Are negative interest-rates becoming a never ending saga?

Today brings this subject to mind and let me open with the state of play in Switzerland.

The Swiss National Bank is maintaining its expansionary
monetary policy, thereby stabilising price developments
and supporting economic activity. Interest on sight
deposits at the SNB remains at – 0.75% and the target
range for the three-month Libor is unchanged at between
– 1.25% and – 0.25%.

As you can see negative interest-rates are as Simple Minds would put it alive and kicking in Switzerland. They were introduced as part of the response to a surging Swiss Franc but as we observe so often what are introduced as emergency measures do not go away and then become something of a new normal. It was back on the 18th of December 2014 that a new negative interest-rate era began in Switzerland.

The introduction of negative interest rates makes it less attractive to hold Swiss franc investments, and thereby supports the minimum exchange rate.

Actually the -0.25% official rate lasted less than a month as on the 15th of January 2015 the minimum exchange rate of CHF 1.20 per euro was abandoned and the official interest-rate was cut to -0.75% where it remains.

Added to that many longer-term interest-rates in Switzerland are negative too. For example the Swiss National Bank calculates a generic bond yield which as of yesterday was -0.26%. This particular phase of Switzerland as a nation being paid to borrow began in late November last year.

The recovery

The latest monthly bulletin tells us this.

Jobless figures fell further, and in February the
unemployment rate stood at 2.4%.

There was a time when this was considered to be below even “full employment” a perspective which has been added to this morning and the tweet below is I think very revealing.

If we look at the Swiss economy through that microscope we see that in this phase the unemployment rate has fallen by 1%. Furthermore we see that not only is it the lowest rate of the credit crunch era but also for much of the preceding period as it was back around the middle of 2002.

So if we look at the Swiss internal economy it is increasingly hard to see what would lead to interest-rates rising let alone going positive again. This is added to by the present position as described by the SNB monthly bulletin.

According to an initial estimate, GDP in Switzerland grew
by 0.7% in the fourth quarter. Overall, GDP thus stagnated
in the second half of 2018, having grown strongly to
mid-year.
Leading indicators and surveys for Switzerland point to
moderately positive momentum at the beginning of 2019.

The general forecasting view seems to be for around 1.1% GDP growth this year. So having not raised interest-rates in a labour market boom it seems unlikely unless they have a moment like the Swedish Riksbank had last December that we will see one this year,

Exchange Rate

There is little sign of relief here either. There was a brief moment round about a year ago that the Swiss Franc looked like it would get back to its past 1.20 floor versus the Euro. But since then it has strengthened and is now at 1.126 versus the Euro. Frankly if you are looking for a perceived safe-haven then does a charge of 0.75% a year deter you? That seems a weak threshold and reminds me of my article on interest-rates and exchange rates from the 3rd of May last year.

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

Well events have proven me right about Argentina but whilst the scale here is much lower we have a familiar drum beat. The domestic economy has been affected but the exchange-rate policy has had over four years and is ongoing.

The Euro

Let me hand you over to the President of the ECB Mario Draghi at the last formal press conference.

First, we decided to keep the key ECB interest rates unchanged. We now expect them to remain at their present levels at least through the end of 2019……….These are decisions that have been taken following a significant downward revision of the forecasts by our staff.

For reasons only known to themselves part of the financial media persisted in suggesting that an ECB interest-rate rise was in the offing and it would be due round about now. The reality is that any prospect has been pushed further away if we note the present malaise and read this from the same presser.

negative rates have been quite successful in our monetary policy.

Although we can never rule out an attempt to continue to impose negative rates on us but exclude the precious in some form.

Sweden

Last December the Riksbank did start to move away from negative interest-rates. The problem is that they now find themselves wearing something of a central banking dunces cap. Having failed to raise rates in a boom they decided to do so in advance of events like this.

Total orders in industry decreased by 2.0 percent in February 2019 compared with January, in seasonally adjusted figures………..Among the industrial subsectors, the largest decrease was in the industry for motor vehicles, down 12.7 percent compared with January. ( Sweden Statistics yesterday)

Like elsewhere the diesel debacle is taking its toll.

The new registrations of passenger cars during 2019 decreased by 15.2 percent compared with last year. There were 27 710 diesel cars in total registered this year, a decrease of 26 percent compared with last year.

