Is Japan the future for all of us?

A regular feature of these times is to compare our economic performance with that of Japan. That has propped up pretty regularly in this crisis mostly about the Euro area but with sub-plots for the US and UK. One group that will be happy about this with be The Vapors and I wonder how much they have made out of it?

I’m turning Japanese, I think I’m turning Japanese
I really think so
Turning Japanese, I think I’m turning Japanese
I really think so.

The two basic concepts here are interrelated and are of Deflation and what was called The Lost Decade but now are The Lost Decades. These matters are more nuanced that usually presented so let me start with Deflation which is a fall in aggregate demand in an economy. According to the latest Bank of Japan Minutes this is happening again.

This is because aggregate demand is
highly likely to be pushed down by deterioration in the labor market and the utilization rate of conventional types of services could decline given a new lifestyle that takes into
consideration the risk of COVID-19.

The latter point echoes a discussion from the comments section yesterday about an extension to the railway to the Scottish Borders. Before COVID-19 anything like that would come with a round of applause but now there are genuine questions about public transport for the future. There is an irony close to me as I have lived in Battersea for nearly 3 decades and a tube line there has been promised for most of that. Now it is on its way will it get much use?

This is a difficult conceptual issue because if we build “White Elephants” they will be counted in GDP ( it is both output and income), but if they are not used the money is to some extent wasted. I differ to that extent from the view of John Maynard Keynes that you can dig and hole and fill it in. If that worked we would not be where we are now. In the credit crunch we saw facets of this with the empty hotels in Ireland, the unused airport in Spain and roads to nowhere in Portugal. That was before China built empty cities.

Inflation Deflation

There is something of a double swerve applied here which I will illustrate from the Bank of Japan Minutes again.

Next, the three arrows of Abenomics should continue to be carried out to the fullest extent until the economy returns to a growth path in which the annual inflation
rate is maintained sustainably at around 2 percent.

A 2% inflation target has nothing at all to do with deflation and this should be challenged more, especially when it has this Orwellian element.

It is assumed that achievement of the price stability target will be delayed due to COVID-19
and that monetary easing will be prolonged further

It is not a price stability target it is an inflation rate target. This is of particular relevance in Japan as it has had stable prices pretty much throughout the lost decade period. It is up by 0.1% in the past year and at 101.8 if we take 2015 as 100, so marginal at most. The undercut to this is that you need inflation for relative price changes. But this is also untrue as the essentially inflation-free Japan has a food price index at 105.8 and an education one of 92.7.

Policy Failure

The issue here is that as you can see above there has been a complete failure but that has not stopped other central banks from speeding down the failure road. It is what is missing from the statement below that is revealing.

: the Special Program to Support Financing in Response to the Novel Coronavirus (COVID-19); an ample provision of
yen and foreign currency funds without setting upper limits; and active purchases of assets such as exchange-traded funds (ETFs).

No mention of negative interest-rates? Also the large-scale purchases of Japanese Government Bonds only get an implicit mention. Whereas by contrast the purchase of equities as in this coded language that is what “active purchases of assets such as exchange-traded funds (ETFs)” means gets highlighted. The 0.1% will be happy but as any asset price rise is omitted from the inflation indices it is entirely pointless according to their stated objective. No wonder they keep failing…

This matters because pretty much every central bank has put on their running shoes and set off in pursuit of the Bank of Japan. Ever more interest-rate cuts and ever more QE bond buying. Perhaps the most extreme case is the ECB (European Central Bank) with its -0.5% Deposit Rate and large-scale QE. On the latter subject it seems to be actively mirroring Japan.

The ECB may not need to use the full size of its recently expanded pandemic purchase program, Executive Board member Isabel Schnabel says ( Bloomberg)

This is a regular tactic of hinting at reductions whereas the reality invariably ends up on the Andrea True Connection road.

More! More! More!

Staying with the Euro area the ECB has unveiled all sorts of policies and has a balance sheet of 6.2 trillion Euros but keeps missing its stated target. We noted recently that over the past decade or so they have been around 0.7% per year below it and that is not getting any better.

In June 2020, a month in which many COVID-19 containment measures have been gradually lifted, Euro area annual inflation is expected to be 0.3%, up from 0.1% in May ( Eurostat )

Real Wage Deflation

This to my mind is the bigger issue. It used to be the case ( in what was called the NICE era by former Bank of England Governor Mervyn King) that wages grew faster than wages by 1-2% per annum. That was fading out before the credit crunch and since there have been real problems. The state of play for the leader of the pack here has been highlighted by Nippon.com.

Wage growth in Japan is also slow compared with other major economies. According to statistics published by the Organization for Economic Cooperation and Development, the average Japanese annual wage in 2018 was the equivalent of $46,000—a mere 0.2% increase on the figure for 2000 ($45,000).

They mean 2% and everyone else seems to be heading that way.

This increase is significantly smaller than those recorded in the same period in the United States ($53,900 to 63,100), Germany ($43,300 to 49,800), and France ($37,100 to 44,500).

The UK has gone from around $39,000 to the same as France at $44.500.

There is an obvious issue in using another currency but we have the general picture and right now it is getting worse everywhere.

Comment

The answers to the question in my title unfold as follows. In terms of central bank action we have an unequivocal yes. They have copied Japan as much as they can showing they have learnt nothing. We could replace them with an AI version ( with the hope that the I of Intelligence might apply). Related to this is the inflation issue where all the evidence is that they will continue to fail. We have here an example of failure squared where they pursue policies that do not work in pursuit of an objective which would make people worse rather than better off.

That last point feeds into the wages issue which in my opinion is the key one of our times. The Ivory Towers of the central banks still pursue policies where wages growth exceeds inflation and their models assume it. Perhaps because for them it is true. But for the rest of us it is not as real wages have struggled at best and fallen at worst. This is in spite of the increasingly desperate manipulation of inflation numbers that has been going on.

So we see different elements in different places. The Euro area is heading down the same road as Japan in terms of inflation and apart from Germany wages too. The UK is an inflation nation so that part we are if not immune a step or two away from, but that means our real wage performance is looking rather Japanese.

There is also another sub-plot.

30y gilt yield < 30y JGB yield ( Divyang Shah )

The Investing Channel

 

Christine Lagarde and the ECB have switched from monetary to fiscal policy

The Corona Virus pandemic has really rather caught the European Central Bank (ECB) on the hop. You see it was not supposed to be like this on several counts. Firstly the “Euro Boom” was supposed to continue but we now know via various revisions that things had turned down in Germany in early 2018 and then the Trumpian trade war hit as well. So the claims of former ECB President Mario Draghi that a combination of negative interest-rates and QE bond buying had boosted both Gross Domestic Product ( GDP) and inflation by around 1.5% morphed into this.

First, as regards the key ECB interest rates, we decided to lower the interest rate on the deposit facility by 10 basis points to -0.50%……..Second, the Governing Council decided to restart net purchases under its asset purchase programme (APP) at a monthly pace of €20 billion as from 1 November. We expect them to run for as long as necessary to reinforce the accommodative impact of our policy rates, and to end shortly before we start raising the key ECB interest rates.

As you can see the situation was quite problematic. For all the rhetoric who really believed that a cut in interest-rates of 0.1% would make a difference when much larger ones had not? Next comes the issue of having to restart sovereign bond purchases and QE only 9 months or so after stopping it. As a collective then there is the issue of what all the monetary easing has achieved? That leads to my critique that it is always a case of “More! More! More” or if you prefer QE to Infinity.

