The world of negative interest-rates now has negative economic growth too

It was not that long ago that many of us “experts” in the interest-rate market felt that negative interest-rates could not be sustained. Back then the past Swiss example could be considered a tax – which remains a way of considering negative interest-rates – and the flicker in Japan was covered by it being Japan. Yesterday brought some fascinating news from the front line which has been in danger of being ignored in the current news flow.

Sweden’s GDP decreased by 0.2 percent in the third quarter of 2018, seasonally adjusted, compared with the second quarter of 2018. GDP increased by 1.6 percent, working-day adjusted, compared with the third quarter of 2017. ( Sweden Statistics).

Firstly let me reassure you that Sweden has no Brexit style plans. What it does have is negative interest-rates as this from the Riksbank shows.

Consequently, in line with the previous forecast, the Executive Board has decided to hold the repo rate unchanged at -0.50 per cent.

I bet they now regret opening their latest forward guidance report like this.

Since the Monetary Policy Report in September, economic developments have been largely as expected, both in Sweden and abroad.

In fact the Riksbank was expecting this.

The most recently published National Accounts paint a picture of  slightly weaker GDP growth in recent years. Nevertheless, the Riksbank deems that economic activity in Sweden has been and continues to be strong.

In fact it has been so nonplussed that it has already reached for the central banking playbook and wondered what is Swedish for Johnny Foreigner?

Riksbank Floden: Sees Increased Uncertainty In World Economy ( @LiveSquawk )

Those who have followed my analysis that central banks will delay moving out of extraordinary monetary policy and negative interest-rates and thus are in danger of being trapped, will have a wry smile at this.

The forecast for the repo rate is unchanged since
the monetary policy meeting in September and indicates that the repo rate will be raised by 0.25
percentage points either in December or in February. As with the first raise, monetary policy will also
subsequently be adjusted according to the prospects for inflation.

That’s the spirit! You keep interest-rates negative through a strong phase of economic growth then you raise them when you have a quarterly decline. Oh hang on. I am not being clever after the event here because a month or so before the Riksbank report on the 6th of September I pointed out this.

This is also true of Sweden because if we look at the narrow measure or M1 we see that an annual rate of growth of 10.5% in July 2017 was replaced with 6.3% this July. …..A similar but less volatile pattern can be seen from the broad money measure M3. That was growing at an annual rate of 8.3% in July 2015 as opposed to the 5.1% of this July.

Since then M1 has stabilised but M3 has fallen further and was 4.5% in October. In fact if you were looking for an area it might effect then it would be domestic consumption so lets take a look.

Household consumption expenditures decreased by 1.0 percent and government consumption expenditures remained unchanged, seasonally adjusted, compared with the previous quarter ( Sweden Statistics).

Time for page 2 of the central banking play book.

Riksbank’s Floden: Recent Data Since Latest Policy Meeting Have Been Disappointing -But There Were Some Temporary Effects In 3Q GDP Data,

Something else caught my eye and it was this.

 Exports grew by 0.3 percent and imports declined by 0.6 percent.

So foreign demand flattered the numbers in a rebuttal to the central banking play book. But if we look at the overall pattern then economics 101 has yet more to think about.

J curve R.I.P. (?) – In Sweden, 2018 is heading for the worst trade year ever. The Oct deficit was SEK8.4bn. One observation: J curve effect does not work and thus the exchange rate channel (on real economy) is partially broken.   ( Stefan Mullin)

So let’s see you have negative interest-rates to boost domestic demand which is falling and you look to drive the currency lower which does not seem to be helping trade. Oh and you plan to raise interest-rates into a monetary decline. What could go wrong?

As it is the end of the week let us have some humour albeit of the gallows variety from Forex Crunch yesterday.

Analysts at TD Securities suggest that their nowcast models point to a 0.6% q/q gain to Sweden’s GDP (mkt: 0.2% q/q on a wide range of estimates), which if materialised would leave TD (and likely the Riksbank) comfortable with a December rate hike


Let us start with a response from Nikolay Markov of Pictet Asset Management.

GDP growth plunged to its lowest pace since the introduction of negative rates in Q1 2015. There is no reason to panic as this is a temporary drop:

There are few things more likely to cause a panic than being told there is no reason for it. I also note he was not so kind to the Swedes. Let us investigate using Swiss Statistics.

Switzerland’s GDP fell by 0.2% in the 3rd quarter of 2018, after climbing by 0.7% in the previous quarter. The strong, continuous growth phase enjoyed by the Swiss economy for one and a half years was suddenly interrupted.

The change has seen annual growth dip from 3.5% to 2.4% so different to Sweden although there has been a fall in the growth of domestic consumption. Quite what a central bank with an interest-rate of -0.75% can do about falling domestic consumption is a moot point. A driver of the decline is a familiar one.

Value added in manufacturing dipped slightly (−0.6%);  Total exports of goods (−4.2%) also contracted substantially.

The official view is that is just a blip but it does require watching as I note this area still seems to be troubled as this from earlier shows.