Anyway this is the official view.

As in December, the forecast for the repo rate indicates that the next increase will be during the second half of 2019, provided that the economic outlook and inflation prospects are as expected.

Japan

This is the country that has dipped its toe into the icy cold world of negative rates by the least but the -0.1% has been going for a while now.

introduced “QQE with a Negative Interest Rate” in January 2016 ( Bank of Japan)

If the speech from Bank of Japan Board Member Harida on March 6th is any guide it is going to remain with us.

I mentioned earlier that the economy currently may be weak, and the same can be said about prices.

Also he gives an alternative view on the situation.

Following the introduction of QQE, the nominal GDP growth rate, which had been negative since the global financial crisis, has turned positive………Barring the implementation of both QE and QQE, Japan’s nominal GDP growth would have remained in negative territory this whole time since 1998.

Is it all about the nominal debt of the Japanese state then? Also he seems unlikely to want an interest-rate increase.

Rather, premature policy tightening in the past caused economic deterioration, a decline in both prices and production, and lowered interest rates in the long run.

Comment

We find that there are two routes to negative interest-rates. The first is to weaken the exchange-rate such as we have seen in Switzerland and the second is to boost the economy like in the Euro area. So external in the former and internal in the latter. It can be combined as if you wish to boost your economy a lower exchange-rate is usually welcome and this pretty much defines Abenomics in Japan.

As we stand neither route seems to have worked much. Maybe a negative interest-rate helped the Euro area and Japan for a while but the current slow down suggests not for that long. So we face something of an economic oxymoron which is that it is the very fact that negative interest-rates have not worked which explains their longevity and while they seem set to be with us for a while yet.

 

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In the future will everybody be paid to issue debt?

This morning has brought a couple of developments on a road I have both expected and feared for some time. This road to nowhere became a theme as I questioned how central banks would respond to the next slow down? We have two examples of that this morning as we see industrial profits in China fall 14% year on year after quality adjustment or 27% without ( h/t @Trinhnomics). Also we have some clear hints – much more useful than so-called Forward Guidance – from ECB President Mario Draghi. So let me jump to a clear consequence of this.

The stockpile of global bonds with below-zero yields just hit $10 trillion — intensifying the conundrum for investors hungry for returns while fretting the brewing economic slowdown.

A Bloomberg index tracking negative-yielding debt has reached the highest level since September 2017………

This latest move if you look at their chart has taken the amount of negative yielding debt from less than US $6 trillion last September to US $10 trillion now as we observe what a tear it has been on. So if you buy and hold to maturity of these bonds you guarantee you will make a loss. So why might you do it?

While negative yields on paper suggest that investors lose money just by holding the obligations, bond buyers could also be looking at price gains if growth stalls and inflation stays low. But along the way, risk assets may be entering the danger zone.

So one argument is the “greater fool” one. In the hope of price gains someone else may be willing to risk a negative yield and an ultimate loss should they hold the bond to maturity.

However there always ways a nuance to that which was that of a foreign investor. He or she may not be too bothered by the risk of a bond market loss if they expect to make more in the currency. This has played out in the German and Swiss bond markets and never went away in the latter and is back in the former. Also investors pile into those two markets in times of fear where a small loss seems acceptable. This has its dangers as those who invested in negative yielding bonds in Italy have discovered over the past year or two.

The more modern nuance is that you buy a bond at a negative yield expecting the central bank to buy it off you at a higher price and therefore more negative yield. Let me give you an example from my country the UK yesterday afternoon. The Bank of England paid 144 for a UK Gilt maturing in 2034 which will mature at 100. This does not in this instance create a negative yield but it does bring a much lower one as a Gilt issue with a 4.5% coupon finds its yield reduced to 1.32%. There was a time the thought that a UK Gilt would be priced at 144 would only raise loud laughs. I also recall that the Sledgehammer QE of the summer of 2016 did create negative yields in the UK albeit only briefly. Of course in real terms ( allowing for inflation) that made the yield heavily negative.

The Euro area

The activities of the European Central Bank under Mario Draghi and in particular the QE based bond buyer have added to the negative yielding bond total. This morning he is clearly pointing us to the danger of larger negative interest-rates and yields as he focuses on what to him is “the precious”.