Next comes the issue of personnel. For all the talk about the ECB being independent the reclaiming of it by the political class was in process via the appointment of the former French Finance Minister Christine Lagarde as President. This of course added to the fact that the Vice President Luis de Guindos had been the Spanish Finance Minister. Combined with this comes the issue of competence as I recall Mario Draghi pointing out he would give Luis de Guindos a specific job when he found one he could do, thereby clearly implying he lacked the required knowledge and skill set. It is hard to know where to start with Christine Lagarde on this subject after her failures involving Greece and Argentina ( which sadly is in the mire again) and her conviction for negligence. Of course she has added to that more recently with her statement about “bond spreads” which saw the ten-year yield in Italy impersonate a Space-X rocket until somebody persuaded her to issue a correction. Although as the last press conference highlighted you never really escape a faux pas like that.

Do you now believe that it is the ECB’s role to control the spreads on government debt?

The Present Situation

This was supposed to be one where monetary policy had been set for the next year or so and President Lagarde could get her Hermes slippers under the table before having to do anything. Life sometimes comes at you quite fast though as this morning has already highlighted. From Eurostat.

In April 2020, the COVID-19 containment measures widely introduced by Member States again had a significant
impact on retail trade, as the seasonally adjusted volume of retail trade decreased by 11.7% in the euro area and
by 11.1% in the EU, compared with March 2020, according to estimates from Eurostat, the statistical office of
the European Union. In March 2020, the retail trade volume decreased by 11.1% in the euro area and by 10.1%
in the EU.
In April 2020 compared with April 2019, the calendar adjusted retail sales index decreased by 19.6% in the euro
area and by 18.0% in the EU.

As you can see Retail Sales have fallen by a fifth as far as we can tell ( normal measuring will be impossible right now and the numbers are erratic in normal times). Also there were large structural shifts with clothing and footwear down 63.5% on a year ago and online up 20.9%. Much of this is due to shops being closed and will be reversed but there is a loss for taxes and GDP which is an issue for ECB policy. Other news points out that May has its troubles as well.

Germany May New Car Registrations Total 168,148 -49.5% Y/Y – KBA ( @LiveSquawk)

Policy Response

For all the claims and rhetoric is that the ECB has prioritised the banks and government’s. So let us start with The Precious! The Precious!

Accordingly, the Governing Council decided today to further ease the conditions on our targeted longer-term refinancing operations (TLTRO III)……. Moreover, for counterparties whose eligible net lending reaches the lending performance threshold, the interest rate over the period from June 2020 to June 2021 will now be 50 basis points below the average deposit facility rate prevailing over the same period.

For newer readers this means that the banks will be facing what is both the lowest interest-rate seen so far anywhere at -1% and also a fix for the problems they have dealing with a -0.5% interest-rate more generally. It also means that whilst the bit below is not an outright lie it is also not true.

In addition, we decided to keep the key ECB interest rates unchanged.

In fact for those who regard the interest-rate for banks as key it is an untruth. Estimates for the gains to the banking sector from this are of the order of 3 billion Euros. Yet another subsidy or if you prefer we are getting the Vapors.

I’m turning Japanese, I think I’m turning Japanese, I really think so
Turning Japanese, I think I’m turning Japanese, I really think so

Fiscal Policy

This is what monetary policy has now morphed into. There is an irony here because one of the reasons the ECB has pursued such expansionary policy is the nature of fiscal policy in the Euro area. That has been highlighted in three main ways. the surpluses of Germany, the Stability and Growth Pact and the depressive policy applied to Greece. But that was then and this is now.

Chancellor Angela Merkel said Wednesday that Germany was set to plow 130 billion euros ($146 billion) into rebooting an economy severely hit by the coronavirus pandemic.

The measures include temporarily cutting value-added tax form 19% to 16%, providing families with an additional €300 per child and doubling a government-supported rebate on electric car purchases.

The package also establishes a €50 billion fund for addressing climate change, innovation and digitization within the German economy. ( dw.com )

Even Italy is being allowed to spend.

Fiat To Use State-Backed Loan To Pay Italy Staff, Suppliers ( @LiveSquawk)

This is the real reason for the QE and is highlighted below.

FRANKFURT (Reuters) – The European Central Bank scooped up all of Italy’s new debt in April and May but merely managed to keep borrowing costs for the indebted, virus-stricken country from rising, data showed on Tuesday.

The ECB bought 51.1 billion euros worth of Italian government bonds in the last two months compared with a net supply, as calculated by analysts at UniCredit, of 49 billion euros.

Comment

Thus President Lagarde will be mulling the words of Boz Scaggs.

(What can I do?)
Ooh, show me that I care
(What can I say?)
Hmmm, got to have your number baby
(What can I do?)

Plainly the ECB needs the flexibility of being able to expand its QE bond buying so that Euro area governments can borrow cheaply as highlighted by Italy or be paid to borrow like Germany. We could see the PEPP plan which is the latest emergency one expanded as it will run out in late September on present trends, also the German Constitutional Court has conveniently given it a bye. But she could do that next time. So finally we have a decision appropriate for a politician!

As to interest-rates we see that the banks have as usual been taken care of. That only leaves the rest of us so it is unlikely. We will only see another cut if they decide that like a First World War general that a futile gesture is needed.

The ECB hints at buying equities and replacing bank intermediation

A feature of this virus pandemic is the way that it seems to have infected central bankers with the impact of them becoming power mad as well as acting if they are on speed. Also they often seen lost in a land of confusion as this from yesterday from the Governor of the Bank of France highlights.

Naturally, there is a huge amount of uncertainty over how the economic environment will evolve, but this is probably less true for inflation.

Okay so the picture for inflation is clearer, how so?

 In the short term, the public health crisis is disinflationary, as exemplified by the drop in oil prices. Inflation is currently very low, at 0.3% in the euro area and 0.4% in France in April; granted, it is particularly tricky to measure prices in the wake of the lockdown, due to the low volume of data reporting and transactions, and the shift in consumer habits, temporary or otherwise.

This is not the best of starts as we see in fact that one price has fallen ( oil) but many others are much less clear due to the inability to measure them.Of course having applied so much monetary easing Francois Villeroy is desperate to justify it.

The medium-term consequences are more open to debate, due notably to uncertainties over production costs, linked for example to health and environmental standards and the potential onshoring of certain production lines; the differences between sectors could be significant, leading to variations in relative prices rather than a general upward path.

As you can see he moves from not being able to measure it to being very unsure although he later points out it is expected to be 1% next year which in his mind justifies his actions. There is the usual psychobabble about price stability being an inflation rate of 2% per annum which if course it isn’t.  #

Policy

It is probably best if you live in a glass house not to throw stones but nobody seems to have told Francois that.

Our choice at the ECB is more pragmatic: since March, we, like the Fed and the Bank of England, have greatly expanded and strengthened our armoury of instruments and in so doing refuted all those – and remember there were a lot of them only a few months ago – who feared that the central banks were “running out of ammunition”.

I will return to that later but let us move onto what Francois regards as longer-term policies.

First, in September 2019, we amended our use of negative rates with a tiering system to mitigate their adverse impacts on bank intermediation. I see no reason to change these rates now.

Actually it has not taken long for Francois to contradict himself on the ammunition point as “see no reason” means he feels he cannot go further into negative interest-rates for the general population. You may also note that he starts with “My Precious! My Precious!” which is revealing. Oh and he has cut the TLTRO interest-rate for banks to -1% more recently.

Plus.

Meanwhile, asset purchases, in operation since mid-2014, reached a total of EUR 2,800 billion in April 2020 and will continue at a monthly average pace of more than EUR 30 billion.

Make of this what you will.

We can also add forward guidance to this arsenal,….. This forward guidance provides considerable leeway to adapt to economic changes thanks to its self-stabilising endogenous component.

New Policy

Suddenly he did cut interest-rates and we are back to “My Precious! My Precious!”

