Recession forecasts for the UK collide with stronger wage growth

As we arrive at UK labour market day the mood music around the UK economy has shifted downwards. For example the Resolution Foundation has chosen this week to publish this.

Technical recessions (where economic output contracts for two consecutive quarters) have come along roughly once a decade in the UK. With the current period of economic
expansion now into its tenth year, there is therefore concern that we are nearer to the next recession than we are to the last.

At this point we do not learn a great deal as since policy has been to avoid a recession at almost nay cost for the last decade then the surprise would be if we were not nearer to the next recession.Also they seem to be clouding the view of what a technical recession ( where the economy contracts only marginally) is with a recession where it contracts by more. But then we get the main point.

Indeed, a simple model based on financial-market data
suggests that the risk of a recession is currently close to levels only seen around the time of past recessions and sharp slowdowns in GDP growth, and is at its highest level since 2007.

Okay so what is it?

One indicator that is often cited as a predictor of future recessions is the difference between longer-term and shorter-term yields on government bonds, often referred to as the ‘slope’ of the yield curve……..If shorter-term rates are above longer-term ones (negative slope), it suggests markets are expecting looser monetary policy in future than today, implying expectations of a deterioration in the outlook for the economy.

Okay and then we get the punchline.

It shows that this indicator has increased significantly in the run up to the previous three recessions. And it has risen from close to zero in 2014 to levels only seen around recessions and sharp slowdowns in GDP growth by 2019 Q2, reflecting the flattening of the yield curve……..

Thoughts

The problem with this type of analysis is that it ignores all the ch-ch-changes that have taken place in the credit crunch era. For example because of all the extraordinary monetary policy including £435 billion of purchases of UK government bonds by the Bank of England there is very little yield anywhere thus the yield curve will be flatter. That is a very different situation to market participants buying and selling and making the yield curve flatter. The danger here is that we record a false signal or more formally this is a version of Goodhart’s Law.

Also frankly saying this is not much use.

Our simple model suggests, therefore, that there is an elevated chance of the UK facing a recession at some point in the next three years.

 

UK Labour Market

The figures themselves provoked a wry smile because the downbeat background in terms of analysis collided with this.

Estimated annual growth in average weekly earnings for employees in Great Britain increased to 3.4% for total pay (including bonuses) and 3.6% for regular pay (excluding bonuses)……..Annual growth in both total pay (including bonuses) and regular pay (excluding bonuses) accelerated by 0.2% in March to May when compared with February to April.

The rise for the latter was the best in the credit crunch era and provoked some humour from Reuters. At least I think it was humour.

The pick-up in pay has been noted by the Bank of England which says it might need to raise interest rates in response, assuming Britain can avoid a no-deal Brexit.

The good news section of the report continued with these.

The UK unemployment rate was estimated at 3.8%; it has not been lower since October to December 1974. The UK economic inactivity rate was estimated at 20.9%, lower than a year earlier (21.0%).

So higher wage growth and low unemployment.

Nuance

Actually as the two factors above are lagging indicators you could use them as a recession signal. But moving to nuance we found that in the employment data. This has just powered away over the past 7 years but found a bit of a hiccup today.

The UK employment rate was estimated at 76.0%, higher than a year earlier (75.6%); on the quarter, the rate was 0.1 percentage points lower, the first quarterly decrease since June to August 2018.

At this stage in the cycle with the employment rate so high it is hard to read especially when we notice these other measures.

Between March to May 2018 and March to May 2019: hours worked in the UK increased by 1.9% (to reach 1.05 billion hours)…….the number of people in employment in the UK increased by 1.1% (to reach 32.75 million)

We gain a little more insight from looking at just the month of May which was strong in this area.

The single month estimate of the employment rate, for people aged 16 to 64 years in the UK, for May 2019 was 76.2%

But not as strong as April which was at 76.4%! Oh and in case you are wondering how the three-month average got to 76% it was because March was 75.5%. You could press the Brexit Klaxon there but no-one seems to be doing so, perhaps they have not spotted it yet. Anyway barring a plunge in June the employment rate should be back.

Wages

We can fig deeper into these as well as we note something we have been waiting for.

the introduction of the new National Living Wage rate (4.9% higher than the 2018 rate) and National Minimum Wage rates which will impact the lowest-paid workers in sectors such as wholesaling, retailing, hotels and restaurants.

When we note who that went to we should particularly welcome it although it is different to wages being higher due to a strong economy as it was imposed on the market. There was also this.

pay increases for some NHS staff which will impact public sector pay growth

That provokes a few thoughts so let me give you some number crunching. Public-sector pay is at £542 per week higher than private-sector pay ( £534) and is growing slightly more quickly at 3.6% versus 3.4%. However if we look back to the year 2000 we see that pay growth has been remarkably similar at around 72%. Actually in the categories measured the variation is very small with manufacturing slowest at 69.3% and construction fastest at 74.8%.

If we look at the case of real wages we get a different picture.

In real terms (after adjusting for inflation), total pay is estimated to have increased by 1.4% compared with a year earlier, and regular pay is estimated to have increased by 1.7%.

It starts well although even here it is time for my regular reminder that the numbers rely on the official inflation series and are weaker if we use the Retail Price Index or RPI. But even so the credit crunch era background remains grim.

For May 2019, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at:

£503 per week in nominal terms

£468 per week in real terms (constant 2015 prices), higher than the estimate for a year earlier (£460 per week), but £5 (1.0%) lower than the pre-recession peak of £473 per week for April 2008

 

The equivalent figures for total pay are £498 per week in May 2019 and £525 in February 2008, a 5.0% difference.