How cold is ‘s auto market? Passenger car sales down 28% in first 3 weeks of Nov. Whole year drop “inevitable”. Car dealers’ inventory climbing and many of them making losses. Authority said bringing back purchase tax cut will not help much. ( @YuanTalks )

Just as a reminder the Swiss National Bank holds some 778.05 billion Swiss Francs of foreign currency investments as a result of its interventions to reduce the exchange-rate of the Swissy.


These developments add to those at some other members of the negative interest-rates club or what is called NIRP.

German economic growth has stalled. As the Federal Statistical Office (Destatis) already reported in its first release of 14 November 2018, the gross domestic product (GDP) in the third quarter of 2018 was by 0.2% lower – upon price, seasonal and calendar adjustment – than in the second quarter of 2018.

And another part of discovering Japan.

Japan’s economy shrank in the third quarter as natural disasters hit spending and disrupted exports.

The economy contracted by an annualised 1.2% between July and September, preliminary figures showed. ( BBC )

As you can see we go to part three of the play book as the poor old weather takes another pounding. Quite what this has done to IMF News I am not sure as imagine how it would report such numbers for the UK?

has had an extended period of strong economic growth—GDP expected to rise by 1.1% in 2018.


Perhaps it has been discombobulated by a period when expansionary monetary policy has not only crunched to a halt but gone into reverse at least for a bit. But imagine you are a central banker right now wondering of this may go on and you will be starting it with interest-rates already negative. Or to use the old City phrase, how are you left?

Oh and hot off this morning’s press there is also this.

In the third quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.1 per cent to the previous quarter and increased by 0.7 per cent in comparison with the third quarter of 2017. ( Italy Statistics)


There as been a development in something predicted by us on here quite some time ago. So without further ado let me hand you over to The Japan Times.

Japan is considering transforming a helicopter destroyer into an aircraft carrier that can accommodate fighter jets, a government source said Tuesday,






Mario Draghi and the ECB prepare for a change of course next month

After a week where the UK has dominated the headlines it is time to switch to the Euro area.  This is for two reasons.  We receive the latest inflation data but also because a speech from European Central Bank President Mario Draghi has addressed an issue we have been watching as 2018 has developed. We have been waiting to see how he and it will respond to the economic slow down that is apparent. This is especially important as during the credit crunch era the ECB has not only been the first responder to any economic downturns it has also regularly found itself to be the only one. Thus it finds itself in a position whereby in terms of negative interest-rates ( deposit rate of -0.4%) and balance sheet ( still expanding at 15 billion Euros per month ) and credit easing still heavily deployed. Accordingly this sentence from Mario echoes what we have been discussing for quite a while.

The key issue at stake is as follows: are we witnessing a temporary “soft patch” or a more lasting deterioration in the growth outlook?

The latter would be somewhat devastating for the man who was ready to do “whatever it takes” to save the Euro as it would return us to discussions about its problems a major one of has been slow economic growth.

Some rhetoric

It seems to be a feature these days of official speeches that they open with what in basketball terms would be called a head fake. Prime Minister Theresa May did it yesterday with an opening sentence which could have been followed by a resignation and Mario opened with what could have been about “broad based” economic growth.

The euro area economy has now been growing for five years, and we expect the expansion to continue in the coming years.

Of course central bankers always expect the latter until there is no other choice. Indeed he confirms that line of thought later.

There is certainly no reason why the expansion in the euro area should abruptly come to an end.

As we move on we get an interesting perspective on the past as well as a comparison with the United States.

Since 1975 there have been five periods of rising GDP in the euro area. The average duration from trough to peak is 31 quarters, with GDP increasing by 21% over that period. The current expansion in the euro area, however, has lasted just 22 quarters and GDP is only around 10% above the trough. In contrast, the expansion in the United States has lasted 37 quarters, and GDP has risen by 21%.

The obvious point is whether you can use the Euro area as a concept before it even existed?! Added to that via the “convergence” promised by the Euro area founders economic growth should be better now than then, except of course we have seen plenty of divergence too. Also you might find it odd to be pointing out that the US has done better especially as the way it is put which reminds us that for all the extraordinary monetary action the Euro area has only grown by 10%. Even that relies on something of a swinging ball as of course he is comparing with the bottom of the dip rather than the past peak as otherwise the number would be a fair bit weaker. Mario is leaving a bit of a trap here, however, or to be more precise he thinks he is.

How have we got here?

First we open with two standard replies the first is that whilst any growth is permanent setbacks are temporary and the other fallback is to blame the weather.

The first is one-off factors, which have clearly played an important role in the underperformance of growth since the start of the year. In the first half of 2018, weather, sickness and industrial action affected output in a number of countries.

Actually that makes the third quarter look even worse as they had gone by then yet growth slowed. He is on safer ground here though.

Production slowed as carmakers tried to avoid building up inventory of untested models, which weighed heavily on economies with large automobile sectors, such as Germany. Indeed, the German economy actually contracted in the third quarter, removing at least 0.1 percentage points from quarterly euro area growth.