We will continue monitoring how banks can maintain healthy earning conditions while net interest margins are compressed. And, if necessary, we need to reflect on possible measures that can preserve the favourable implications of negative rates for the economy, while mitigating the side effects, if any. That said, low bank profitability is not an inevitable consequence of negative rates.

This matters because so far banks have found it difficult to offer depositors less than 0%. There have been some examples of it but in general not so . Thus should the ECB offer a deposit rate even lower than the current -0.4% the banks would be hit and for a central banker this is very concerning. This is made worse in the Euro area by the parlous state of some of the banks. Mario is also pointing us towards the ” favourable implications of negative rates for the economy” which has led Daniel Lacalle to suggest this.

Spain: Mortgage lending rises 16% in the middle of a slowdown with 80% of leading indicators in negative territory.

There is an attempt by Mario to blame Johnny Foreigner for the Euro area slow down.

The last year has seen a loss of growth momentum in the euro area, which has extended into 2019. This has been predominantly driven by pervasive uncertainty in the global economy that has spilled over into the external sector. So far, the domestic economy has remained relatively resilient and the drivers of the current expansion remain in place. However, the risks to the outlook remain tilted to the downside.

Those involved in the domestic economy might be worried by the use of the word “resilient” as that is usually reserved for banks in danger of collapse and we know what invariably happens next. But no doubt you have noted that in spite of the rhetoric we are pointed towards the economy heading south.

Then we get the central banking mic-drop as we wonder if this is the new “Whatever it takes ( to save the Euro)”.

We are not short of instruments to deliver on our mandate.

That also qualifies as an official denial especially as the actual detail shows that things from Mario’s point of view are not going well.

The weakening growth picture has naturally affected the inflation outlook as well. Our projections for headline inflation this year have been revised downwards and we now see inflation at 1.6% in 2021. Slower growth will also lead to a more muted recovery in underlying inflation than we had previously expected.

Comment

We have seen today that not only are there more people finding that debt pays in a literal sense but we have arrived in a zone where more of this is in prospect. I have explained above how this morning has brought a suggestion that there will be more of it in the Euro area and by implication around Europe as it again acts as a supermassive black hole. But let me now introduce the possibility of a new front.

Back in the 1980s the superb BBC television series Yes Prime Minister had an episode where Sir Humphrey Appleby suggests to Prime Minister Jim Hacker.

Why don’t you announce a cut in interest-rates?

Hacker responds by saying the Bank of England will not do it to which Sir Humphrey replies by suggesting a Governor who would ( and then does…). Now in a modern era of independent central banks that cannot possibly happen can it?

 He said the Fed should immediately reverse course and cut rates by half a percentage point.

Those are the words of the likely US Federal Reserve nominee Stephen Moore as spoken to the New York Times. Just in case you think that this is why he is on his way to being appointed I would for reasons of balance like to put the official denial on record.

And he promised he would demonstrate independence from Mr. Trump, whose agenda Mr. Moore has helped shape and frequently praised.

Returning directly to my theme of the day this in itself would not take US yields negative but a drop in the official interest-rate from 2.5% to 2% would bring many other ones towards it. For a start it would make us wonder how many interest-rate cuts might follow? Some of these thoughts are already in play as the US Treasury Note ten-year yield which I pointed out was 2.5% on Friday is 2.39% as I type this, In the UK the ten-year Gilt yield has fallen below 1% following the £2.3 billion of Operation Twist style QE as it refills its coffers on its way back to £435 billion.

 

Can we stop interest-rates falling and going negative?

This week has seen a development I have long-expected and forecast. That is that the establishment will respond to the next economic slow down with negative interest-rates. The rationale for that is in one sense simple as in most places interest-rates never went back up again and if they did by not much, Only yesterday I looked at my own country the UK where in the decade or so since the credit crunch the Bank of England has raised interest-rates by a net 0.25%. Not much is it? Last time around the only reason it did not cut interest-rates even lower it was because it feared that the creaking IT systems of the UK banks could not take it. As it was some mortgages ( mostly with Cheltenham & Gloucester if I recall correctly) went below 0% and were dealt with via capital repayments to stop a HAL 9000 style moment.