Again that relies on a flattering inflation measure. But the grim truth is that real wages are in a depression and have been so for a bit more than a decade.

Comment

So there you have it in spite of the fears around this sector of the UK economy continues to perform strongly and give quite a different measure to say economic output or GDP. Also as we note the increase in hours worked and that GDP growth is fading we are seeing a wage growth pick-up with weak and probably negative productivity growth. We will have to see how that plays out but let me show you something else tucked away in the detail and let us go back to the Resolution Foundation.

Real pay growth grew by more than 3.5% for the real estate sector but fell by more than 1.0% in the arts and entertainment sector.

A bit harsh on luvvies who have been one of the strongest sectors in the economy. But I have spotted something else which may be a factor in why estate agents and the like are doing so well.

The proportion of UK mortgage lending at (LTV) ratios of 90% or higher was 18.7% of all mortgage lending in 2019 Q1. ( @NobleFrancis )

Odd that as I recall out political class singing along with Depeche Mode.

Never again
Is what you swore
The time before
Never again
Is what you swore
The time before

 

 

 

 

 

What to do with a problem like Germany? Cut interest-rates further….

Over the past year there has been something of a sea change for the economy of Germany. After a period of what in these times was strong economic growth the engine of the Euro area has stuttered and coughed. If we look at it in annual terms economic growth went from the 2.2% of 2016 and 2017 to 1.4% last year and the latter was the story of two halves as the second half saw the economic contract in the third quarter and flat line in the fourth. This fits with our subject of yesterday Deutsche Bank which has seen its share price fall by 36% over the past year as both it and its home economy have struggled. Oh and that new bad bank plan rallied the share price for a day and a bit as it is back to 6.03 Euros. So it looks like another new plan is singing along with Queen.

Another one bites the dust
Another one bites the dust
And another one gone, and another one gone
Another one bites the dust.

What Next?

The opening quarter of this year offered some relief as Germany saw the economy grow by 0.4%. However yesterday in its June report the Bundesbank pointed out that it was not convinced that this represented a genuine turn for the better. 

Special effects that contributed to a noticeable rise in gross domestic product in the first quarter are either expiring or being reversed.

Google Translate is a little clunky here but we see that it feels that the construction industry will not have boosted the economy.

So is the construction industry on a quarterly average with certain Rebound effects. Due to weather conditions, construction activity had widened considerably in the winter months.

Also it feels that the ongoing problems with sales of diesel engined cars which we see pretty much everywhere we look will impact again after flattering things as 2019 opened.

Furthermore, due to delivery difficulties as a result of the introduction of the new emissions test procedure WLTP (Worldwide Harmonized Light Vehicles Test Procedure) last fall. Deferred car purchases have been made up for the most part.

It notes that the industrial production sector had a rough April.

Industrial production decreased in the April 2019 strongly. In seasonally adjusted account it fell below the previous month’s level by 2½%. As a result, industrial production also fell sharply compared to the mean of the winter months (- 2%).

Do the business surveys back this up?

If we start with construction then here is the latest from Markit.

After a solid performance in early-spring, the German
construction sector continued to lose momentum during May, recording its weakest rise in total activity for four months……It’s been a largely positive start to the year for the sector, but a first fall in new orders in nine months points to some downside risks to the short-term outlook.

So broadly yes and maybe further slowing is ahead. 

However as we look wider Markit is more optimistic than the Bundesbank.

The Composite Output Index continued to point to a modest
pace of growth across Germany’s private sector. At 52.6, the latest reading was up from 52.2 in April and the highest in three months, but still below the long-run series average of 53.4 (since 1998).

That is interesting as central banks love to peruse PMI numbers. Mind you perhaps they had advance warning of this released this morning from the ZEW Institute.

The German ZEW headline numbers for June showed that the economic sentiment index arrived at -21.1 versus -5.9 expectations and -2.1 last. While the sub-index current conditions figure jumped to 7.8 versus 6.0 expected and 8.2 booked previously, bettering market expectations. ( FXSTREET )

There is a little irony in the present being better than expected but it is rather swamped by the collapse in expectations. The ZEW is an arcane index that is hard to get a handle on so we should not overstate its significance but the change is eye-catching.

A policy response

I was going to point out that this was going to be an influence on the policy of the European Central Bank or ECB. This comes in two forms as firstly Germany is such a bell weather for the Euro area and according to recently updated ECB capital key is 26.4% of it. Also of course there is the thought that overall ECB policy is basically set for Germany. Thus I was expecting some news or what have become called “sauces” from the ECB summer camp at Sintra which opened last night. This morning we have already learned that President Draghi packed more than his shorts, sun cream and sunglasses.

In this environment, what matters is that monetary policy remains committed to its objective and does not resign itself to too-low inflation.

Here he is setting out his stall and the emphasis is his. There is a clear hint in the way that he is pointing at “too-low inflation” as in the coded language of central bankers it leads to this.

Looking forward, the risk outlook remains tilted to the downside, and indicators for the coming quarters point to lingering softness.

So now not only do we have too-low inflation we have a weak economy too. So if we were a pot on the stove we are now gently simmering. Then Mario turns up the gas.

In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.

First though we have to wait as he continues with the dead duck that is Forward Guidance.

We remain able to enhance our forward guidance by adjusting its bias and its conditionality to account for variations in the adjustment path of inflation.

After all if it worked we would not be here would we? But then we get to boiling point.

This applies to all instruments of our monetary policy stance.

Further cuts in policy interest rates and mitigating measures to contain any side effects remain part of our tools.

And the APP still has considerable headroom.