This is another marker being put down because it you are thinking that you might need to further expand monetary policy it is best to try to get the Germans onside and reminding them that they too have issues will help. Indeed for those who believe that ECB policy is essentially set for Germany it may be not far off a clincher.

There is something that may worry German car producers if they are followers of ECB euphemisms.

The latest data already show production normalising.

After all the ECB itself may not achieve that.


This paragraph is interesting on quite a few levels.

The second source of the slowdown has been weaker trade growth, which is broader-based. Net exports contributed 1.4 percentage points to euro area growth in 2017, while so far this year they have removed 0.2 percentage points. World trade growth decelerated from 5.2% in 2017 to 4.6% in the first half of this year.

Oddly Mario then converts a slow down in growth to this.

We are witnessing a long-term slowdown in world trade.

As we note the change in the impact of trade on the Euro area there are several factors in play. You could argue that 2017 was a victory for the “internal competitiveness” austerity model applied although when we get to the collective that is awkward as the Euro area runs a large surplus driven by Germany. From the point of view of the rest of the world they would like it to reduce although the preferable route would be for the Euro area ( Germany ) to import more.


Mario cheers rightly for this.

Over the past five years, employment has increased by 9.5 million people, rising by 2.6 million in Germany, 2.1 million in Spain, 1 million in France and 1 million in Italy.

I bet he enjoyed the last bit especially! But later there is a catch which provides food for thought.

 But since 2013 more than 70% of employment growth has come from those aged 55-74. This partly reflects the impact of past structural reforms, such as to pension systems.

Probably not the ECB pension though as we are reminded of “Us and Them” by Pink Floyd.

Forward he cried from the rear
And the front rank died
And the general sat
And the lines on the map
Moved from side to side.

Also whilst no doubt some of these women wanted to work there will be others who had no choice.

The share of women in work has also risen by more than 10 percentage points since the start of EMU to almost 60% – its highest level ever

Put another way this sentence below could fit into a section concerning the productivity crisis.

 In addition, countries that have implemented structural reforms have in general seen a rise in labour demand in recent years compared with the pre-crisis period. Germany, Portugal and Spain are all good examples.

There is a section on wages but Mario end up taking something of an each-way bet on this.

But in the light of the lags between wages and prices after a period of low inflation, patience and persistence in our monetary policy is still needed.

Money Supply and Credit

This is how central bankers report a sustained and considerable slow down in the money supply.

The cost of bank borrowing for firms fell to record lows in the first half of this year across all large euro area economies, while the growth of loans to firms stood at its highest rate since 2012. The growth rate of loans to households is also the strongest since 2012, with consumer credit now acting as the most dynamic component, reflecting the ongoing strength of consumption.

Also the emphasis below is mine and regular readers are permitted a wry smile.

Household net worth remains at solid levels on the back of rising house prices and is adding to continued consumption growth.


We are being warmed up for something of a change of course in case it is necessary.

When the Governing Council met in October, we confirmed our confidence in the economic outlook………….When the latest round of projections is available at our next meeting in December, we will be better placed to make a full assessment of the risks to growth and inflation.

As if they are not already thinking along those lines! The next bit is duo fold. It reminds us that the Euro area has abandoned fiscal policy but does have a kicker for the future.

To protect their households and firms from rising interest rates, high-debt countries should not increase their debt even further and all countries should respect the rules of the Union.

The kicker is perhaps a hint that there is a solution to that as well.

In conclusion, I want to emphasise how completing Economic and Monetary Union has become more urgent over time not less urgent – and not only for the economic reasoning that has always underpinned my remarks, but also to preserve our European construction………….more Europe is the answer.

There Mario leaps out of his apparent trap singing along to Luther Vandross.

I just don’t wanna stop
Oh my love, a million days in your arms
Is never too much (never too much, never too much, never too much)



What next for the War on Cash?

Yesterday we took a look at a country which seems to be happy heading for a post cash era. Sweden has seen nearly a halving of cash use in the past decade and the size of the change would be even larger if we factored in inflation and did the calculation in real terms. This is particularly significant as we remind ourselves that Sweden already has negative interest-rates, and as I pointed out yesterday there are roads ahead where it would cut them further from the current -0.5%. The reason why cash is an issue for negative interest-rates is that it offers 0%, and so there must be a “tipping point” where interest-rates go so negative that bank deposits switch to cash in enough size to create a bank run. Such a prospect has created terror in central banking halls and boardrooms and has been the main barrier to interest-rates being cut even lower than they have. In my own country the Bank of England was so terrified of the impact of lower interest-rates on the “precious” that it claimed 0.5% was a “lower bound”, even when other countries were below it. That had a different reason ( their creaking antiquated IT systems could not cope with 0%) but told us of their primary response function.

Cash in the USA

The Financial Times has taken a look at this and seems upset at the result.

Americans can’t quit cash

If we switch to the actual research which was undertaken by  the Federal Reserve Banks of Atlanta, Boston, Richmond, and San Francisco we see the following.