Of course more than a few central banks continue to have negative interest-rates as we look at Denmark, the Euro area, Japan, Sweden and Switzerland. The ECB may pause this morning to mull whether it will get its deposit rate ( -0.4%) back even to zero as it note German factory orders some 7% lower than the previous year in December. This brings us to the driver of the current situation which is the economic slow down we have been following and indeed predicting via the decline in money supply growth. That remains as a slow down and has not yet signalled an overall recession but none the less it has produced quite a change.

The San Francisco Fed

It is far from a coincidence that the San Francisco Fed has produced a paper on negative interest-rates this week. After all the overall Federal Reserve has put up the white flag on interest-rate increases as we wait to hear what was discussed when Chair Powell had dinner with President Trump on Monday night.  Anyway the paper seems to open with a statement of regret.

Traditionally, it has been assumed that nominal interest rates cannot fall below zero, known as the “lower bound.” Ever since 2008, researchers have debated how much monetary policy was constrained by this lower bound and how much it affected economic outcomes. To work around this constraint, the Federal Reserve turned to unconventional monetary policy tools such as forward guidance and large-scale asset purchases.

Also an admission that QE was driven by the belief that interest-rates could not go below zero. I cannot be too churlish about that because there was a time when I did not think so either at least on a sustained basis although it was around 20 years ago and before the full impact of the Japanese lost decade! I do not know if one of the drivers of this thought was fear of what negative interest-rates would do to the US banks but history has seen a potential revision.

In this Economic Letter, I consider whether pushing rates below zero would have improved economic outcomes in the United States in the aftermath of the financial crisis.

For a central banker the answer is clearly yes.

Model estimates suggest that reducing the effective lower bound for the federal funds rate to –0.75% would have reduced economic slack by as much as one-half at the trough of the recession and sped up the ensuing recovery. While the boost to the economy would have been negligible after 2014, inflation would have been higher throughout the recovery by about half a percentage point on average.

There are various points here. First the central banker assumption that higher inflation is a good thing whereas in reality the ordinary person is likely to be worse off via lower real wages. Next the interesting observation that it is a temporary gain. Finally there is a later reference to Switzerland which took interest-rates to -0.75% so we are left with the view that this paper might recommend even more negative rates if only someone else had been brave/silly enough to try them. It omits to point out that Switzerland has not escaped from this as it is still at -0.75%.

How does this work?

An old friend appears.

In the model, the output gap falls with the interest rate.

Ah so it works because we assume it will. What could go wrong? Whilst we are at the Outer Limits of fantasy why not throw in the kitchen sink.

However, expectations about the future path of the fed funds rate matter, including any Federal Reserve announcements about its path—known as forward guidance—as well as expectations about being at the zero lower bound.

I am not sure if that is chutzpah, ignorance or just simple Ivory Tower non-thinking. After all we have just had a Forward Guidance U-Turn so are we following the old or new versions and if so what was the cost of the change? Those who have fixed their mortgage expecting higher interest-rates for example. Whereas now Men at Work are being played.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

Rather oddly the paper says that the output gap is pushed higher when the author must mean lower, But there is a bigger space oddity which is this.

According to these simulations, the negative lower bound would have reached its maximum effect in the first quarter of 2011. Setting the lower bound at –0.25% would have increased the output gap by 1.5 percentage points, while pushing the lower bound down further to –0.75% would have contributed an additional 0.4 percentage point to the output gap. This means that a rate of –0.25% would have done most of the job, and allowing it to drop further would have accomplished fewer additional benefits.

Let us subject that to a sense check because we know that the US Federal Reserve did cut its official interest-rate to 0% ( technically 0% to 0.25%) but that going a mere extra 0.25% would make much of a difference? From the previous peak the US had cut by 5% so would an extra 0.25% make any difference at all?

The IMF goes further

Here we go.

One option to break through the zero lower bound would be to phase out cash.

It wants to go as Madonna would put it, deeper and deeper.

To illustrate, suppose your bank announced a negative 3 percent interest rate on your bank deposit of 100 dollars today.

They need a tax or fine or cash to achieve this.