For newer readers the APP is the Asset Purchase Programme or how it has operated what has become called Quantitative Easing or QE. This is significant because if there is a country which lacks headroom it is our subject of today Germany. This is because it has been running a fiscal surplus and reducing its national debt which combined with the existing ECB purchases means there are not so many to buy these days. Not Italy though as there are plenty of its bonds around.

Finally we get a reinforcement of the theoretical framework with this.

What matters for our policy calibration is our medium-term policy aim: an inflation rate below, but close to, 2%. That aim is symmetric, which means that, if we are to deliver that value of inflation in the medium term, inflation has to be above that level at some time in the future.

Comment

We may have seen the central banking equivalent of what is called a “one-two” in boxing. Yesterday the German Bundesbank talks of an economic contraction and today Mario Draghi is hinting that more easing  is on its way.  What this may mean is that whilst the Bundesbank is unlikely to be leading the charge for easier policy it will not stand in its way. Also if Mario Draghi is going to do this there is not a lot of time left as he departs in October, does he plan to go with a bang?

This has already impacted German financial markets as they look at the newswires and price German bonds even higher. After all if you expect a large buyer why not make them pay for it? So it is now being paid even more to borrow as the benchmark ten-year yield reaches another threshold at -0.3%. Or if you prefer the futures contract has hit all time highs in the 172s.

Of course if the easing worked we would not be here so there is an element of going through the motions about this. Also let’s face it only central bankers and their cheerleaders think low inflation is a bad idea. Sadly the media so rarely challenge them on how they will make people better off via them being poorer.

 

Argentina looks trapped in a now familiar downwards spiral

Just over a year ago on the 3rd of May 2018 I gave some advice on here to Argentina about its ongoing economic and currency crisis.

The problem is twofold. Firstly you can end up chasing your own tail like a dog. What I mean by this is that markets can expect more interest-rate rises each time the currency falls and usually that is exactly what it does next. Why is this? Well if anticipating a 27,25%% return on your money is not doing the job is 30.25% going to do it? Unlikely in my view as we note that the currency has fallen 5% this week.

Events accelerated later that day as the Argentine central bank the BCRA did this.

This article came to late for the BCRA it would appear as just before 5 pm UK time they raised interest-rates to 33.25%. I would place a link bit nobody seems to have told the English version of their website yet.

That backed up my point and that theme just carried on as this from Reuters on April Fools Day highlights.

Argentina has established an interest rate floor of 62.5 percent, the central bank said in a statement on Monday, as the country looks to rein in stubborn inflation and ease concerns about a run on the local peso currency.

As of yesterday the interest-rate was 71.44% which must feel somewhat bizarre to ordinary Argentine’s in a world of low and indeed negative interest-rates. Another sign of trouble is the gap to deposit rates which were 51.94% yesterday.

The Argentine Peso

Let me hand you over to the Buenos Aires Times.

Argentina’s peso, the worst-performing emerging-market currency this year, could see more volatility as investors learn how to connect the latest pieces of the country’s complex political puzzle……..So far this year, the peso has slumped by about 16 percent against the US dollar and equity assets have been shaky.

As you can see the situation has continued to deteriorate. In fact there has been something of a double-whammy as interest-rates have soared above 70% and the Peso has gone from 21.52 versus the US Dollar when I wrote my post to 45.2 as I type this. Indeed things are so bad that even Bitcoin supporters are trolling the situation.

If an Argentinian had bought Bitcoin at the highest point of the “biggest bubble in history”, in 2017, he would have been better off than leaving his money in his Argentinian bank account. So tell me again how Bitcoin is a horrible store of value. ( @josusanmartin )

Of course you can look at that the other way which is that he has gone to the outer limits of cherry-picking by choosing the Argentine Peso.

Inflation, Inflation,Inflation

The currency fall was always going to led to inflation and the situation is such that as the Buenos Aires Times reports the government has resorted to direct controls.

The government agreed with leading supermarkets that the price of 60 essential products of the food basket will be frozen for at least six months.

The list includes 16 manufacturing companies of rice, sugar, milk, yoghurt, flour, tea and coffee, among others, whose products will be available at 2,500 outlets as from April 22.

At the same time, the Macri administration agreed with slaughterhouses to offer beef cuts at 149 pesos per kilo (120,000 kilos weekly), which will be available at the Central Market and at other retail outlets.

I am pleased that they are focusing on such an important area that is regarded by central bankers as non-core.  I fear however that this is a sign that some people are in real trouble.

However the statement below is something of a hostage to fortune.

“We are entering into a new phase. Currency instability is now something of the past, which guarantees a lower inflation rate,” Economy Minister Nicolás Dujovne said at a press conference

Moving to the present situation there is this.

The government plan was announced in the same week as March’s inflation data of 4.7 percent was revealed, sending alarm-bells ringing among Macri administration officials. Prices have now increased 11.8 percent increase in the first quarter of the year and 54.7 percent in the last 12 months.

As you can see we now have a triple-play of economic woe with high interest-rates, a devalued currency and high inflation

Fourmidable

Let us advance on the economic situation with trepidation and an apology to Manchester City for appropriating their current punchline. A chill is in the air from this.

Consumption in supermarkets also dropped 8.7 percent in March compared to the same period last year, accumulating a 7.3 percent decline so far this year, according to a report by the consultancy Scentia. ( Buenos Aires Times)

The OECD has updated its economic forecasts this morning and in spite of its efforts to cheer lead for the present IMF programme it has downgraded economic growth from the -1.5% of March to -1.8% now. This is something we have become familiar with in IMF programmes as we note that last summer the government was forecasting 1.5% growth for this year. This comes on top of the 2.5% contraction in 2018. So recession and depression.