In October 2017, U.S. consumers each made on average 41.0 payments for the month . Thus, on average, an adult consumer made 1.3 payments per day. Notably, an average
of 40.2 percent of consumers per day reported making zero payments. Also in October 2017, U.S. consumers each made on average $3,418 worth of payments for
the month.

So after finding out how much as well as how often? We get to see via what method.

In October 2017, consumers paid mostly with cash (30.3 percent of payments), debit cards (26.2 percent), and credit cards (21.0 percent). These instruments accounted for three-quarters of the number of payments, but only about 40 percent of the total value of payments, because they tend to be used more for smaller-value payments. In contrast,
electronic payments accounted for 30.3 percent of the value of total payments but only 8.9 percent of the number
of payments. Checks, at 17.7 percent, continued to account for a relatively high percentage of the value of

As you can see cash remains king (queen) in volume terms but has faded in value terms. The bit that sticks out to me is the amount still accounted for by Checks ( cheques) as I am struggling to think of the last time that I used one. Also the comments section provides a reason as to why cash remains in use for small payments on such a large-scale in the US.

Americans carry cash for smaller transactions partly because their unstinting devotion to the $1 bill means it is much lighter.  I can carry round a bunch of 1s and 5s for coffee in the day at a fraction of the weight of the euros or pounds that would do the similar job in Europe. ( Saughton)

For those unaware UK coins are fairly heavy and the £1 and £2 coins get more use than you might expect as the Bank of England has had its struggles with getting £5 notes into general circulation. So suit and trouser pockets can take a bit of a pasting. If we continue in the same vein even the convenience of digital payments faces an apparent challenge.

Those of us still paying cash are standing in lines behind phonsters fumbling with their payment app. When it looks faster and easier I’ll switch. ( Proclone )

That may be because it does not work well.

The other main reason the US lags on electronic purchases is because the cashless infrastructure is atrocious. ( Saughton)

Also that it may be businesses rather than consumers which prefer cash.

Mom and pop stores and restaurants may require cash for any transaction, and almost all do for purchases under $10. Cheques for larger payments are also due to vendor requirement. That dynamic would be worth comparing to other markets instead of implying consumer preference. ( Pharmacy )

What about the Euro area?

I noted that the replies pointed out the way that cash remains prevalent in Germany (historical), Belgium ( tax-avoidance) and Austria ( see Germany) so let us take a look. From the European Central Bank or ECB.

The survey results show that in 2016 cash was the dominant payment instrument at POS. In terms of number, 79% of all transactions were carried out using cash,
amounting to 54% of the total value of all payments. Cards were the second most frequently used payment instrument at POS; 19% of all transactions were settled using a payment card. In terms of value, this amounts to 39% of the total value paid at POS. ( POS = Point Of Sale )

I doubt using geography as a method of analysis will surprise you much.

In terms of number of transactions, cash was most used in the southern euro area countries, as well as in Germany, Austria and Slovenia, where 80% or more of POS transactions were conducted with cash……… In
terms of value, the share of cash was highest in Greece, Cyprus and Malta (above 70%), while it was lowest in the Benelux countries, Estonia, France and Finland (at,
or below, 33%).

The ECB thinks it tells us this.

This seems to challenge the perception that
cash is rapidly being replaced by cashless means of payment.

It then goes further.

The study confirms that cash is not only used as a means of payment, but also as a store of value, with almost a quarter of consumers keeping some cash at home as a
precautionary reserve. It also shows that more people than often thought use high denomination banknotes; almost 20% of respondents reported having a €200 or
€500 banknote in their possession in the year before the survey was carried out.

This means that the ECB will find itself in opposition to more than a few of its population soon.

 It has decided to permanently stop producing the €500 banknote and to exclude it from the Europa series, taking into account concerns that this banknote could facilitate illicit activities. The issuance of the €500 will be stopped around the end of 2018, when the €100 and €200 banknotes of the Europa series are planned to be introduced,



Let us consider the relationship between the use of cash and financial crime. You may note that the ECB statement uses the word “could”. That as I pointed out back on the 5th of May 2016 is because the German Bundesbank thinks this.

There is scant concrete information on the extent to which cash is being used to facilitate illicit activity……… the volume of notes devoted to such transactions is unknown and would be extremely difficult, if not impossible, to estimate.

So the ECB seems to be basing its policy on the rhetoric of Kenneth Rogoff who in a not entirely unrelated coincidence thinks that central banks will have to go even further into negative interest-rates next time around. Our Ken has been rather quite recently on the subject of cash equals crime. This may be because if we look above we see that Estonia has moved away from cash both relatively and absolutely and yet you will have had to have spent 2018 under a stone to have missed this.

Danske Bank Estonia has been revealed as the hub of a $234bn money laundering scheme involving Russian and Eastern European customers. ( Frances Coppola)

Perhaps the authorities were too busy checking on the 500 Euro notes and missed a crime that would have taken four of out five of the total Euro area circulation. Priorities eh?