The supply of liquidity to banks has been reinforced in terms of quantity and, above all, through an incentivising price structure. Interest rates on TLTROIII operations were cut dramatically on 12 March and again on 30 April and are now, at -1%

There is also this.

Above all, we have created the EUR 750 billion Pandemic Emergency Purchase Programme (PEPP)…….First, flexibility in terms of time. We are not bound by a monthly allocation…….Second, flexibility in terms of volume. Unlike the PSPP, we are not committed to a fixed amount – today, the PEPP can go “up to EUR 750 million”, and we stated on 30 April that we were prepared to go further if need be.

If we look at the weekly updates which have settled at around 30 billion Euros per week the original 750 billion will run out as September moves into October if that pace is maintained. So it looks likely that there will be more although as the summer progresses things will of course change quite a bit.

Then Francois displays even more of what we might call intellectual flexibility. You see he is not targeting spreads or “yield curve control” or a “spread control” but he is….

While there is a risk that the effects of the crisis may in some cases be asymmetric, we will not allow adverse market dynamics to lead to unwarranted interest rate hikes in some countries.

So he is trying to have his cake and eat it here.

Innovation

This word is a bit of a poisoned chalice as those have followed the Irish banking crisis will know. But let me switch to this subject and open with a big deal for the ECB especially since the sleeping giant known as the German Constitutional Court has shown signs of opening one eye, maybe.

And this brings me to my third point, flexibility in terms of allocation between countries.

He means Italy of course.

Next up is one of the sillier ideas around.

Allow me to say a final word on another development under discussion: the possibility of “going direct” to finance businesses without going through the bank channel. The truth is that we do this already, and have done since 2016, by being among the first central banks to buy corporate bonds.

He is probably keen because of this.

The NEU-CP market in Paris is by far the most active in the euro area, with outstandings of EUR 72 billion in mid-May, and the Banque de France’s most recent involvement since the end of March has been very effective and widely acknowledged by industry professionals.

Ah even better he has been able to give himself a slap on the back as well.

He is eyeing even more.

With its new Main Street Lending Program, the Fed recently went a step further by giving itself the possibility to fund the purchases of bank loans to businesses, via a special-purpose vehicle created with a US Treasury Department guarantee

If banks are bad, why are we subsidising them so much? Also why would central banks full of banks be any better?

After sillier let us have silliest.

ECB’s Villeroy: Would Not Put At Forefront Likelihood Of Buying Up Equities ( @LiveSquawk )

Comment

There is a familiar feel to this as we observe central bankers twisting and turning to justify where they find themselves. Let me start with something which in their own terms has been a basic failure.

This sluggishness in prices comes after a decade of persistently below-target inflation, which has averaged 1.3%.

This provides a range of contexts as of course the inflation picture would look very different if they made any real effort to measure  the one third or so of expenditure that goes on housing costs. In other areas this would be a scandal as imagine how ignoring a third of Covid-19 cases would be received? Also you might think that such failure after negative interest-rates and 2.8 billion Euros of QE might lead to a deeper rethink. This policy effort has in fact ended up really being about what was denied in this speech which is reducing bond yields so governments can borrow more cheaply. The hints in it have helped the ten-year yield in Italy fall to 1.55% as I type this.

Oh the subject of the ECB buying equities I am reminded that I suggested on the 2nd of March it would be next to make that leap of faith. I still think it is in the running however the German Constitutional Court may have slowed it up. The hint has helped the Euro Stoxx 50 go above 3000 today as equity markets continue to be pumped up on liquidity and promises. But more deeply we see that if we look at Japan what has been achieved by the equity buying? The rich have got richer but the economy has not seen any boost and in fact pre this crisis was in fact doing worse. So he is singing along with Bonnie Tyler.

I was lost in France
In the fields the birds were singing
I was lost in France
And the day was just beginning
As I stood there in the morning rain
I had a feeling I can’t explain
I was lost in France in love

 

The central banking parade continues

The last 24 hours have seen a flurry of open mouth operations from the world’s central bankers. There are a couple of reasons for this of which the first is that having burst into action with the speed of Usain Bolt they now have little to do. The second is that they have become like politicians as they bask centre stage in the media spotlight. The third is that their policies require a lot of explaining because they never achieve what they claim so we see long words like “counterfactual” employed to confuse the unwary.

The land of the rising sun

Let us go in a type of reverse order as Governor Kuroda of the Bank of Japan has been speaking this morning and as usual has uttered some gems.

BoJ Gov Kuroda: Repeats BoJ Would Not Hesitate To Add Additional Easing If Needed -BoJ Has Several Tools And Measures To Deploy If Required ( @LiveSquawk )

This is something of a hardy perennial from him the catch though comes with the “if required” bit. You see the April Economic Report from the Ministry of Finance told us this.

The Japanese economy is getting worse rapidly in an extremely severe situation, due to the Novel Coronavirus…….Concerning short-term prospects, an extremely severe situation is expected to remain due to the influence of the infectious disease. Moreover, full attention should be given to the further downside risks to the domestic and foreign economy which are affected by the influence of the infectious disease.

So if not now when? After all the Japanese economy was already in trouble at the end if 2019 as it shrank by 1.8% in the final quarter. Actually he did kind of admit that.

BoJ’s Kuroda: Japan’s Economy To Be Substantially Depressed In Q2

Then looking at his speech another warning Klaxon was triggered.

In the meantime, it expects short- and long-term policy interest rates to remain at their present
or lower levels.

This raises a wry smile because in many ways the Bank of Japan is the central bank that likes negative interest-rates the least. Yes it has one of -0.1% but it tiptoed into it with the minimum it felt it could and stopped, unlike in other easing areas where it has been happy to be the leader of the pack. Why? Well after nearly 30 years of the lost decade it still worries about the banking sector and whether it could survive them and gives them subsidies back as it is. Frankly it has been an utter disaster and shows one of the weaknesses of the Japanese face culture.

Oh and as we mull the couple of decades of easing we got this as well.

KURODA: RECENT EASING ACTION INCLUDING MORE ETF PURCHASES IS TEMPORARY ( @DeltaOne)

This morning there was just over another 100 billion Yen of equity ETF purchases as we mull another refinement of the definition of temporary in my financial lexicon for these times. It appears to mean something which keeps being increased and never ends.

The Bank of England

The new Governor Andrew Bailey gave an interview to Robert Peston of ITV last night which begged a few questions. The first was how its diversity plans seem to involve so much dealing with the children of peers of the realm and Barons in particular? This of course went disastrously wrong with Deputy Governor Charlotte Hogg who seemed to know as little about monetary policy as she did about the conflict of interest issue which led to her departure. During the interview Robert Peston seemed to be exhibiting a similar degree of competence as I pointed out on social media.

@Peston  now says that buying hundreds of billions of debt is different to a decade ago when the Bank of England bought er hundreds of billions of debt. It is frightening that this man was once BBC economics editor.

There was a policy element although it was not news to us I am sure it was to some.

Governor of the Bank of England Andrew Bailey has told ITV’s Peston show that one of the main purposes of the Bank buying £200bn of government debt – and probably more over the course of the Covid-19 crisis – is to “spread the cost of this thing to society” and help the government avoid a return to austerity. ( ITV)

To the extent that there was a policy announcement the whole interview was very wrong as it should be on the Bank of England website for all to see rather than boosting the career of one journalist and network. As I note how that person’s career had been under pressure we see the UK establishment in action. I also note that two subjects were not mentioned.

  1. The apparent dirty protest at the FCA on Andrew Bailey’s watch
  2. The doubling of overdraft interest-rates after a botched intervention by the FCA on Andrew Bailey’s watch.