Consequently the OECD finds itself reporting that the unemployment rate has risen by 2% since 2017 to 9.1%.

100 Year Bond

Here is Bloomberg from yesterday.

Argentine bond spreads against US Treasuries rose 19 basis points to 962, double the average for Latin America……..The country’s five-year credit default swaps also rose 1.3 percent to 1,274 basis points.

There was a bit of a rally today but in general the bonds of Argentina trade about 9.3% over their US equivalents. However bonds in Peso’s yield more highly with the 9-year being at 23%.

The 100 year bond is trading at 68.5, but I suppose you have 98 or so years left to get back to 100.

Comment

Those who have followed the recent history of the International Monetary Fund will find the statement below awfully familiar.

The authorities’ policies that underly the Fund-supported arrangement are bearing fruit. The high fiscal and current account deficits – two major vulnerabilities that led to the financial crisis last year – are falling. Economic activity contracted in 2018 but there are signs that the recession has bottomed out, and a gradual recovery is expected to take hold in the coming quarters. ( Managing Director Christine Lagarde)

There are similarities with her “shock and awe” description for Greece as I note the OECD 2.1% economic growth forecast for next year is the same number as was forecast for it at this stage. I also note that the “exports fairy” is expected to make an appearance although so far the trade adjustment in the first quarter of 2019 has involved them falling slightly and imports falling by around 27%. Again familiar and as Japan showed us yesterday the import plunge will flatter the next set of GDP numbers. There is a different situation in that the currency has devalued although Argentina rather than defaulting on some of its debt is finding the foreign currency part of it ever more expensive whilst it is in the teeth of a fiscal contraction.

Even the Financial Times is questioning the IMF and Christine Lagarde.

When the IMF completed its third review of Argentina’s economy in early April, managing director Christine Lagarde boasted that the government policies linked to the country’s record $56bn bailout from the fund were “bearing fruit”.

The IMF has strongly supported the present government.

Even former senior fund officials are concerned by the organisation’s exposure to Argentina, and the potential fallout should its biggest ever programme implode.

Of course we do not know who will win the election in October but we face a situation of economic crisis which follows other crises in Argentina. Also most of us unlike the FT live in a world where Lagarde lost her credibility years ago.

In truth this was always going to be a really difficult gig along the lines of when Neil Young decided to stop playing his hits and just play his new (unpopular) album. As the comment below suggests what is really needed is long-term reform which is exactly what the IMF has not provided in Greece.

“Argentina has signed 22 agreements with the IMF, most of which ended with bitterness on both sides.”

Clearly neither side has heard the phrase ‘once bitten, twice shy’! ( Donald in the FT)

 

 

 

Italy exits recession but sadly continues its economic depression

Today brings Italy into focus as we find out how it did in the first three months of this year. The mood music has been okay ( 0.3% GDP growth in France) and really rather good ( 0.7% GDP growth in Spain) but we are of course looking at the country described in economic terms as a girlfriend in a coma. The situation has recently deteriorated yet again as highlighted below.

As you can see there has been quite a plunge which illustrates part of the girlfriend in a coma issue. This is that in any economic slow down Italy participates but in a period of growth it grows much less than its peers. So it has for the whole of this century been “slip-sliding away” as Paul Simon would say. Putting that into numbers in the better periods it struggles to grow at more than 1% per annum on average. An example of that has been provided by the last six years as if we look at the period from the beginning of 2013 to the end of 2018 we see that GDP growth was less than 5%. This means that the 402.8 billion Euros of quarterly economic output at the end of 2018 was still a long way short of a number that according to the chart nudged over 425 billion early in 2008. Putting it another way it has joined in with the drops including the Euro area crisis of 2010-12 but not shown anything like the same enthusiasm for the rallies.

Fiscal Problems

This was something of a headliner last autumn as the Italian government pressed the Euro area authorities for some more laxity on the annual deficit before mostly being forced back. But this is not really the problem as Italy has not been an over spender and let me highlight with the data.

The government deficit to GDP ratio decreased from 2.5% in 2016 to 2.4% in 2017. In 2018, the Government deficit to Gross Domestic Product ratio was 2.1%

The primary surplus as a percentage of GDP was 1.4% in 2017, unchanged with respect to 2016.

In 2015 the deficit was 2.6% so we can see that Italy had behaved according to Euro area rules by being below 3% on an annual basis and furthermore had been trimming it.

The catch is that with the low level of economic growth even that has led to this as Eurostat lists those who fail the Maastricht criteria.

Greece (181.1%), Italy (132.2%), Portugal (121.5%), Cyprus (102.5%), Belgium (102.0%), France (98.4%) and Spain (97.1%)

The total has risen from 2.173 trillion Euros at the end of 2015 to 2.32 trillion Euros at the end of last year. As it happens that is nearly exactly the same size as France and the catch is that the French national debt has been rising faster which creates its own worries. But the Italian problem is the way that its debt relates to the lack of economic growth which means that relatively it poses a bigger question.

The dog that has not barked has been the issue of debt costs which would have made all of this much worse if we lived in a bond vigilantes world. But instead the advent of Euro area QE from the ECB means that debt costs have fallen for Italy. In 2015 they cost 68.1 billion Euros or 4.1% of GDP as opposed to 65 billion Euros or 3.7% of GDP last year. Extraordinary really! How? Here you go.

Italian version. Excluding QE, Italy‘s public debt ratio is 110% of GDP. ( @fwred )

Also via cheaper borrowing costs which have risen over the past year  but were believe it or not negative at the short-end for a while. Back in the Euro area crisis I recall the benchmark ten-year yield reaching 7% which puts the current 2.63% into perspective.