There are levels I think where this will be come more urgent. I have suggested before that I think that around -2% would be the level where people might move away from banks on a larger scale. So far in terms of headline official rates the lowest is the -0.75% of Switzerland. Of course another problem area would be created if we saw bank bailins on any scale which may be a reason why so many bank share prices have struggled.

Me on Core Finance TV




How easily could the promises of an interest-rate rise from the Riksbank turn into another cut?

Today brings us to the country which on one measure has dipped into the world of negative interest-rates more than anyone else. This is the world of the Riksbank of Sweden which has this interest-rate on deposits with it.

The standing deposit facility means that the counterparty may have a positive balance on its account in RIX at the end of the day. The counterparty then receives interest calculated as the repo rate minus 0.75 percentage points. If this entails a negative interest rate, the counterparty pays interest to the Riksbank.

This is because the headline Repo rate is -0.5% meaning that the standing deposit facility is currently -1.25%.

For some time now, partly because as we will come to in a minute negative interest-rates have proved to be much longer lasting than promised or in official language been temporary, we have looked at the impact of this in cash and its availability. That has been in the news this week.

As cash use is declining rapidly, it is important that the Riksdag adopt a position on the issue of what constitutes legal tender in Sweden and its connection to the Swedish krona as a currency. Any legislation should be as technology-neutral as possible in order to also be applicable to any future means of payment issued by the Riksbank. ( Riksbank)

Sweden is a country which is in the van of those using electronic means of payment and if we look at the official figures the amount of money ( notes & coins) in circulation has been falling, at times sharply. The amount was 88 billion Kronor in 2013 and in subsequent years then has gone 80 billion, 77 billion, 65 billion and then 57 billion. The trend gets even clearer if we look back to 2008 the table suggests that the amount was around 107 billion. So we are left wondering if this year the amount will be half what it was in 2008.

However you spin it the situation is such that cash needs protection according to the Riksbank.

The Committee proposes a requirement that companies shall be able to deposit their daily cash takings in their bank accounts. The Riksbank wishes to go a step further even in this regard. Banks should also be obliged to ensure that private individuals can make deposits.

Of course some will think to quote Hamlet “”The lady doth protest too much, methinks”

The State of Play

According to the Riksbank things are going really rather well.

Economic activity in Sweden is strong and inflation is at the target of 2 per cent. Since the monetary policy decision in September, developments have for the most
part been as expected and the forecasts remain largely unchanged.

It hammers home the point even more later.

In Sweden, too, economic developments have been largely as expected and economic activity has been good for a long period of time……….. Inflation increased to
2.5 per cent in September, partly as a result of rapidly rising energy prices. Different measures of underlying inflation are lower and inflationary pressures are still assessed to be moderate. However, there are signs that inflationary pressures are rising and the conditions are good for inflation to remain close to the target of 2 per cent in the coming years.

I have given the full detail on the inflation situation because it highlights the mess that the Riksbank has put itself in. Inflation has gone above target and like so many central banks it is then keen to find any measure which gives a different but then trips over its own feet by telling us “inflationary pressures are rising”. So we have a tick in the box for an interest-rate rise.

Let us now look at the economic performance.

The labour market situation is expected to remain strong, even if GDP growth slows down going forward.

This is based on this from Sweden Statistics.

Sweden’s GDP increased by 0.8 percent in the second quarter of 2018, seasonally adjusted and compared with the first quarter of 2018. GDP increased by 2.5 percent, working-day adjusted and compared to the second quarter of 2017.

If we look back we see that GDP growth was 2.6% in 2014 then 4.5% in 2015 and then 2.7% in 2016. So the position has been strong for a while although the per capita (person) situation is not as strong as the population has risen by 2.3% over the same period.

Monetary Policy

If we note that the economy has been doing well and inflation is above target you would not expect this.

 the Executive Board has decided to hold the repo rate unchanged at -0.50 per cent.

There are two issues here the first is how it has arrived at a strong economy and inflation above target with interest-rates negative and the next is how doing something about this remains just around the corner.

the Executive Board assesses that it will soon be appropriate to start raising the repo rate at a slow pace. The forecast for the repo rate is unchanged since the monetary policy meeting in September and indicates that the repo rate will be raised by 0.25 percentage points either in December or February.

As an aside it used to be the case that central banks used to think that what is now called Forward Guidance was a bad idea. The Bundesbank of Germany was particularly enthusiastic about trying to act in an unexpected fashion. There is however a catch.

As you can see it has a 0% success rate with its interest-rate forecasts so whilst in theory it has a policy opposite to that of the Bundesbank in practice it has turned out to have even more surprises. Well unless you possess enough brains to figure out the game. Even more than the Bank of England it has attempted to get the changes provided by an interest-rate rise from promising it rather than delivering it. If there is a clearer case of the central banking boy (girl) who cried wold I do not know it.

