros) as a result of the policy initiated some years ago to reduce the borrowing in this segment.

The Italian Treasury has also noted the trends we are discussing today.

As a result of these developments, the yield differentials between Italian government securities and similar securities from other core European countries (in particular, Germany) started to increase in September 2016……. the final two months of 2016 have been marked by a significant increase in interest rates in the bond market in the United States,

Although we are also told this

In Europe, the picture is very different.

Anyway those who have followed the many debacles in this particular area which have mostly involved Mario Draghi’s past employer Goldman Sachs will note this next bit with concern.

Again in 2017, the transactions in derivatives instruments will support active portfolio management, and they will be aimed at improving the portfolio performance in the current market environment.

Should problems emerge then let me place a marker down which is that the average maturity of 6.76 years is not the longest.

Portugal

Here the numbers are more severe as Portugal has a ten-year yield of 4.24% and of course it has a similar national debt to economic output ratio to Italy so it is an outlier on two fronts. It need to raise this in 2017.

The Republic has a gross issuance target of EUR 14 billion to EUR 16 billion through both auctions and syndications.

To be fair it started last month but do you see the catch?

The size was set at EUR 3 billion and the new OT 10-year benchmark was finally priced at 16:15 CET with a coupon of 4.125% and a re-offer yield of 4.227%.

That is expensive in these times of a bond market super boom. Portugal has now paid off some 44% of its borrowings from the IMF but it is coming with an increasingly expensive kicker. Maybe that is why the European establishment wanted the IMF involved in its next review of Portugal’s circumstances.

Also at just over five years the average maturity is relatively short which would mean any return of the bond vigilantes would soon have Portugal looking for outside help again.

As of December 31, 2016 the Portuguese State direct debt amounted to EUR 236,283 million, decreasing 0.5% vis-à-vis the end of the previous month ( 133.4% of GDP).

Comment

Bond markets will of course ebb and flow but recently we have seen an overall trend and this does pose questions for several countries in the Euro area in particular. The clear examples are Italy and Portugal but there are also concerns elsewhere such as in France. These forces take time but a brake will be applied to national budgets as debt costs rise after several years when politicians will have been quietly cheering ECB policies which have driven falls. Of course higher inflation will raise debt costs for nations such as Italy which have index-linked stocks as well.

If we step back we see how difficult it will be for the ECB to end its QE sovereign bond buying program and even harder to ever reverse the stock or portfolio of bonds it has bought so far. This returns me to the issues I raised on January 19th.

If we look at the overall picture we see that 2017 poses quite a few issues for central banks as they approach the stage which the brightest always feared. If you come off it will the economy go “cold turkey” or merely have some withdrawal systems? What if the future they have borrowed from emerges and is worse than otherwise?

Meanwhile with the ECB being under fire for currency manipulation ( in favour of Germany in particular) it is not clear to me that this from Benoit Coeure will help.

The ECB has no specific exchange rate target, but the single currency has adjusted as a consequence. Since its last peak in 2011, the euro has depreciated by almost 30% against the dollar. The euro is now at a level that is appropriate for the economic situation in Europe.

The Monte Paschi saga continues

Firstly let me wish you all a very Happy New Year as we approach the month of January. As we switch to an ongoing theme which has occupied on here for some years it is linked to something else in the news or rather what is called fake news. From the Financial Times earlier this morning.

In an interview with the Financial Times, Mr Pitruzzella, head of the Italian competition body since 2011, said EU countries should set up independent bodies — co-ordinated by Brussels and modelled on the system of antitrust agencies — which could quickly label fake news, remove it from circulation and impose fines if necessary.

“Post-truth in politics is one of the drivers of populism and it is one of the threats to our democracies,” Mr Pitruzzella said. “We have reached a fork in the road: we have to choose whether to leave the internet like it is, the wild west, or whether it needs rules that appreciate the way communication has changed. I think we need to set those rules and this is the role of the public sector.”

I am pleased about this as I gave some examples of past fake news only on the 22nd of this month.

*PADOAN: ITALIAN BANKS ARE NOT WEAK (January)

*PADOAN: PERCEPTION OF ITALIAN BANKING SYSTEM HEALTH `DISTORTED’ (July)

Oh and he was on CNBC in September.

Bailout for Italian banks has been ‘absolutely’ ruled out

So Mr.Pitruzzella can start with the past pronouncements of Italy’s Finance Minister! Once he has done that he can move onto the prime minister who has just departed. From Business Insider.

At the beginning of this year, Prime Minister Renzi said: “Today, the bank is healed, and investing in it is a bargain. [Monte dei Paschi] has been hit by speculation, but it is a good deal. It went through crazy vicissitudes, but today it is healed —it’s a good brand.