I note that this issue reappears from time to time. From Lorenzo Codogno earlier.

My op-ed written with ⁦⁩ on “Italydebt restructuring would do enormous damage” published today in Italy’s business daily Il Sole 24 Ore.

In some ways Euro area membership might help. What I mean by that is if the Bank of Italy wrote off its holdings of Italian bonds then the Euro as a currency might not be affected all that much as it reflects the overall area and especially a fiscally conservative Germany.

On the other side of the coin there is something which is a hardy perennial.

Euro area banks sold domestic government bonds in March (-€13bn net). The total over the past 12-month is still positive (+€23bn) but that’s all due to Italy where banks have started to increase their sovereign exposure again over the past year or so. ( @fwred )

Perhaps they are hoping there will be another ECB inspired party along the lines of this described in Il Sole 24 Ore. The emphasis is mine.

Although these loans are tied to loans to the real economy, it is expected that there will be some flexibility in its implementation in such a way as to allow banks to use the funds to buy government bonds, earning money on the rate differential (“carry trade” in jargon) ). Only when the ECB publishes the details of the transaction in June will we know how generous the new Tltro will be.

Perhaps it will be a leaving gift from Mario Draghi to the banks he used to supervise meaning Grazie Mario may be a new theme. It makes me wonder if profits from what has been called “gentlemen of the spread” maybe the only profits Italian banks these days? Also let me apologise to female traders on behalf of the author of that phrase.

Labour Market

This has brought some welcome news today.

In March 2019, the number of employed people increased compared with February (+0.3%, +60 thousand); the employment rate rose to 58.9% (+0.2 percentage points)…..The number of unemployed persons fell by 3.5% (-96 thousand); the decline involved men and women and all age classes. The unemployment rate dropped to 10.2% (-0.4 percentage points), the youth rate decreased to 30.2% (-1.6 percentage points).

As a headline the rising employment rate and falling unemployment and especially youth unemployment rates are welcome. But sadly we only have to look back to February and recall the unemployment rate was published at 10.7% to see a sadly familiar issue. It is unreliable as January was revised down by 0.5% as was March last year but February last year was revised up by 0.9%.

There is also this highlighted a year ago by a paper for the Swiss National Bank.

An exception is Italy where productivity growth started to stagnate 25 years ago

Okay why?

We find that resource misallocation has played a sizeable role in slowing down Italian productivity growth. If misallocation had remained at its 1995 level, in 2013 Italy’s aggregate productivity would have been 18% higher than its actual level. Misallocation has mainly risen within
sectors than between them, increasing more in sectors where the world technological frontier has
expanded faster.

Comment

There was both good and nor so good news in the mid-morning release.

In the first quarter of 2019 it is estimated that the gross domestic product (GDP), expressed in chained values ​​with reference year 2010, adjusted for calendar effects and seasonally adjusted, increased by 0.2% compared to the previous quarter and by 0, 1% in tendential terms.

The good news is that Italy has recovered the ground lost in the second half of last year but the kicker is that it has grown by only 0.1% in a year, which is well within the margin of error. Or if you prefer it has escaped recession but remains stuck in a depression.

Another perspective is provided by the fact that this is the first time quarterly economic growth has risen since the end of 2016. As to the productivity problem I think that it is linked to the weakness of the banking sector which needs to look beyond punting Italian bonds as a modus operandi if Italy is to improve and escape its ongoing depression.

The unfolding economic crisis in Italy as adult diapers enter the inflation basket

One of the routes that human emotions take when confronted with a problem starts with anger and then goes to denial. If there was an element of anger in the election of the so-called populist government in power in Italy then we have seen denial on a grand scale towards the end of last week..

Italy PM Conte: The country’s economic fundamentals remain strong.

That is as even the casual observer must be aware of comical Ali status but wait there is more.

’s PM Says Government Remains Positive on Growth Forecasts || denial

says that “the government is pushing ahead on the implementation of measures that have already been approved, and their effect will contribute to a progressive growth in the second part of the year” || first half is gone, sorry mate. ( @liukzilla )

Italian ministers and prime ministers operating mentally for a land far,far away to coin a phrase of course nothing new, We can recall Prime Minster Renzi recommending the shares of the bank Monte Paschi which collapsed and former finance minister Padoan who continually told us the Italian banks were in good shape as the house burned around him.

What provoked this new phase?

Something of a bombshell was released by the Italian statistics office on Tuesday as it looked at the industrial sector.

In December 2018 the seasonally adjusted turnover index decreased by 3.5% compared to the previous month (-2.7% in domestic market and -4.7% in non-domestic market); the average of the last three months compared to the previous three months decreased by 1.6% (-1.5% in domestic market and -1.8% in non-domestic market).

This is worse than it looks as turnover data includes price rises and whilst there is not much consumer inflation recorded in Italy there is some in the industrial sector.

The total producer price index increased by 4.1% compared with December 2017 (5.2% on domestic market and 1.2% on foreign market).

The situation was also grim if you looked at the likely future.

The unadjusted industrial new orders index decreased by 5.3% with respect to the same month of the
previous year (-4.6% in domestic market and -3.6% in non-domestic market).

A little care is needed as these sort of numbers are volatile but they have impacted at a time when weak numbers were feared and then arrived on an ever larger scale.

Fitch Ratings

There was some good news for Italy in that it avoided a downgrade late on Friday although it came with a familiar message.

GDP growth has stalled as domestic policy uncertainty and weaker external demand has dragged down investment, while private consumption growth has also lost momentum. Fitch forecasts GDP growth of 0.3% in 2019, down from 0.8% in 2018 (compared with the 1.2% we forecast for both years at our previous review in August), with investment growth falling to 0.4% from 3.8% last year.