Money Supply

You may not be surprised to read that money supply growth soared in response to  the negative interest-rates and QE of the Riksbank. In fact narrow money growth rate 15% at the opening of 2016 and broad money just failed to make double digit growth as it peaked at 9.9%. You might think if you look at the GDP growth data for the year that it was time to raise interest-rates but like the Bank of England when it had the chance the Riksbank apparently knew better.

Now we find something awkward for the recycled promise of an interest-rate rise. This is that in 2018 narrow money growth has fallen from 8.4% to 6.8% and broad money growth has fallen from 5.4% to 4.5% and as the 5.4% was a freak number if you look at the series as we had 6.4% through the spring. So looking at them in isolation you might be thinking of an easing. Oh hang on…..


The Riksbank changed course around 5 years ago and since then has mostly run a pro-cyclical monetary policy and reversed the conventional view on how to operate it. Regular readers will recall that was partly driven by Paul Krugman calling them “sado-monetarists” and they may also note that mentions of Mr. Krugman have noticeably faded. But they will also be aware that I have argued that negative interest-rates were described pretty accurately by Elvis Presley.

We’re caught in a trap
I can’t walk out
Because I love you too much, baby

But as even supporters of the guidance are suggesting that there may only be one interest-rate rise I see trouble ahead. Monetary growth is plainly slowing and this week has brought news that such slowing in the Euro area is having an effect. The Bundesbank is worried about economic growth in Germany and this morning’s Markit business survey told us this.

The pace of Eurozone economic growth slipped
markedly lower in October, with the PMI setting the
scene for a disappointing end to the year.

So whilst two members of the Riksbank did vote for an interest-rate increase today I can see two scenarios increasing in probability. One is that they eventually do raise but then reverse quite quickly. Or more darkly that the next move is either another cut or easing in another form such as QE which would be the final confession that they are in as Coldplay put it.

And I lost my head
And thought of all the stupid things I said
Oh no what’s this
A spider web and I’m caught in the middle



Should the ECB be reformed and how?

This morning has brought an intriguing opinion piece in the Alphaville section of the Financial Times. It concerns the European Central Bank and comes from what you might call a classic insider as the header suggests.

Lorenzo Bini Smaghi, Société Générale chairman, Project Associate at the Harvard Kennedy School’s Belfer Center for Science and International Affairs, and Senior Fellow at LUISS School of European Political Economy in Rome.

This covers a lot of ground as after all shouldn’t  being chairman of Societe Generale be a full-time job? This dichotomy where lower jobs are full-time but more senior ones are not seems to be ever more common. With a share price less than a quarter of what it was at its peak and furthermore it being down 25% over the past year you might think directors would be fully employed trying to make things better. Of course we are invariably told that such people can have so many roles because they are so capable and intelligent which of course then begs the question of how we are where we are?

For some reason the Financial Times header was a little forgetful of the fact that Mr Bini Smaghi was an Executive Board member of the ECB for six years from 2005. This matters as it is likely that he is being used like a weather vane, so let us take a look.

The Inflation Target

Here is the opening salvo, with which regular readers will be familiar.

The ECB’s primary objective is price stability, defined as “a rate of inflation below but close to 2 per cent”. The average inflation rate over the 20 years of the euro has been 1.7 per cent, which may suggest success.

Now even your average Martian will be aware that the last decade has not been a success but look what Lorenzo picks out.

However, the result has been less satisfactory (a dalliance with deflation) in more recent periods.

This focusing on deflation is misleading for several reasons. Firstly he is deliberately equating falling prices or disinflation with shrinking aggregate demand or deflation. This matters because Lorenzo’s “deflation” was essentially the result of a lower oil price as I pointed out at the time. Also rather than a problem, at a time of restricted wage growth lower and indeed negative inflation provides an economic boost via its positive impact on real wages. I pointed this out back on the 29th of January 2015.

However if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly.

Thus Lorenzo is flying something of a false flag here and is an example of what I predicted back then.

 If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.

You will not be surprised to find that the suggestion is a loosening of the target as seen below.

 Furthermore, research shows that the ECB’s policy decisions over the years anyway reflect a symmetric interpretation of the target around 2 per cent. So why not move to such a target? It would at least be more transparent.

This matters even more if we note that in spite of the negative interest-rates and the QE inspired balance sheet expansion the ECB has in its own terms not yet achieved its target. This is because whilst inflation is above 2% at 2.1% of that some 0.8% is energy costs which are mostly outside its control. Putting it another way it is remarkable how little consumer inflation has been created by so much monetary easing. In fact with it so low we have to question whether it also has disinflationary influences not predicted by economics 101.

Thus even what seems a minor reshuffling of the target would if we remain in a similar situation to now lead to the possibility of a large policy change. We could get QE to its current maximum in terms of Euro area sovereign bonds where they are bought up to the limit imposed by the German bond market. In a way it all comes from this misrepresentation or lie.

 reconsider the definition of price stability.

Price stability would be 0% not 2% per annum. In response my suggestion would be to lower the Euro area inflation target to either 1.5% or 1%.


The next bit is even odder.