So both “healed” and “bargain” need to go into my financial lexicon for these times as we wonder how much of Matteo Renzi’s own money was invested?

The bailout or is it bail in?

Finance Minister Padoan ( who lest we forget was briefly  in the running to be the new prime minister) seems to be upset if someone points out his dissembling as this from Reuters highlights.

In unusually critical comments of the euro zone’s banking supervisor, Pier Carlo Padoan told a newspaper that the ECB’s new capital target was the result of a “very rigid stance” in its assessment of the bank’s risk profile.

 

“It would have been useful, if not kind, to have a bit more information from the ECB about the criteria that led to this assessment,” Padoan told the financial newspaper Il Sole 24 Ore.

You would think that by now Mr.Padoan would know pretty much everything about Monte Paschi and I note that “very rigid stance” is quite different to saying that the ECB is wrong. If we look at the numbers then using the word embarrassing simply does not tell half the story.

Monte dei Paschi, Italy’s third biggest lender and the world’s oldest, said on Monday the ECB had estimated its capital shortfall at 8.8 billion euros (7.5 billion pounds), compared with a 5 billion-euro gap previously indicated by the bank.

So the fake news that was most prevalent about Monte Paschi in 2016 was driven by the Ittalian government and the Bank of Italy telling us that a 5 billion Euro private rescue could work. In fact they would have lost their money just like the previous 3 rescues as it was not enough. In some ways it reminds me of the rights issue of around £12 billion that Royal Bank of Scotland undertook only a few months before collapsing which must have been based on a misrepresentation and should have resulted in prosecutions accordingly.

What no doubt is particularly irking Finance Minister Padoan is this from The Bank of Italy.

The difference between the amount of the capital injection for Banca Monte Dei Paschi di Siena calculated on the basis of the ‘market solution’ (€5 billion) and the amount required in the case of a ‘precautionary recapitalization’ by the Italian state (€8.8 billion) depends on the different hypotheses and objectives of the two measures, which also imply different methods of calculation and lead to different results.

We get a long explanation of the detail in an attempt to divert us from the fact that the Bank of Italy knows the Euro area recapitalisation rules and thus has deliberately overlooked them until now. As we progress we see not only the cost to the Italian state but the sum set aside for compensation to the retail bondholders.

the immediate cost to the State would therefore amount to about €4.6 billion (€2.1 billion to cover the first requirement and €2.5 billion to satisfy the second); to this must be added the subsequent compensation of retail subscribers (about €2 billion, to be verified on the basis of the status of the subscribers and their actual willingness to adhere to the State compensation scheme), for a total of about €6.6 billion.

This morning Italy’s new Prime Minster has joined the fray as shown below from Il Sole 24 Ore.

In his first end-of-year news conference, new Italian Prime Minister Paolo Gentiloni……….This content is now becoming “subject of a discussion with the supervisory board of the ECB, while the tranquillity, size and significance of our intervention is not in question.”

What has he left to discuss? Also given the lifespan of Italian Prime Ministers which is the same as UK Premiership football managers he first end of year news conference may also be his last.

The 20 billion Euro problem

Is this an official denial that “up to” now means more than? From Prime Minister Gentiloni again.

As affirmed by Padoan in recent days, the €20 billion from the bank rescue decree is still enough to help both MPS and other banks, such as the two Veneto lenders (Veneto Banca and Popolare Vicenza), run by the Atlante Fund, which could seek extraordinary public support.

The obvious truth is that like the two efforts at funding the Atlante private-sector bank rescue vehicle it is simply not enough. Some of the smaller sums might have worked if they had been applied early enough and been accompanied by genuine reform but in the meantime things have been allowed to rot and deteriorate.

Meanwhile Monte Paschi is going to issue some more debt according to Reuters. Please form an orderly queue.

Italy’s Banca Monte dei Paschi di Siena, which is being bailed out by the state, plans to issue 15 billion euros ($15.8 billion) of debt next year to restore liquidity and boost investor confidence, several newspapers said on Friday.

Comment

There are not many subjects in the financial sphere that have been subject to fake news more than Monte Paschi over the past few years. The really damning part of this is that so much of that has come from the government of Italy as well as the bank’s board. All the claims of business of usual have been replaced by a need of 8.8 billion Euros of equity capital and 15 billion Euros of bonds. Underlying this is a banking legal system called the “Draghi Laws” after the current president of the ECB after his time at the Italian Treasury and the Bank of Italy. Time for some Fleetwood Mac.

Tell me lies
Tell me sweet little lies
(Tell me lies, tell me, tell me lies)
Oh, no, no you can’t disguise
(You can’t disguise, no you can’t disguise)
Tell me lies
Tell me sweet little lies

Meanwhile Finance Minster Padoan is on the wires again. From Reuters.

“The bank is in optimal condition and will have great success,” he said.