There are several issues here so let us open with Fitch being wrong again and in the circumstances by quite a bit, But the theme of Italy slowing down from not very much continues and frankly it may still be over optimistic. We do not know what the latter part of 2019 will look like but as we have observed above Italy which was already in recession at the end of last year has slowed further at the opening of this. Also the investment growth in 2018 does not seem to have helped much. However you spin it we return to the “Girlfriend in a Coma” theme.

This would take the five-year average to 0.9%, compared with the ‘BBB’ median of 3.2%, and leave the level of Italy’s real GDP still 3.5% below that in 2007. We continue to assess Italy’s trend rate of growth at around 0.5%.

Fiscal Problems

Considering their changed view on the economy Fitch seems very timid on the subject of their likely impact on the fiscal situation.

Fitch forecasts an increase in the general government deficit from 1.9% of GDP in 2018 to 2.3% this year, and 2.7% next, 0.1pp higher than at our previous review.

The danger here is that the fiscal deficit starts as Paul Simon puts it “slip-sliding away.” For the moment the labour market looks okay as shown by the Monthly Economic Report.

In the labour market, employment stabilized and the unemployment rate decreased only marginally.

But if the recession leads to job shedding then falling tax revenue and higher social security spending can see fiscal numbers deteriorate quickly. I have seen this happen in the UK in the past although fortunately as last week showed the UK is presently going the other way with improvements. This moves us onto the national debt and the emphasis is mine.

Fitch forecasts an increase in general government debt to 132.3% of GDP in 2020 from 131.7% in 2018, driven by lower nominal GDP growth, and a 0.7pp weakening in the primary balance from 2018-2020. This compares with the current ‘BBB’ median of 38.5% of GDP and would leave Italy as one of the most highly indebted sovereigns we rate, exposed to downside risks and with reduced scope for counter-cyclical fiscal policy.

Whilst the increase is only marginal it depends on the rather rose-tinted view of fiscal deficit changes we looked at above. Official projections invariably show the ratio falling in a denial of reality as it keeps going up. Also pressure is being provided by the way that Italian bond yields have risen with the ten-year yield now 2.77%. Whilst that is historically low it is much higher than Italy had started to get used too.

Also there are concerns about the structure of the debt. This starts with the fact that the ECB is no longer buying each month. There is still support  from its 368 billion Euros of holdings but relative to the size of the Italian debt pile it bought less than elsewhere as it buys on a ratio (capital key) that relates more to economic performance. Next comes the fact that as well as Italian banks French and German banks piled into Italian debt. It did not turn out to be the “easy money” they hoped for and as FT Alphaville pointed out last April led to some strange developments.

It may seem surprising that the French public bank Société de Financement Local, SFIL, has a very big exposure to the Italian sovereign debt.

But then maybe not so strange.

It was set up following the bankruptcy of Dexia.

Back then this was the state of play, what could go wrong?

The national central bank reports that banks resident in Italy had a total exposure of €626.8bn to the domestic general government in January 2018.

As we look forwards we see that Italy has an active maturity schedule to say the least and should it need more borrowing the heat could be on. This year will be especially busy with some 282 billion Euros of redemptions according to the Italian Treasury.

Comment

There is a fair bit to consider and let me add another bit of context via Fitch Ratings.

The competitiveness of the Italian economy held up in 2018. Both export and import volume growth slowed (to 0.3% and 0.7% respectively) in common with eurozone peers, and a somewhat higher income balance also supported a current account surplus estimated at 2.6% of GDP in 2018, 0.2pp lower than the year before.

Looked at in this light the Italian economy looks strong and to that we can add the private savings held. But there is no balance of payments crisis as we mull how all this “competitiveness” does not make the economy do better than it does. Meanwhile money seems to escape none the less.

We forecast some moderation in the size of net portfolio outflows, which totalled 5.1% of GDP in 2017 and 6.7% in 2018, and for net external debt/GDP to remain at close to 51% of GDP in 2020, high relative to the peer group median of 8% of GDP.

So there are clear dangers ahead for Italy and it is not clear to me this will help as they channel their inner Andy Haldane.

Istat updates the Social Mood on Economy Index, the new experimental index first released in October 2018. The index provides daily measures of the Italian sentiment on the economy. These measures are derived from samples of public tweets in Italian captured in real time.

More significant as a hint of ch-ch-changes come from looking at an addition to the basket for inflation measurement.

adult diapers

Maybe that is the most significant factor today if we consider the longer term.

Podcast

 

 

Italy may be in a recession but more importantly its depression never ended

The last 24 hours have brought the economic problems and travails of Italy into a little sharper focus. More news has arrived this morning but before we get there I would like to take you back to early last October when the Italian government produced this.

Politics economy, reform action, good management of the PA and dialogue with businesses and citizens will therefore be directed towards achieving GDP growth of
at least 1.5 percent in 2019 and 1.6 percent in 2020, as indicated in new programmatic framework. On a longer horizon, Italy will have to grow faster than the rest of Europe, in order to recover the ground lost in the last
twenty years.

This was part of the presentation over the planned fiscal deficit increase and on the 26th of October I pointed out this.

If we look back we see that GDP growth has been on a quarterly basis 0.3% and then 0.2% so far this year and the Monthly Economic Report tells us this.

The leading indicator is going down slightly suggesting a moderate pace for the next months.

They mean moderate for Italy.So we could easily see 0% growth or even a contraction looking ahead as opposed some of the latest rhetoric suggesting 3%  per year is possible. Perhaps they meant in the next decade as you see that would be an improvement.