Suppose also that the central bank announced that cash-dollars would now become a separate currency that would depreciate against e-dollars by 3 percent per year. The conversion rate of cash-dollars into e-dollars would hence change from 1 to 0.97 over the year.

Comment

There is quite a bit to consider here but let me start with the concept of arrogance. This is because monetary policymakers have had the freedom over the past decade to do pretty much what they liked and if it had worked we would not be here would we? Yet like Jose Mourinho in the football transfer market they always want more, more, more. Actually I am being a little unfair on Jose as there was a time his policies brought plenty of success.

Combined with this is an obsessive clinging onto failed past concepts. The output gap has had a dreadful credit crunch yet here it is again. Next the idea that higher inflation is good has ( thank God) had a bad run too but central bankers confuse what is good for the banks with what is good for the rest of us. The reality that no country or economic area has gone into negative interest-rates and then recovered is simply ignored whereas so far they have all sung along with Muse.

Glaciers melting in the dead of night
And the superstars sucked into the super massive
Super massive black hole
Super massive black hole
Super massive black hole
Finally is the idea that those who do not worship at this particular monetary altar need to be punished. Just like in the novel 1984……

When will the ECB ease monetary policy again?

Sometimes life catches up with you really fast and we have seen another example of this in the last 24 hours, so let;s get straight to it.

Analysts at Deutsche Bank say European Central Bank’s Mario Draghi indicated the possibility of a one-off interest rate hike at his last press conference. With his next appearance due on Thursday, the president may choose to feed or quell that speculation. ( Bloomberg)

I found this so extraordinary that I suggested on social media that Deutsche Bank may have a bad interest-rate position it wants to get rid of. After all at the last press conference we were told this and the emphasis is mine.

Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. We continue to expect them to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

Now Forward Guidance by central banks is regularly wrong but it is invariably due to a cut in interest-rates after promising a rise rather than an actual rise. The latter seems restricted to currency collapses. So let us move onto the economic situation which has been heading south for a while now as the declining money supply data we have been tracking has been followed by a weakening economic situation.

France

This morning brought more worrying news from the economy of France from the Markit PMI business survey. It started well with the manufacturing PMI rising to 51.2 but then there was this.

Flash France Services Activity Index at 47.5 in January (49.0 in December), 59-month low.

So firmly in contraction territory as we look for more detail.

Private sector firms in France reported a further
contraction in output during the opening month of
2019. The latest decline was the fastest for over four
years, even quicker than the fall in protest-hit
December. The strong service sector that had
supported a weak manufacturing sector in the
second half 2018 declined at a faster rate in January.
Meanwhile, manufacturers recovered to register
broadly-unchanged production.

These numbers added to the official survey released only yesterday.

In January 2019, the balances of industrialists’ opinion on overall and foreign demand in the last three months have recovered above their long-term average – they had significantly dropped over the past year.

They record a manufacturing bounce too, but the general direction of travel is the same as the number for foreign demand has fallen from 21.8 at the opening of 2018 to 3.6 now and the number for global demand has fallen from 21.7 to 1.0 over the same timescale.

Perhaps we get an idea of a possible drop from wholesale trade.

The composite indicator has fallen back by five points compared to November 2018. At 99, it has fallen below its long-term average (100) for the first time since January 2017.

But in spite of a small nudge higher in services the total picture for France looks rather poor as we note that it looks as though it saw a contraction in December and that may well have got worse this month.

Germany

There was little solace to be found in the Euro area’s largest economy.

“The Germany PMI broke its recent run of
successive falls in January thanks to a stronger
increase in service sector business activity, but the
growth performance signalled by the index was still
one of the worst over the past four years.
“Worryingly for the outlook, the recent soft patch in
demand continued into the New Year.”

So some growth but not very much and I note Markit are nervous about this as they do not offer a suggestion of what level of GDP ( Gross Domestic Product) grow is likely from this. This of course adds to the flatlining we seem to have seen for the second half of 2018 as around 0.2% growth in the fourth quarter merely offset the 0.2% contraction seen in the third quarter.

Also the recovery promised by some for the manufacturing sector does not seem to have materialised.

Manufacturing fell into contraction in January as
the sector’s order book situation continued to
worsen, showing the steepest decline in incoming
new work since 2012.

The driving force was this.