The United States

Something rather ominous happened last night as The Hill reports.

“He has done a very good job over the last couple of months, I have to tell you that,” Trump told reporters during a meeting with the governors of Colorado and North Dakota. “Because I have been critical, but in many ways I call him my ‘MIP.’ Do you know what an MIP is? Most improved player. It’s called the Most Improved Player award.”

We noted back in November 2018 that The Donald was taking charge of US monetary policy and that Jerome Powell had become something of a toy. Indeed there was more.

The president said he still is at odds with Powell over his stance on negative interest rates. Trump has for months pushed negative interest rates, arguing the U.S. is on an unfair playing field if other countries have negative rates.

Whilst I disagree with The Donald on negative interest-rates he is at least honest and we know where he stands. Whereas Chair Powell said this.

Speaking to the Peterson Institute for International Economics, Powell said negative interest rates are “not something that we’re looking at,” ( Forbes)

Is that an official denial? Anyway it does not go that well with this.

The economic toll has taken an outsized toll on lower-income households, Powell said, with 40% of those employed in February and living in a household that makes less than $40,000 a year losing their job in March.

Conceptually this is a real issue for the US Federal Reserve as such people are unlikely to have many holdings ( or indeed any…) of the assets it keeps pumping up the price of.

Comment

As we survey the scene some of it is surreal. I noted on Tuesday that the US had already seen two examples of negative interest-rates and one has deepened in the meantime. US Feds Funds futures have moved as high as 100.025 for the summer of 2021 and 100.05 for the autumn. Now -0.05% is not a lot but these things have a habit of being like a balloon that is about to be inflated.

You may also note that those who have claimed central banks are independent of government have been silent recently.Perhaps they are busy redacting past comments?

Missing for today’s update so far has been the European Central Bank or ECB. This is because it is involved in something of an internal turf war.

The shock at the ruling is palpable in the corridors of power in Berlin as Karlsruhe’s three-month deadline runs down.

Officials are trying to work out a way of satisfying the court without eroding the independence of the ECB, which has kept the euro zone intact through a decade of crises.

One lawmaker described feeling like a bomb disposal expert, “because the Constitutional Court has put an explosive charge under the euro and the EU”. ( Reuters)

Hang on! Someone still thinks central banks are independent…….

Negative GDP growth and negative interest-rates arrive in the UK

Sometimes things are inevitable although what we are seeing now is a subplot of that. What I mean is that with the people in charge some trends have been established that I have warned about for most if not all of the credit crunch era. Let us start with something announced this morning which is more of a symptom than a cause.

UK gross domestic product (GDP) in volume terms was estimated to have fallen by 2.0% in Quarter 1 (Jan to Mar) 2020, the largest fall since Quarter 4 (Oct to Dec) 2008.

When compared with the same quarter a year ago, UK GDP decreased by 1.6% in Quarter 1 2020; the biggest fall since Quarter 4 2009, when it also fell by 1.6%.

This was in fact a story essentially about the Ides of March.

The decline in the first quarter largely reflects the 5.8% fall in output in March 2020, with widespread monthly declines in output across the services, production and construction industries.

Let us look deeper into that month starting with what usually is a UK economic strength.

There was a drop of 6.2% in the Index of Services (IoS) between February 2020 and March 2020. The biggest negative driver to monthly growth, wholesale and retail trade; repair of motor vehicles and motorcycles, contributed negative 1.27 percentage points; public administration and defence was the largest positive driver, contributing 0.01 percentage points.

Well there you have it as the biggest upwards move was 0.01%! There were other factors which should be under the category that Radiohead would describe as No Surprises.

In services, travel and tourism fell the most, decreasing by 50.1%, while accommodation fell by 45.7% and air transport by 44%.

By the entirely unscientific method of looking up in the air in Battersea and noting the lack of planes it will be worse in April. Next up was this.

Construction output fell by 5.9% in the month-on-month all work series in March 2020; this was driven by a 6.2% decrease in new work and a 5.1% decrease in repair and maintenance; all of these decreases were the largest monthly falls on record since the monthly records began in January 2010.

Then this.

Production output fell by 4.2% between February 2020 and March 2020, with manufacturing providing the largest downward contribution, falling by 4.6%……….The monthly decrease of 4.6% in manufacturing output was led by transport equipment, which fell by 20.5%, with the motor vehicles, trailers and semi-trailers industry falling by a record 34.3%

So the vehicle sector which was already seeing hard times got a punch to the solar plexus.

The Problems Here

There are a whole multitude of issues with this. I regularly highlight the problems with the monthly GDP data and this time we see it is that month ( March) which is material. So we have a drop based on numbers which are unreliable even in ordinary times and let me give you a couple of clear examples of what Taylor Swift would call “Trouble,Trouble,Trouble”.

However, non-market output has long been recognised as a measurement challenge and is one that is likely to be impacted considerably by the coronavirus (COVID-19) pandemic.

What do they mean? Let me look at what right now is the crucial sector.

The volume of healthcare output in the UK is estimated using available information on the number of different kinds of activities and procedures that are carried out in a period and weighting these by the cost of each activity.

In other words they do not really know. Regular readers will recall I covered this when I looked at a book I had helped a bit with which was when Pete Comley wrote a book on inflation. This pointed out that the measurement in the government sector was a combination of sometimes not very educated guesses. Some areas have surged.

The rise in the number of critical care cases is likely to increase healthcare output, as this is among some of the most high-cost care provided by the health service.

Some have not far off collapsed.

For example, the suspension of dental and ophthalmic activities (almost 6% of healthcare output), the cancellation and postponement of outpatient activities (13% of healthcare output), and elective procedures (19% of healthcare output) will likely weigh heavily on our activity figures.

So the numbers will be not far off hopeless. I mean what could go wrong?

 Further, our estimates may be affected by the suspension of some data collections by the NHS in England, which include patient volumes in critical care in England.

Inadvertently our official statisticians show what a shambles the measurement of education is at the best of times.

The volume of education output is produced by weighting the number of full-time equivalent students in different educational settings by the costs of educating the students in that setting.

They miss out another factor which is people doing stuff for themselves. For example my neighbour who fixed his washing machine. I have joined that club but more incompetently as I have a machine that now works but with a leak. Another example is parents now doing their own childcare rather than using nurseries or nanny’s which make be better but reduces GDP.

Oh and it would not be me if I did not point out that the inflation estimates used may be of the Comical Ali variety.

Comment

Now let me switch to the trends which the pandemic has given a shove to but were already on play. Let me return to my subject of yesterday and apologies for quoting my own twitter feed but it is thin pickings for mentions.

Negative Interest-Rates in the UK Klaxon! The two-year UK Gilt yield has fallen to -0.04% this morning

Not entirely bereft though as this from Moyeen Islam notes.

GBP 50yr OIS swap now negative for the first time

This matters if you are a newer reader because once this starts it spreads and sometimes like wildfire. A factor in this was the fact that one of the Bank of England’s loose cannons was on the airwaves yesterday.

“The committee are certainly prepared to do what is necessary to meet our remit with risks still to the downside,” Broadbent told CNBC on Tuesday.

“Yes, it is quite possible that more monetary easing will be needed over time.”

The absent-minded professor needs a minder or two as he can do a lot of damage.

“That is not to say that we stop thinking about this question, but that for the time being is where rates have gone,” he added.

So we have a level of layers here. How did he ever get promoted for example? In some ways even worse how he was switched from being an external member to being a Deputy Governor which opens a Pandora’s Box of moral hazard straight out of the television series Yes Prime Minister. The one clear example of him standing out from the crowd was in the late summer of 2016 when he got things completely wrong.

Moving on “My Precious! My Precious!” is rarely far away.