The two pillars are analysis of economic and monetary data, but the latter — money and credit aggregates — have proved over time to be unreliable predictors of inflationary pressures……….. In July 2008, for instance, the resilient fast pace of credit growth justified the rate hike which was made, even as the real economy had started to show signs of a slowdown

Actually if we look at annual M1 growth which is the leading indicator for monetary data the annual rate of growth had fallen from 11.7% in December 2005 to 0.1% in July 2008. So the truth is that the ECB simply looked at (backwards-looking) credit growth rather than the clear signal from M1. Actually, looking at like that the series without seasonal adjustment could hardly be much clearer.


As you can imagine our bank chairman is not keen on the way countries can be excluded from this. After all who will think of the banks holding their debt? Here is his proposed solution.

Consideration should be given to return to a system based on progressive haircuts.

Share risk, as well as supervision

This would have the Starship Enterprise on yellow if not red alert. This is the current state of play.

Banks that are solvent, but do not have adequate collateral, may require the central bank to act as a so-called “lender of last resort”. That function for banks is still decentralized, with the national central banks bearing the risks.

So if an Italian bank were to fail it is the responsibility of the Bank of Italy to step in. Whereas Lorenzo wants this.

In particular, if the decision on whether a bank is solvent and is eligible to emergency lending is centralized, the risk for such lending should be shared.

So in this new universe the ECB would be responsible and not the Bank of Italy as the federal web gets more steel and perhaps titanium. The issue of being “solvent” is usually a red herring as central banks seem to find the most disastrous business models as being viable.

Exit Troika, stage left

Nobody seems to have told Lorenzo about the nomenclature change to “The Institutions”, but of course bankers often struggle with current events. Anyway it is hard to disagree with the thrust here, frankly who would want to be a member of it?

Remaining a member of the Troika is now less justified, and the unpopularity of adjustment programmes tends to erode the ECB’s reputation and independence.

Let somebody else take the blame!


The good news is the implied view that the ECB needs reform. Sadly the predictable part is that it heads in a direction which has so far caused more trouble than it has solved. For those who believe that the Euro establishment want crises so that they can present what they wanted to achieve anyway as part of the crisis resolution there is another tick in that box. My suggestion would be for a much more root and branch reform of central banking. For example inflation control has morphed into inflation creation or in consumer inflation terms attempted inflation control. Plus of course a boost for those who own assets.

However it is also true that the ECB has been left exposed and in the cold by the Euro establishment. The lack of any political response in terms of economic policy to the credit crunch left it and monetary policy with far too much to do. It has overplayed its hand in response, and must now fear heading into the next downturn with its foot still pressing down on the accelerator. At least it managed to shuffle its holdings of Greek debt largely to another Euro area body but that process and its insistence on full repayment added to the crisis at its height.

Heading forwards I would have two main suggestions.

  1. Lower the inflation target
  2. Much more questioning of what QE actually achieves.

Sweden is a curious mixture of monetary expansionism and fiscal contraction

This morning has brought us a new adventure in the world of central bank Forward Guidance.

The Executive Board has therefore decided to hold the repo rate unchanged at −0.50 per cent. If the economy develops as expected, there will soon be scope to slowly reduce the support from monetary policy. The forecast for the repo rate indicates that it will also be held unchanged at the monetary policy meeting in October and then raised by 0.25 percentage points either in December or February.

You may already have realised that this is from the Riksbank of Sweden and that there is something awfully familiar about this as Martin Enlund highlights below.

There are a multitude of issues here. Let us start with the fact that the Riksbank was ahead of the game in offering Forward Guidance before the concept was formally devised. I guess that sits well with being the world’s oldest central bank. But the catch so typical of the way that Forward Guidance has developed is that it has proven spectacularly wrong! Indeed I cannot think of any central bank that has such a malfunctioning crystal ball. Ever since 2012 an interest-rate rise and indeed succession of rises has been just around the corner on a road that has been so straight even the Roman Empire would be proud of it.

One of the features of Forward Guidance is that it is supposed to allow businesses and households to plan with certainty. The reality here is that they have been consistently pointed in the wrong direction. Indeed their promises of interest-rate rises morphed into interest-rate cuts in the period from 2012 to 2016. Such that their forecasts if we try to average them, suggested the repo rate now would be of the order of 3-4%, rather than the actual -0.5%. If we look at the period when the repo rate has been negative they have consistently suggested it is temporary but it has been permanent so far, or if you prefer has been temporary as defined in my financial lexicon for these times.I think that there are two major possibilities here. The first is that they are collectively incapable of seeing beyond the end of their noses. The other is that it has been a deliberate policy to maintain negative interest-rates whilst promising to end them.

A more subtle suggestion might be that this is all for the foreign exchanges who do take a least some notice rather than the average Swede. After all if he or she did take notice of the Forward Guidance they have probably long since given up.

The Krona

We get the picture here from this from Bloomberg.

Sweden’s elections this weekend could spell more pain for an already floundering currency.