Political rhetoric suggesting 3% economic growth is a regular feature of fiscal debates because growth at that rate fixes most fiscal ills. The catch is that in line with the “Girlfriend in a Coma” theme Italy has struggled to maintain a growth rate above 1% for decades now. Also as we look back I recall pointing out that we have seen quarterly economic growth of 0.5% twice, 0.4% twice, then 0.3% twice in a clear trend. So we on here were doubtful to say the least about the fiscal forecasts and were already fearing a contraction.

Yesterday

All Italy’s troubles were not so far away as the statistics office produced this.

In the fourth quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross
Domestic Product (GDP) decreased by 0.2 per cent with respect to the previous quarter and increased by
0.1 per cent over the same quarter of previous year.

Whilst much of the news concentrates on Italy now being in a recession the real truth is the way that growth of a mere 0.1% over the past year reminds us that it has never broken out of an ongoing depression. If we look at the chart provided we see that in 2008 GDP was a bit over 102 at 2010 prices but now it has fallen below 97. So a decade has passed in fact more like eleven years and the economy has shrunk. Also I see the Financial Times has caught onto a point I have been making for a while.

Brunello Rosa, chief executive of the consultancy Rosa and Roubini, has pointed out that, on a per capita basis, Italy’s real gross domestic product is lower than when the country adopted the euro in 1999. Over the same period Germany’s per capita real GDP has increased by more than 25 per cent, while even recession-ravaged Greece has performed better than Italy on the same basis.

On that basis Italy has been in a depression this century if not before. Indeed if you look at the detail it comes with something that challenges modern economic orthodoxy, so let me explain. In 1999 the Italian population was 56,909,000 whereas now it is just under 60.5 million. Much of the difference has been from net migration which we are so often told brings with it a list of benefits such as a more dynamic economic structure and higher economic growth. Except of course, sadly nothing like that has happened in Italy. As output has struggled it has been divided amongst a larger population and thus per head things have got worse.

Meanwhile this seems unlikely to help much.

Italy’s statistical institute will soon have a new president, the demographer Gian Carlo Blangiardo. He has recommended calculating life expectancy from conception – rather than birth – so as to include unborn babies. ()

Also population statistics in general have taken something of a knock this week.

Pretty interesting – New Zealand just found it has 45,000 fewer people than it thought. In a population of 4.9 million (maybe), that means economists might have to start revising things like productivity and GDP growth per capita. ( Tracy Alloway of Bloomberg).

Can I just say chapeau to whoever described it as Not So Crowded House.

The banks

I regularly point out the struggles of the Italian banks and say that this is a factor as they cannot be supporting the economy via business lending so thank you to the author of the Tweet below who has illustrated this.

As you can see whilst various Italian government’s have stuck their heads in the sand over the problems with so many of the Italian banks there has been a real cost in terms of supporting business and industry. This has become a vicious circle where businesses have also struggled creating more non-performing loans which weakens the banks as we see a doom loop in action.

What about now?

The GDP numbers gave us an idea of the areas involved on the contraction.

The quarter on quarter change is the result of a decrease of value added in agriculture, forestry and fishing
as well as in industry and a substantial stability in services. From the demand side, there is a negative
contribution by the domestic component (gross of change in inventories) and a positive one by the net
export component.

The latter part is a bit awkward for Prime Minister Conte who has taken the politically easy way out and blamed foreigners this morning. As to the industrial picture this morning;s PMI business survey suggests things got worse rather than better last month.

“January’s PMI data signalled another deterioration in Italian manufacturing conditions, with firms struggling in the face of a sixth consecutive monthly fall in new business. Decreases in output, purchasing activity and employment (the first in over four years) were recorded, marking a weak start to 2019.”

The spot number of 47.8 was another decline and is firmly in contraction territory.

Comment

This is as Elton John put it.

It’s sad, so sad (so sad)
It’s a sad, sad situation
And it’s getting more and more absurd

Italy has been in an economic depression for quite some time now but nothing ever seems to get done about it. Going back in time its political leadership were keen to lock it into monetary union with France and Germany but the hoped for convergence has merely led to yet more divergence.

One of the hopes is that the unofficial or what used to be called the black economy is helping out. I hope so in many ways but sadly even that is linked to the corruption problem which never seems to get sorted out either. Oh and whilst many blame the current government some of that is a cheap shot whilst it has had its faults so has pretty much every Italian government.

 

Podcast

Argentina is counting the cost of its 60% interest-rates

In these times of ultra low interest-rates in the western world anywhere with any sort of interest-rate sticks out. In the case of Argentina an official interest-rate of 60% sticks out like a sore thumb in these times and in economic terms there is a second factor in that it has been like that for a while now. So the impact of this punishing relative level of interest-rates will be building on the domestic economy. Also the International Monetary Fund is on hand as this statement from Christine Lagarde yesterday indicates.

“I commended Minister Dujovne and Governor Sandleris on decisive policy steps and progress thus far, which have helped stabilize the economy. Strong implementation of the authorities’ stabilization plan and policy continuity have served Argentina well, and will continue to be essential to enhance the economy’s resilience to external shocks, preserve macroeconomic stability and to bolster medium-term growth.

“I would like to reiterate the IMF’s strong support for Argentina and the authorities’ economic reform plan.”

The opening issue is that sounds awfully like the sort of thing the IMF was saying about Greece when it was predicting a quick return to economic growth and we then discovered that it had created an economic depression there. Of course Christine Lagarde was involved in that debacle too although back then as Finance Minster of France rather than head of the IMF. Also the last IMF press conference repeated a phrase which ended up having dreadful connotations in the Greek economic depression.