Broadbent said the potential to stimulate demand would have to be weighed against the impact on banks’ ability to lend, adding that “this is a question that has been thought about on and off since the financial crisis.”

Today we see action on that front.

Britain’s housing market set for comeback ( Financial Times)

I hardly know where to start with that but if we clear the room from the champagne corks fired by the FT I have two thoughts for you. I did warn that all the promised small business lending would end up in the mortgage market just like last time and indeed the time before ( please feel free to add a few more examples). Next whilst some prices may look the same for a while the champagne corks will be replaced by a sense of panic as prices sing along to Tom Perry and his ( Bank of England ) Heartbreakers.

And all the bad boys are standing in the shadows
And the good girls are home with broken hearts
And I’m free
Free fallin’, fallin’
Now I’m free
Free fallin’, fallin’

The Investing Channel

 

 

The future for cash is more hopeful than you might think

This is a hardy perennial pf a subject but it now comes with a new twist provided for us by Which Money.

According to the Bank of England: ‘Like any other surface that large numbers of people come into contact with, banknotes can carry bacteria or viruses.’ So whether handling cash, debit card or credit cards, wash your hands when you get home. If you can, pay using a bank card.

That seems rather unpleasant doesn’t it? Also I do hope that the new plastic bank notes are cleaner than the old ones or the Bank of England has scored something of an own goal here. Still at least you are no longer in danger of former Governor Mark Carney dipping into into your curry.

However Which point out that many still use cash.

Many are still reliant on cash. Two thirds of those who depend on cash have no digital skills and over a third are likely to be a vulnerable customer. It may be impractical for these people to apply & learn to use a debit card for online shopping in the midst of the pandemic.

There are also age issues here.

Nearly half of those who rely or depend on cash are aged over 65, while nearly a third are aged 55 to 64. Both groups are more likely to need to self-isolate and ask friends, family or volunteers to shop for them.

Actually that reminds me of one of my aunts who is suing cash to settle with her neighbours who are kindly doing some shopping for her. I have helped her fix her internet so she could pay them online if necessary but I have no great hopes although she does realise the hygiene danger in using an ATM.

In the week the UK went into lockdown, ATM use fell by 50%, according to ATM network Link.

On the other side of the coin the banks do occassionally get something right.

The good news is that many banks and building societies have introduced the ability for you to pay a cheque in by taking a photo of it and uploading it to your mobile bank app.

Sweden

Now let us have a ying to the yang above as Sweden is the country which has moved the furthest in terms of using electronic money.

Cash is used to a lesser extent. The figure shows that the proportion of those who paid for their most recent purchase in cash has decreased from 39 per cent in 2010 to 13 per cent in 2018. (As from the beginning of 2018, the question refers only to purchases in physical shops). Source: The Riksbank.

If we switch to a more modern payment method which is using your smartphone then according to the Riksbank it is now as popular as using cash.

Number of payments by Swish increasing sharply. The figure shows that the number of Swish payments (millions of payments per year) made by mobile phone (in real time) has increased from 0 in 2012 to 400 million in 2018. Source: Bankgirot.

On a personal level I remember being impressed when the patient ahead of me paid for their physio with their phone which let me putting some notes in my bag feel a little antediluvian. But on the other hand I have seen people getting into a mess trying to pay that way at the supermarket. The trend are clear though.

 In ten years, the average Swede has doubled their card use.

Cash in circulation has been dropping for some time but there has been something of a reversal in recent times. For example it was over 100 billion Kroner in 2010 and fell to 57 billion in 2017 but has since picked up to 63 billion so we will have to see. The rally is of course minor compared to the previous drop but is intriguing when for example the use of smartphones for payment might make you think it would drop further. Maybe negative interest-rates have had an inverse effect in the same way they have boosted saving.

Speaking of negative interest-rates there have been some ch-ch-changes in approach and the emphasis is mine.

At today’s monetary policy meeting, the Executive Board has decided to continue the purchases of covered bonds and government bonds until the end of September, and to hold the repo rate unchanged at zero per cent. The Riksbank is prepared to continue to use the tools at its disposal to  support the economy and inflation.

This is very significant because it previously was one of the standard-bearers for negative interest-rates. Having plunged into their icy-cold grip early in 2015 they only ended the experiment at the end of last year and went as low as -0.5%. Yet in spite of the economic situation described by them below they have not returned.

The great uncertainty over the course of the pandemic
means that the Riksbank, in this report, has chosen to discuss developments on the basis of two different scenarios, rather than a single specific forecast. In these scenarios, GDP in Sweden this  year will be 7 or 10 per cent lower than in 2019, respectively, at  the same time as unemployment will rise to close to 10 or 11 per
cent, respectively.

Staying with the cash issue we now see that unless there is yet another U-Turn from the Riksbank it will not be put under pressure by the establishment lust for negative interest-rates for some time if at all. Of course for the Riksbank this means it has run negative interest-rates in a boom and raised them in a collapse which gives them something of a dunce’s cap or as Madness would put it.

You’re an embarrassment

Comment

There are many different perspectives here. I have looked at Sweden moving away from negative interest-rates and in a minor way ( banks only) Japan nudged away a little yesterday. On the other hand the Euro area seems firmly in their grasp. There have been rumours about New Zealand today which look just that for now but also ones about the US Federal Reserve. However I think they are not the central banking go to they once were not because of any concern for us but because of The Precious.

The reach of negative rates is limited, however, because commercial banks find it hard to charge negative rates to their retail depositors, who might choose to hold their wealth in cash. ( St. Louis Fed)

Of course ambitious young central bankers will be trying to think up ways of subverting this.

Also whilst Sweden has seen less cash in circulation others have seen it rise.

There are over 70 billion pounds worth of notes in circulation…….That is roughly twice as much as a decade ago… ( Bank of England)

The US has seen a not dissimilar pattern with the amount of cash in circulation being US $942 billion back in 2010 but US $1745 billion in March this year.

So the in spite of moves like the phasing out of the 500 Euro note by the ECB there is in fact more cash around in many places. So it is not dead yet. As ever the official campaign to discredit it goes on.

Large sums are also likely to be held overseas or for illegal uses: the so-called ‘shadow’ economy. ( Bank of England)

Meanwhile the large amounts of banking fraud going on is something they hope you will not spot although to be fair the Riksbank of Sweden gives it a mention.

The number of frauds with stolen card details or identities has increased, for example.

What can the ECB and European Commission do to help the Euro area economy?

Today our focus switches to the Euro area and the European Central Bank as we await a big set piece event from the ECB. However as is his wont The Donald has rather grabbed the initiative overnight. From the Department of Homeland Security.

(WASHINGTON) Today President Donald J. Trump signed a Presidential Proclamation, which suspends the entry of most foreign nationals who have been in certain European countries at any point during the 14 days prior to their scheduled arrival to the United States. These countries, known as the Schengen Area, include: Austria, Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Italy, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Netherlands, Norway, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, and Switzerland.

I have pointed it out in this manner as sadly the mainstream media is misreporting it with Beth Rigby of Sky News for example tweeting it as Europe. Much of it yes but not all of it. Moving on to our regular economics beat this will impact on an area we looked at back on the 27th of February.

Announcing the new findings, ENIT chief Giorgio Palmucci said tourism accounted for 13 percent of Italy’s gross domestic product…… tourism-related spending by both French residents and non-residents, represents around 7.5% of GDP (5% for residents, 2.5% for non-residents)…..This figure represented 11.7% of GDP, 0.4% more than in 2016.  ( Spain)

Numbers must have been hit already in what is as you can see an important economic area. One sector of this is illustrated by the German airline Lufthansa which has a share price dipping below 9 Euros or down 11% today as opposed to over 15 Euros as recently as the 19th of February. There are the beginnings of an official response as you can see from @LiveSquawk below.