Weakness in the auto industry was once again widely reported, as was a slowdown in demand from China.

Euro area

The central message here followed that of the two biggest Euro area economies we have already looked at. The decline in the composite PMI suggests on ongoing quarterly GDP growth rate of 0.1%. Added to it was the suggestion that the future is a lot less than bright.

New orders for goods fell for a fourth successive
month, declining at a rate not seen since April
2013, while inflows of new business in the service
sector slipped into decline for the first time since
July 2013

Inflation

The target is just below 2% as an annual rate so we note this.

The euro area annual inflation rate was 1.6% in December 2018, down from 1.9% in November

Of course being central bankers they apparently need neither food nor energy so they like to focus on the inflation number without them which is either 1.1% or 1% depending exactly which bits you omit, But as you can see this is hardly the bedrock for an interest-rate rise which is reinforced by this from @fwred of Bank Pictet.

More bad news for the ECB. Our PMI price pressure gauge fell by the largest amount since mid-2011, to levels consistent with monetary easing along with activity indicators.

Comment

The situation has become increasingly awkward for Mario Draghi and the ECB as a slowing economy and lower inflation have been described by them as follows.

When you look at the economy, well, you still see the drivers of this recovery are still in place. Consumption continues to grow, basically supported by the increase in real disposable income, which, if I am not mistaken, is at the historical high since six years or something, and households’ wealth. Business investments continue to grow, residential investment, as I said in the IS [introductory statement] is robust. External demand has gone down but still grows.

Yet as we can see the reality is that economic growth looks like it has dropped from the around 0.7% of 2017 to more like 0.1% now. If we were not where we are with a deposit rate of -0.4% and monthly QE having only just ended they would be openly looking at an interest-rate cut or more QE.

Whilst we have been observing the slow down in the M1 money supply from just under 10% to 6.7% the ECB has lost itself in a world of “ongoing broad-based expansion”. It is not impossible we will see some liquidity easing today via a new TLTRO which would also help the Italian banks but we will have to see.

As to why there has been talk about an interest-rate rise well it is not for savers it is for the precious and the emphasis is mine.

As a result, reductions in
rates can end up having a similar effect as a flattening of the yield curve, as banks interest
revenue drops along with rates, but interest costs only adjust partially because of the zero
lower bound on retail deposits. In this situation, lowering rates below zero can pose a
threat to banks’ profitability. ( ECB November 2018)

Now we can’t have that can we?

Me on The Investing Channel

 

ECB monetary policy can inflate house prices at least….

Tomorrow the European Central Bank meets for what has become a crucial policy meeting. There is a lot for it to discuss on the economic front and let us open with an element of deja vu.

Bank Of Spain Governor De Cos: No Signs Of New Property Bubble In Spain – RTRS ( @LiveSquawk )

It is hard not to think of the “Never believe anything until it is officially denied” by the apocryphal prime minister Jim Hacker at this point. He is responding to this covered by El Pais yesterday.

The International Monetary Fund (IMF) is calling on Spain to monitor the price of real estate following a rebound of the property market after years of crisis. After analyzing late 2017 statistics, the global agency has detected early signs of “a slight overvaluation,” although it stressed that there is still nothing like a new housing bubble in Spain.

Here is a reminder of the state of play which is that Spain is a nation of home owners.

The IMF finds that house prices increased by around 15% between 2014 and 2017, but that sales are being driven by existing housing stock rather than new housing. Another change from pre-crisis days is that the home ownership rate has dropped from 80% to 77% as people increasingly turn to the rental market.

Let us bring the numbers up to date via INE from the end of last week.

The annual variation of the Housing Price Index (IPV) in the third quarter of 2018 increases four tenths and stands at 7.2%……The quarterly variation of the general IPV in the third quarter of 2018 is 2.2%.

The IMF seems to have missed that the pace of house price growth has picked up in Spain. Not only the 2.2% quarterly rise but the fact that the overall index set at 100 in 2015 is now at 120.5. Returning to the role of the ECB a typical mortgage rate (over 3 years) is 1.93%.

Ireland

Last time around a housing boom and later bust in Spain was accompanied by one in Ireland so let us check in on yesterday’s official update.