It’s on track as of our last mission which was, you know, in December.

As the track was from AC/DC.

I’m on the highway to hell
On the highway to hell
Highway to hell
I’m on the highway to hell
No stop signs, speed limit
Nobody’s gonna slow me down

So let us investigate further.

Monetary policy

The plan is to contract money supply growth so you could look at this as like one of those television programmes that take us back to the 1970s.

In particular, the BCRA undertakes not to raise the monetary base until June 2019. This target brings about a significant monetary contraction; while the monetary base increased by over 2% monthly in the past few months, it will stop rising from now onwards. Then, the monetary base will dramatically shrink in real terms in the following months.

So you can see that the central bank of Argentina is applying quite a squeeze and is doing it to the monetary base because it is a narrow measure, Actually it explains it well in a single sentence.

The BCRA has chosen the monetary base as it is the aggregate it holds a grip on.

It is doing it because it can. Although I am a little dubious about this bit.

The monetary base targeting will be seasonally adjusted in December and June, when demand for money is higher.

It is usually attempts to control broad money that end up targeting money demand rather than supply. It is being achieved with this.

the BCRA undertakes to keep the minimum rate on LELIQs at 60% until inflation deceleration becomes evident.

Also there will be foreign exchange intervention if necessary, or more realistically there has been a requirement for it.

The monetary target is supplemented with foreign exchange intervention and non-intervention measures. Initially, the BCRA would not intervene in the foreign exchange market if the exchange rate was between ARS34 and ARS44. This range is adjusted daily at a 3% monthly rate until the end of the year, and will be readjusted at the beginning of next year. The BCRA will allow free currency floating within this range, considering it to be adequate.

Finally for monetary policy then monetary financing of the government by the central bank is over.

As it has already been reported, the BCRA will no longer make transfers to the Treasury.

Fiscal Policy

Another squeeze is on here as the BCRA points out.

Finally, the new monetary policy is consistent with the targets of primary fiscal balance for 2019 and of surplus for 2020.

Yes in terms of IMF logic but the Greek experience told a different story. There a weaker economy made the fiscal targets further away and tightening them weakened the economy in a downwards spiral.

So where are we?

The squeeze is definitely as my calculations based on the daily monetary report show that the monetary base has shrunk by just under 4% in the last 30 days. If we move onto the consequences of this for the real economy then any central bankers reading this might need to take a seat as the typical mortgage rate in December was 48%. To give you an idea of other interest-rates then an overdraft cost 71% and credit card borrowing cost 61%.

If we look for the impact of such eye-watering levels we see that mortgage growth was on a tear because annually it is 54% up of which only 0.1% came in the last month. Moving to unsecured borrowing overdraft growth has been -1.2% over the past 30 days but credit card growth has been 3.5% so perhaps there has been some switching.

Economic growth

This has gone into reverse as you can see from this from the statistics office.

The provisional estimate of the gross domestic product (GDP), in the third quarter of 2018, had a fall of 3.5% in relation to the same period of the previous year.
The seasonally adjusted GDP of the third quarter of 2018, with respect to the second quarter of 2018, showed a variation of -0.7%.

So a weaker quarter following on from a 4.1% dip in the second quarter of 2018 which was mostly driven by the impact of a drought on the agricultural sector. Looking back the Argentine economy did recover from the credit crunch pretty well but the recorded dip so far takes us back to 2011 or eight years backwards.

The IMF points out this year should get the agricultural production back which is welcome.

However,
in the second quarter, a rebound in agricultural
production (expected to fully recover the 30 percent
production lost in 2018 because of the drought)
should lead to a gradual pickup in economic activity.

But if we put that to one side there has to be an impact from the credit crunch. Also whilst this is good.

The recession and peso depreciation are quickly lowering the trade deficit.

It does come with something which has a very ominous sign for domestic consumption.

The adjustment mainly reflects
lower imports, reflecting a contraction in
consumption and investment.

Moving to inflation then here it is.

The general level of the consumer price index (CPI) representative of the total number of households in the country registered in December a variation of 2.6% in relation to the previous month.

Comment

There is a fair bit to consider here as we see a monetary squeeze imposed on an economy suffering from a drought driven economic contraction. Also I have form in that I warned about the dangers of raising interest-rates to protect a currency on May 3rd.

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.

Interest-rates were half then what they are now and I have already pointed out what mortgage rates now are. As to what sort of a economic crunch is coming the latest from the statistics office looks rather ominous.

The statistics office’s monthly economic activity index fell 7.5% y/y in November after dropping 4.2% in the previous month.

As to the business experience this from Reuters gives us a taste of reality.

Like many small businessmen, Meloni has found himself caught in a vice. Sales from his plant in the town of Quilmes, 30 km (19 miles) outside the capital Buenos Aires, shrank by just over one third last year as Argentina’s economy sank deep into recession…..

 

Meloni said the plant, which makes fabrics, used to operate 24 hours a day from Monday to Saturday but now just operates 16 hours a day, five days a week. Like many other businesses, Meloni advanced the holidays to his roughly 100 employees with the hope that once summer ends in March, demand will pick up.

It is very expensive to make people in Argentina which keeps people in a job (good) but with lower pay from less work (bad) and if it keeps going will collapse the company (ugly).

Back in the financial world I also wonder how this is going?

About a year after emerging from default, Argentina has surprised investors by offering a 100-year bond.

The US-dollar-denominated bond is offered with a potential 8.25 per cent yield.

Podcast

Here are my answers to questions asked about the Euro area economy