Spanish Foreign Minister Gonzalez: Spain To Special Steps To Support Tourism

I presume the minister means the tourism sector here as there is nothing that can be done about current tourism as quarantines and the like move in exactly the opposite direction.

There is also the specific case of Italy where it is easier now I think to say what is open rather than closed. As the economic numbers will be out of date we can try and get a measure from the stock market. We see that the FTSE MIB index is at 17,000 as I type this as opposed to 25,477 on the 19th of last month. It is of course far from a perfect measure but it is at least timely and we get another hint from the bond market. Here we see for all the talk of yield falls elsewhere the ten-year yield has risen to 1.3% as opposed to the 0.9% it had fallen to. That is a signal that there are fears for how much the economy will shrink and how this will affect debt dynamics albeit we also get a sign of the times that an economic contraction that looks large like this only raises bond yields by a small amount.

Meanwhile actual economic data as just realised was better.

In January 2020 compared with December 2019, seasonally adjusted industrial production rose by 2.3% in the euro area (EA19) and by 2.0% in the EU27, according to estimates from Eurostat, the statistical office of the
European Union. In December 2019, industrial production fell by 1.8% in the euro area and by 1.6% in the EU27.

The accompanying chart shows a pick-up in spite of this also being true.

In January 2020 compared with January 2019, industrial production decreased by 1.9% in the euro area and by
1.5% in the EU27.

The problem is that such numbers now feel like they are from a different economic age.

The Euro

This has been strengthening through this phase as we note that the ECB effective or trade weighted index was 94.9 on the 19th of February and was 98.14 yesterday. So if there is a currency war it is losing.

As to causes I think there is a bit of a Germany effect an the interrelated trade surplus. But the main player seems to be the return of the carry trade as Reuters noted this time last year.

On the other hand, the Japanese yen, Swiss franc and euro tend to be carry traders’ funding currencies of choice, as their low yields make them attractive to sell.

Yields in Switzerland on the benchmark bond return -0.35 percent; in Germany barely 0.07 percent. But the euro has been particularly popular this year as the struggling economy has further delayed policy tightening plans in the bloc.

Of course both Euro interest-rates and yields went lower later in the year as the ECB eased policy yet again. But can you spot the current catch as Reuters continues?

Should U.S. growth deteriorate, international trade conflicts escalate or the end of the decade-long bull run crystallise, the resulting volatility spike can send “safe” currencies such as the yen, euro and Swiss franc shooting higher, while inflicting losses on riskier emerging markets.

Comment

There is quite an economic shock being applied to the Euro area right now and it is currently being headlined by Italy. In terms of a response the Euro area has been quiet so far in terms of action although ECB President Christine Lagarde has undertaken some open-mouth operations.

Lagarde, speaking on a conference call late on Tuesday, warned that without concerted action, Europe risks seeing “a scenario that will remind many of us of the 2008 Great Financial Crisis,” according to a person familiar with her comments. With the right response, the shock will likely prove temporary, she added. ( Bloomberg).

 

I have no idea how she thinks monetary action will help much with a virus pandemic but of course in places she goes ( Greece, Argentina) things often get worse and indeed much worse. She has also rather contradicted herself referring to the great financial crisis because she chose not to coordinate her moves with the US Federal Reserve as happened back then. Also all her hot air contrasts rather with her new status as a committed climate change warrior.

A real problem is the limited room for manoeuvre she has which was deliberate. In my opinion she was given the job and was supposed to have a long honeymoon period because her predecessor Mario Draghi had set policy for the early part of her term. But as so often in life  we are reminded of the Harold MacMillan statement “events, dear boy, events” and now Christine Lagarde has quite a few important decisions to make. Even worse she has limited room. It used to be the case that the two-year yield of Germany was a guide but -1% seems unlikely and instead we may get a frankly ridiculous 0.1% reduction to -0.6% in the Deposit Rate.

The ECB may follow the Bank of England path and go for some credit easing to rev up the housing market, so expect plenty of rhetoric that it will boost smaller businesses. We may see the credit easing TLTRO with a lower interest-rate than the headline to boost the banks ( presented as good for business borrowers).

However the main moves now especially in the Euro area are fiscal even more than elsewhere as the monetary ones have been heavily used. So the ECB could increase its QE purchases to oil that wheel. Eyes may switch to European Commission President Von der Leyen’s statement yesterday.

These will concern in particular how to apply flexibility in the context of the Stability and Growth Pact and on the provision of State Aid.

I expect some action here although it is awkward as again President Von der Leyen had a pretty disastrous term as German Defence Minister. Although not for her, I mean for the German armed forces. So buckle up and let’s cross our fingers.

Also do not forget there may be a knock on effect for interest-rates in Denmark and Switzerland in particular as well as Sweden.

The Investing Channel

Can QE defeat the economic impact of the Corona Virus?

The weekend just passed has seen more than a few bits of evidence of the spread of the Corona Virus especially in Japan, South Korea, Italy and Iran. It has been a curious phase in Japan where on that quarantined cruise ship they have seemed determined to follow as closely as they can to the plot of the film Alien. Even China has been forced to admit things are not going well. This is President Xi Jinping in Xinhua News.

The epidemic situation remains grim and complex and it is now a most crucial moment to curb the spread, he noted.

Yet later in the same speech we are told this.

Stressing orderly resumption of work and production, Xi made specific requirements to that end.

Back on February 3rd we looked at the potential impact on the economy of China but today we can look wider. Let us open by seeing the consequences of some of the rhetoric being deployed.

Bond Markets

UST 30-Year yield falls to an all-time low 1.83 ( @fullcarry )

So we see an all-time low for the long bond in the worlds largest sovereign bond market. Rallies in bond markets are a knee-jerk response to signs of financial turmoil except it is supposed to be for the certainty of yield or if you prefer  interest. The catch is that there is not much to be found even in the US now and if we look wider afield we see that in one of the extreme cases of these times there is none to be found at all. This is because even the thirty-year yield in Germany is now -0.04% so in fact it is being paid to borrow all along its maturity spectrum.

It was only on Friday that I pointed out some were suggesting that the “bond vigilantes” might return to the UK whereas the UK Gilt market has surged also today with the 50 year Gilt at a mere 0.76%.

These are extraordinary numbers which come on the back of all the interest-rate cuts and all the central bank QE bond buying. Of course the latter is ongoing in the Euro area and in Japan. So let us look at them in particular.

The ECB has already hinted in the past that a reduction in its deposit rate to -0.6% could be deployed but frankly their situation is highlighted by talking about a 0.1% move. After all if full percentage points have not helped then how will 0.1%? Even they are tilling the ground on this front as they join the central banking rush to claim lower interest-rates are nothing to do with them at all.

Interest rates in advanced economies have been on a broad downward path for more than three decades
and remain close to historical lows.[5]
As has been highlighted in many studies, the drivers of this long-term pattern largely boil down to
demographics, productivity and the elevated net demand for safe assets. ( ECB Chief Economist Lane on Friday )

Next comes the issue that an extension of QE is limited by that fact that there are not so many bonds to buy on Germany and the Netherlands. But the reality is that under pressure this “rules based organisation” has a habit of changing the rules.

Switching to Japan we see that Governor Kuroda has been speaking too.

RIYADH (Reuters) – The Bank of Japan will be fully prepared to take necessary action to mitigate the impact of the coronavirus on the world’s third-largest economy, its Governor Haruhiko Kuroda said.

Okay what?

He also repeated the view that, while the central bank stands ready to ease monetary policy further “without hesitation”, it saw no immediate need to act.