Residential property prices increased by 8.4% nationally in the year to October. This compares with an increase of 8.5% in the year to September and an increase of 11.7% in the twelve months to October 2017.

As you can see the heat is on again and is heading towards levels which caused so much trouble last time around.

Overall, the national index is 17.6% lower than its highest level in 2007. Dublin residential property prices are 20.1% lower than their February 2007 peak, while residential property prices in the Rest of Ireland are 22.7% lower than their May 2007 peak.

Also they have got there rather quickly.

Property prices nationally have increased by 83.8% from their trough in early 2013. Dublin residential property prices have risen 98.0% from their February 2012 low, whilst residential property prices in the Rest of Ireland are 77.9% higher than at the trough, which was in May 2013.

Now that it has got the central banking holy grail of higher house prices the ECB seems to have, for some reason got cold feet about putting them in the consumer inflation index.

The ECB concludes that the integration of the OOH price index would deteriorate the current
frequency and timeliness of the HICP, and would introduce an asset element. Against this
background, it takes the view that the OOH price index is in practice not suitable for
integration into the official HICP.

It has turned into a classic bureaucratic move where you promise something have a committee formed to do it which concludes so sadly that it will not do it. The reasons stated were known all along.

Economic growth

Whilst house price developments will put a smile on the faces of Governing Council members other economic developments may wipe that smile away. One possible bright spot has gone a bit dark. From France24.

 

The Bank of France said the Eurozone’s second-biggest economy would eke out growth of only 0.2% in the three months to December, down from 0.4% in a previous estimate and from that rate in the third quarter.

“Services activity has slowed under the impact of the movement. Transport, the restaurant and auto repair sectors have gone backwards,” the bank said in its latest company survey.

The forecast is well short of the 0.8% that would be needed to meet the government’s 2018 growth target of 1.7%.

That was reinforced by the production and manufacturing data for October which was up on the month but 0.1% lower than a year ago. The growth shortfall will only make the next French problem worse. From Reuters.

Macron announced wage increases for the poorest workers and a tax cut for most pensioners on Monday to defuse discontent, leaving his government scrambling to come up with extra budget savings or risk blowing through the EU’s 3 percent of GDP limit.

That is especially awkward considering how vocal the French government had been about the Italian budget plans which in percentage terms was set to be a fair bit smaller.

Italy

The perennial under performer in economic terms seems to be in yet another “girlfriend in a coma” style phrase. From the latest monthly economic report.

In Italy, the GDP decreased marginally in the third quarter due to a contraction in both gross fixed investments and private consumption. On the contrary, the net exports contributed positively to growth.

The employment stabilized on past months levels recording a re-composition, which favored full time employees. Unemployment rate increased and was complemented by a reduction in inactive persons.

Italian inflation continued to be lower than the Eurozone average but the gap is closing.
In November, both the consumer confidence and the composite indicators decreased. The leading indicator stabilized on past months minimum values confirming the business cycle weakness.

There is a genuine danger of what some of the media have decided to call a technical recession. I get the point about it being within the margin of error and applaud their sudden conversion to this cause. But missing from this is the fact that this is an ongoing depression in Italy which shows not only no sign of ending but may be getting worse.

Comment

This will be a meeting of two halves. The awkward part is that after all the extraordinary monetary action involving negative interest-rates, QE and credit easing the Euro area economy has slowed from a quarterly growth rate of 0.7% to 0.2%. If we were not where we are the ECB would be discussing a stimulus programme. Except of course the plan is to announce the end to monthly QE bond purchases. Some places are suggesting a delay to future interest-rate increases as they catch up with my long-running view that Mario Draghi has no intention of raising them on his watch.

The second half will be the one emphasised which is that the ECB has hit its inflation target.

Euro area annual inflation is expected to be 2.0% in November 2018, down from 2.2% in October 2018, according to a flash estimate from Eurostat.

Okay not the 1.97% level defined by the previous President Jean-Claude Trichet but close enough. I wonder if any of the press corps will have the wit to ask about the U-Turn on including house prices in the inflation measure and whether that is because monetary policy can inflate house prices?

 

 

 

 

 

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

Switzerland

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.

Comment

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)

Japan

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.

Trade

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.

Employment

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.

Comment

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)

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