As ever I will skip past the politics and look at the currency. One cannot do so without first noting the role of the Euro here which is like a big brother or sister to its neighbouring nations. When it cut interest-rates it put pressure on them to cut as well. So let us look at the Krona versus the Euro.

What we see is a clear pattern. Essentially the monetary easing of the Riksbank has taken the Krona from 8.4 versus the Euro in the late summer of 2012 to 10.57 as I type this. So a gentle depreciation to add to the negative interest-rates in terms of monetary policy as we rack up the stimulus count.

We can take that wider by looking at the trade-weighted or Kix Index. If we do so we get a similar result as the 102 of late summer 2012 has been replaced by 121 now. Just for clarity this index operates in the reverse direction to the usual method as a higher number indicates a weaker currency.

If we switch to inflation prospects then some should be coming through as the Wall Street Journal reported yesterday.

Down 10% against the dollar, the krona has fallen more than any other developed-market currency. Among the 10 most heavily traded currencies in the world, it has undershot even China’s Yuan—itself under pressure from the trade conflict with the U.S.—and the U.K.’s Brexit-bruised pound.

So commodity prices will have risen in Krona terms from this effect.


This has been another feature of the expansionary toolkit of the Riksbank

At the end of August, the Riksbank’s government bond
holdings amounted to just over SEK 330 billion, expressed as a  nominal amount .Net purchases of government
bonds will be concluded at the turn of the year, but principal  payments and coupon payments will be reinvested in the government bond portfolio until further notice.

So what has become regarded as a pretty regular QE programme which politicians love as it reduces borrowing costs for them. One generic point I would note is that these Operation Twist style reinvestments are only happening because QE has proven rather permanent rather than the extraordinary and temporary originally claimed. So far only the US Federal Reserve is attempting any unwind. Many argue this does not matter, but when you have redistributed both wealth and income towards the already wealthy I think that it does.

Money Supply

This has been an issue across more than a few countries recently, as we have been observing slow downs. This is also true of Sweden because if we look at the narrow measure or M1 we see that an annual rate of growth of 10.5% in July 2017 was replaced with 6.3% this July. If we look back we see that a major player in this has been the QE purchases because when the Riksbank charged into the bond market in 2015 the annual rate of growth in M1 went over 15% in the latter part of that year. Now we see as QE slows down so has M1 growth.

A similar but less volatile pattern can be seen from the broad money measure M3. That was growing at an annual rate of 8.3% in July 2015 as opposed to the 5.1% of this July. So we see clearly looking at these why the Riksbank has just balked on a promise to raise interest-rates at today’s meeting. Taken in isolation that is sensible and in fact much more sensible than the Bank of England for example which has just raised Bank Rate into monetary weakness.

House Prices

I would like to present this in a new way. We have a conventional opening as according to Sweden Statistics house prices fell by 1.2% in 2012 ( they measure one or two dwelling buildings) which explains the about turn in monetary policy seen then. But if we switch to narrow money growth we see that it looks like there is a link. It peaked in 2015 as did house price growth (10.8%). It remained strong in 2016 and 17 as did house price growth ( 8.4% and 8.3% respectively). Okay so with money supply growth fading what has happened to house prices more recently?

In the last three-month period, from June to August 2018, prices rose by almost 1 percent on an annual basis compared with the same period last year.

Boom to bust? As ever we need to be careful about exact links as for example the latest couple of months have been stronger. But what if monetary growth continues to slow?


Readers will be pleased to discover that the Riksbank has investigated its own policies and given itself a clean bill of health.

The Riksbank’s overall assessment is that the side‐effects
of a negative policy rate and government bond purchases
have so far been manageable.

Where there is a clear question is a policy involving negative interest-rates, QE and a currency depreciation when the economy is doing this.

Activity in the Swedish economy remains high. GDP growth in the second quarter was surprisingly rapid and together with strong indicators, this suggests that economic activity is still not slowing down.

Inflation is also on target. So why is policy so expansionary? Perhaps Fleetwood Mac are correct.

I never change
I never will
I’m so afraid the way I feel

Should they reverse course and find the economy and house prices heading south thoughts will be a lot harsher than the “Oh Well” of Fleetwood Mac.

Oddly we find that fiscal policy is operating in the opposite direction as this from the Swedish Debt Office shows.

For the twelve-month period up to the end of July 2018, central government payments resulted in a surplus of SEK 109.6 billion. Central government debt amounted to SEK 1,196 billion at the end of July. This corresponds to 2.3 and 25.3 percent, respectively, of GDP.

We are in a rare situation where they could genuinely argue they have a plan to pay it all off. The catch comes with the fact that with a ten-year bond yield of 0.54% and a low national debt they have no real need to. So a joined up policy would involve ending negative interest-rates and some fiscal expansionism wouldn’t it?



What can we expect next from the ECB?

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

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

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

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

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

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

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

The dog days are over
The dog days are done

A nagging problem

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

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

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

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

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

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

What happens next?

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

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

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

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

A Space Oddity

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

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

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

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

If true that is a bit grim.


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

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


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

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

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