That reminds me of the time he denied any plans to move to negative interest-rates and a mere eight days later he did. The next bit seems to be from a place far,far,away.

Kuroda said there was no major change to the BOJ’s projection that Japan’s economy would keep recovering moderately thanks to an expected rebound in global growth around mid-year.

Perhaps he was hoping that people would forget that GDP fell by 1.6% in the last quarter of 2018 meaning that the economy was 0.4% smaller than a year before.Or that Japanese plans for this year involved an Olympics in Tokyo that is now in doubt, after all the Tokyo Marathon has been dramatically downsized. I write that sadly as there are a couple of people who train at Battersea Park running track with hopes of competing in the Olympics.

But the grand master of expectations here was this from the G 20 conference over the weekend.

“I’m not going to comment on monetary policy, but obviously central bankers will look at various different options as this has an impact on the economy,” Mnuchin said.

Gold

There have been various false dawns for the price of gold and of course enough conspiracy theories about this for anyone. But gold bugs will be singing along with Spandau Ballet as they note a price of US $1688 is up over 23% on a year ago.

Gold
(Gold)
Always believe in your soul
You’ve got the power to know
You’re indestructible, always believe in, ‘cos you are ( Spandau Ballet )

Equity Markets

This have faced something of a conundrum as fears of a slowing world economy have been been by the hopium of even more central bank easing. Last week the Dax 30 of Germany hit an all-time high and today it is down 3.6% at 13,070 as I type this. So for all the media panic today it remains close to its highest ever.

Currencies

There are two main trends here I want to mark. The first is that we seem to be again in a period of what might be called King Dollar. Also there is this.

SNB propping up 1.0600 in $EURCHF ( @RANSquawk )

Trying that at 1.20 imploded rather spectacularly in January 2015. For newer readers the Swiss Franc (CHF) has been strong as the reversal of the pre credit crunch carry trade has been added to by the perceived strength of Switzerland. This was exacerbated as its neighbour the Euro area kept cutting interest-rates and went negative. So the Swiss National Bank are presently intervening against a safe haven flow towards the Swissy.

I have suggested for a while now I could see the Swiss National Bank cutting interest-rates to -1% and expect not to be “so lonely” as The Police put it. Also I would remind you that 20% of the intervention will be reinvested in the US equity market.

Comment

Who knew that interest-rate cuts and QE could be effective cures for the Corona Virus? Especially as they have not worked for much else. Although there are also whispers that it can cure climate change too. This highlights the moral and intellectual bankruptcy at play as central bankers try to offer more central planning to fix the problems of past central planning. The Corona Virus is of course not their fault but anything unexpected was always going to be a problem for a group determined not to allow a recession and thus any reform under creative destruction.

Meanwhile the rest of us wait to see the full economic impact as we mull the flickers of knowledge we get. For example Jaguar Land Rover saying it only has 2 weeks supply of some parts or reports that for some US pharmaceuticals 80% of the basic ingredients come from China. So the latter could see large demand they cannot supply and higher prices just as we see lower demand and inflation elsewhere. More conventionally there is this for France which must send a chill down the spine of Italy to its boot.

The drop off in tourist numbers is an “important impact” on France’s economy, Bruno Le Maire, the country’s finance minister, said…….France is one of the most visited countries in the world, and tourism accounts for nearly 8% of its GDP.

Podcast

 

 

 

 

The ECB now considers fiscal policy via QE to be its most effective economic weapon

Yesterday saw ECB President Christine Lagarde give a speech to the European Parliament and it was in some ways quite an extraordinary affair. Let me highlight with her opening salvo on the Euro area economy.

Euro area growth momentum has been slowing down since the start of 2018, largely on account of global uncertainties and weaker international trade. Moderating growth has also weakened pressure on prices, and inflation remains some distance below our medium-term aim.

In the circumstances that is quite an admittal of failure. After all the ECB has deployed negative interest-rates with the Deposit Rate most recently reduced to -0.5% and large quantities of QE bond buying. No amount of blaming Johnny Foreigner as Christine tries to do can cover up the fact that the switch to a more aggressive monetary policy stance around 2015 created what now seems a brief “Euro boom” but now back to slow and perhaps no growth.

But according to Christine the ECB has played a stormer.

 The ECB’s monetary policy since 2014 relies on four elements: a negative policy rate, asset purchases, forward guidance, and targeted lending operations. These measures have helped to preserve favourable lending conditions, support the resilience of the domestic economy and – most importantly in the recent period – shield the euro area economy from global headwinds.

It is hard not to laugh at the inclusion of forward guidance as a factor as let’s face it most will be unaware of it. Indeed some of those who do follow it ( mainstream economists) started last year suggesting there would be interest-rate increases in the Euro area before diving below the parapet. There seems to be something about them and the New Year because we saw optimistic forecasts this year too which have already crumbled in the face of an inconvenient reality. Moving on you may note the language of of “support” and “helped” has taken a bit of a step backwards.

Also as Christine has guided us to 2018 we get a slightly different message now to what her predecessor told us as this example from the June press conference highlights.

This moderation reflects a pull-back from the very high levels of growth in 2017, compounded by an increase in uncertainty and some temporary and supply-side factors at both the domestic and the global level, as well as weaker impetus from external trade.

As you can see he was worried about the domestic economy too and mentioned it first before global and trade influences. This distinction matters because as we will come too Christine is suggesting that monetary policy is not far off “maxxed out” as Mark Carney once put it.

For balance whilst there is some cherry picking going on below I welcome the improved labour market situation.

Our policy stimulus has supported economic growth, resulting in more jobs and higher wages for euro area citizens. Euro area unemployment, at 7.4%, is at its lowest level since May 2008. Wages increased at an average rate of 2.5% in the first three quarters of 2019, significantly above their long-term average.

Although it is hard not to note that the level of wages growth is worse than in the US and UK for example and the unemployment rate is much worse. You may note that the rate of wages growth being above average means it is for best that the ECB is not hitting its inflation target. Also we get “supported economic growth” rather than any numbers, can you guess why?

Debt Monetisation

You may recall that one of the original QE fears was that central banks would monetise government debt with the text book example being it buying government bonds when they were/are issued. This expands the money supply ( cash is paid for the bonds) leading to inflation and perhaps hyper-inflation and a lower exchange-rate.

What we have seen has turned out to be rather different as for example QE has led to much more asset price inflation ( bond, equity and house prices) than consumer price inflation. But a sentence in the Christine Lagarde speech hints at a powerful influence from what we have seen.

 Indeed, when interest rates are low, fiscal policy can be highly effective:

Actually she means bond yields and there are various examples of which in the circumstances this is pretty extraordinary.

Another record for Greece: 10 yr government bonds fall below 1% for the first time in history (from almost 4% a year ago)  ( @gusbaratta )

This is in response to this quoted by Amna last week.

 “If the situation continues to improve and based on the criteria we implement for all these purchases, I am relatively convinced that Greek bonds will be eligible as well.” Greek bonds are currently not eligible for purchase by the ECB since they are not yet rated as investment grade, one of the basic criteria of the ECB.

Can anybody think why Greek bonds are not investment grade? There is another contradiction here if we return to yesterday’s speech.

Other policy areas – notably fiscal and structural polices – also have to play their part. These policies can boost productivity growth and lift growth potential, thereby underpinning the effectiveness of our measures.

Because poor old Greece is supposed to be running a fiscal surplus due to its debt burden, so how can it take advantage of this? A similar if milder problem is faced by Italy which you may recall was told last year it could not indulge in fiscal policy.

The main target in President Lagarde’s sights is of course Germany. It has plenty of scope to expand fiscal policy as it has a surplus. It would in fact in many instances actually be paid to do so as it has a ten-year yield of -0.37% as I type this meaning real or inflation adjusted yields are heavily negative. In terms of economics 101 it should be rushing to take advantage of this except we see another example of economic incentives not achieving much at all as Germany seems mostly oblivious to this. There is an undercut as the German economy needs a boost right now. Although there is another issue as it got a lower exchange rate and lower interest-rates via Euro membership now if it uses fiscal policy and that struggles too, what’s left?

Mission Creep

If things are not going well then you need a distraction, preferably a grand one

We also have to gear up on climate change – and not only because we care as citizens of this world. Like digitalisation, climate change affects the context in which central banks operate. So we increasingly need to take these effects into account in central banks’ policies and operations.

Readers will disagree about climate change but one thing everyone should be able to agree on is that central bankers are completely ill equipped to deal with the issue.

Comment

This morning’s release from Eurostat was simultaneously eloquent and disappointing.

In December 2019 compared with November 2019, seasonally adjusted industrial production fell by 2.1% in the
euro area (EA19)……In December 2019 compared with December 2018, industrial production decreased by 4.1% in the euro area……The average industrial production for the year 2019, compared with 2018, fell by 1.7% in the euro area

The index is at 100.6 so we are nearly back to 2015 levels as it was set at 100 and we have the impact of the Corona Virus yet to come. Actually we can go further back is this is where we were in 2011. Another context is that the Euro area GDP growth reading of 0.1% will be put under pressure by this.

In a nutshell this is why the ECB President wants to discuss things other than monetary policy as even central bankers are being forced to discuss this.

 We are fully aware that the low interest rate environment has a bearing on savings income, asset valuation, risk-taking and house prices. And we are closely monitoring possible negative side effects to ensure they do not outweigh the positive impact of our measures on credit conditions, job creation and wage income.

But central bankers are creatures of habit so soon some will be calling for yet another interest-rate cut.

Let me finish with some humour.

Governors had to stop trashing policy decisions once taken and keep internal disputes out of the media, presenting a common external front, 11 sources — both critics and supporters of the ECB’s last, controversial stimulus package — told Reuters.

Yep, the ECB has leaked that there are no leaks….

 

 

 

The ECB Review should put house prices in its inflation measure

Today brings the Euro area and European Central Bank into focus as the latter announces its policy decision. In terms of a change today I am not expecting anything as policy was set for the early part of the tenure of Christine Lagarde as ECB President by her predecessor Mario Draghi when he cut the main interest-rate to -0.5% and restarted QE bond purchases late last year. If you think about it that was quite revelaing as to what Mario thought about the capabilities of his “good friend” Christine. But whilst the surface may be quiet there is quite a bit going on underneath as highlighted by this from the Financial Times.

Lagarde’s legacy building begins at the ECB

I would say that this is an extraordinary level of sycophancy but then this is standard for the FT which of course called Bank of England Governor a “rock star”. Still I guess the media have to compete for priority at the various press conferences. After all the idea was a classic political style tactic of playing for time. But the catch is that it seems likely to end up with actual changes just as the time when the ECB is at its most intellectually lightweight. Also there is something of a swerve in that the ECB is in effect being allowed to set its own exam paper. Most of us wish we could have done that at school, college and university! More seriously central bank mandates are supposed to be set by elected politicians. Now whilst the ECB is headed by politicians these days ( Lagarde and De Guindos) they have been appointed rather than elected.

What is going on?

This is really extraordinary stuff because if you think about it Mario Draghi acquired a legacy by responding to events ( Whatever it takes to save the Euro…) whereas wht we have now is self-chosen as described above,

 Every good central banker needs a legacy. Mario Draghi, the former head of the European Central Bank, is widely credited with rescuing the eurozone from a debt crisis. Today his successor, Christine Lagarde, will kick off the search for a defining cause of her own.

Also this “Every good central banker needs a legacy” provokes the question why? Before we note that this is very damning of a former FT favourite Mark Carney who is leaving without one.

Oh and did I mention buying time?

Ms Lagarde will launch the second strategic review in the 20-year history of the ECB — a process that she has said will last until December as it turns “every stone” in search of ways to fine tune its monetary policy toolkit.

Also just like we have seen in various wars if your main priority is going badly it is time for some mission creep.

One of the most controversial ideas Ms Lagarde has proposed for the review is to make tackling climate change a “mission-critical” priority of the ECB. It is easy to see why this idea appeals to Ms Lagarde, with extreme weather events increasing in frequency and intensity every year — the latest being the wildfires raging across Australia — and pushing green issues to the top of the political agenda.

Indeed it is with the Euro area economy struggling. A diversion is badly needed.

With the Ivory Tower style economic modelling in so much trouble you might think this is really rather cruel and heartless.

For a start, the ECB could integrate climate-related risks into all its modelling and take more account of them when valuing collateral it accepts from financial institutions, as proposed by Banque de France governor François Villeroy de Galhau.

Collateral is a potentially explosive issue as the Bank of England discovered early in the credit crunch when it found that it had received “Phantom Securities” ( the clue is in the name). This is even more likely in a fashionable cause such as climate change.

A problem with this is that it would lead to central bankers choosing which stocks to favour which even the equity loving Tokyo Whale tries to avoid.

Environmental campaigners are calling on the ECB to do even more and repurpose its €2.6tn asset-purchase programme, known as quantitative easing (QE), by divesting “brown” bonds issued by carbon-intensive companies while increasing purchases of green bonds…….Critics say it is up to politicians, not central banks, to decide which companies to favour and which to penalise.

Meanwhile back on the day job.

Growth expectations have been scaled down.

If we switch to CNBC we see something which is quite damning for an ECB which has been so expansionist and interventionist. After negative interest-rates and all the QE this is the result.

Monetary policy action in Frankfurt is not expected by some market watchers for the whole of 2020. With inflation sluggish and no real economic rebound in sight, the majority of economists expect the ECB to adopt a “wait and see” approach.

The International Perspective

This matters on an international perspective as has been revealed by the head of the Swiss National Bank today.

“We know that negative rates also have side effects, that is the reason why we changed the threshold,” Jordan told CNBC, referring to the SNB raising the limit before the charge of -0.75% applied to commercial bank deposits at the central bank.

That is an awkward one for Christine Lagarde to mull as she imposes negative interest-rates but there is more.

ordan’s colleague Andrea Maechler said on Wednesday the SNB would end negative interest rates “as soon as we are able,” when asked about the central bank’s ultra-loose monetary policy aimed at curbing the Swiss franc’s over-valuation.

In essence it is the ECB that runs Swiss monetary policy as another ECB interest-rate cut seems likely to push the SNB to -1% as an official interest-rate. There is a similar state of play in Denmark. As to Sweden it’s central bank has been something of an unguided missile in the way it has raised interest-rates into an economic slow down so who knows what it will do next?

Comment

The opening issue is how did the ECB end up with its review being headed by someone known for incompetence ( Greece and then Argentina) as well as having a conviction for negligence in a fraud case?

Perhaps the fact above is related to a state of pay where nobody seems to be discussing the actual mandate or what we might call the day job. This is to keep consumer inflation as defined by HICP ( what we call CPI in the UK) below but close to 2% per annum. This was later refined by former President Jean-Claude Trichet to 1.97%, mostly because that is what it averaged in his watch.

There is a warning there because the apparent success on Trichet’s watch was combined with the credit crunch. Ooops! More specifically there were the house price booms and then busts in Spain and Ireland in particular. This allows me to suggest a fix which is to put house prices in the inflation index to help avoid that occurring again. Also it would represent not only a tightening of policy but adding an area that somehow they have managed to mean to include but forget for two decades now. Otherwise they had better keep playing Elvis on their loudspeakers.

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