Mario Draghi and the ECB look for more expansionary Euro area fiscal policy

As we travel the journey that is the credit crunch era we pick up some tasty morsels of knowledge along the way. Some were provided by Mario Draghi and the European Central Bank yesterday which announced this.

we decided to launch a new series of quarterly targeted longer-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021, each with a maturity of two years. These new operations will help to preserve favourable bank lending conditions and the smooth transmission of monetary policy.

As ever “the precious” otherwise known as the banks is prioritised ahead of everything else. Also I was asked if this meant the ECB “knew something” to which the answer is simple, if they did then they would have done it last summer. But there was a much bigger pivot.

This happens in a context where the debt to GDP ratio in the eurozone is actually falling.

There was a move towards making a broad hint for more fiscal policy or easing here. Mario also went out of his way to point out that borrowing for Euro area governments is very low.

The simple action of maintaining the stock unchanged in this context actually is a continuous easing because interest rates are pushed downward by this action. You can see this because since we decided in June last year, interest rates have gone down, they keep on going down, the term premium is negative, so conditions are very, very accommodative.

Not only that but he intends to keep it that way.

If you add to this what I’ve just said, it’s the chained element of this, of the horizon over which we’ll carry out purchases to keep the stock unchanged moves together with the forward guidance.

So Mario is pointing out to government’s that if they borrow the ECB will in general be there to help keep borrowing costs low or as we shall see in a bit negative. After all we now live in a world where even Greece can do this.

On Tuesday 5thMarch the Hellenic Republic, rated B1 Moody’s/ B+ S&P/ BB- Fitch/ BH DBRS (stb/ pos/ stb/ pos), priced a €2.5 billion 10-year Government Bond (GGB) due 12th March 2029. The new benchmark carries a coupon of 3.875% and reoffer yield of 3.900%, equating to a reoffer price of 99.796%. Joint bookrunners on the transaction were BNP Paribas, Citi, Credit Suisse, Goldman Sachs Intl, HSBC and J.P. Morgan. ( Note the past behaviour of Goldman Sachs in relation to Greece seems to be no barrier at all to future business…..)

Why so cheap? Well there are two main factors. One is that it is looking to run fiscal surpluses and the other is that whilst it is not in the ECB QE programme it may well be in a future one and that is looking more likely by the day. As to the economy it is with a heavy heart that I point out this which speaks for itself.

The available seasonally adjusted data
indicate that in the 4 th quarter of 2018 the Gross Domestic
Product (GDP) in volume terms decreased by 0.1% in comparison with the 3rd quarter of 2018,
while in comparison with the 4th quarter of 2017, it increased by 1.6%.

Mario also gave us a reminder of the scale of Euro area bond buying so far.

Just to give you an idea, the balance sheet of the ECB is about 42 – 43% of the eurozone GDP. The Fed is about half of it now. In order to keep this stock unchanged, we continue purchasing something in the order of €20 billion a month of bonds.

Here are more hints on the subject with also I think a nod to his home country Italy.

Regarding fiscal policies, the mildly expansionary euro area fiscal stance and the operation of automatic stabilisers are providing support to economic activity. At the same time, countries where government debt is high need to continue rebuilding fiscal buffers. All countries should continue to increase efforts to achieve a more growth-friendly composition of public finances.

Bond Yields

Let us start with the largest Euro area economy with is Germany. We saw bond prices rise and yields fall quite quickly in response to this. The German ten-year yield fell from 0.12% to 0.06% which makes us wonder if we may see another spell of it going negative like it did in the summer and autumn of 2016? It would not take a lot as the nine-year yield is now -0.1%.

So Germany can borrow essentially for nothing should it so choose over a ten-year horizon. That is in nominal terms and if we see inflation in this period then the real cost will be negative. Yet if you read through the cheerleading it is aiming for a fiscal surplus.

The general government budget surplus
will fall from roughly 1½% of GDP in
2018 to roughly 1% of GDP in 2019.
In 2019 and subsequent years, a fiscal
impact will be made in particular by
the priority measures contained in the
Coalition Agreement and other measures.
The implementation of these measures
will reduce the federal budget surplus. ( Draft Budget October 2018).

Although those numbers are already suffering from the TalkTalk critique and on that subject RIP Mark Hollis.

Baby, life’s what you make it
Celebrate it
Anticipate it
Yesterday’s faded
Nothing can change it
Life’s what you make it

Why? Well we have indeed moved on since this as the German economy shrank in the second half of 2018.

which forecasts a real growth rate of 1.8% in both 2018 and
2019. This means that Germany’s economy is expected to keep growing at a pace that slightly exceeds potential output.

Also if we look around we see that European supranational bodies can borrow very cheaply too. Maybe not at German rates but often pretty near. After considering that now let us return to Mario Draghi yesterday.

Now, Philip Lane is an excellent acquisition for the ECB but we are not going to ask him about this Eurobond thing. The Eurobond is again not something that the ECB can force or just decide about; again it’s an inherently political decision. And of course this doesn’t detract at all from the argument that it’s absolutely rational to have a safe asset at European level.

We have seen the Eurobond case made many times and so far Germany keeps torpedoing it, but we also know that in Europe these sort of things tend to happen eventually after of course a forest of denials and rejections.

Comment

We have seen quite a few phases now of the Euro area crisis. For a while it looked like “escape velocity” had been achieved but now we see to be facing many of the same problems with quarterly economic growth having gone 0.1%, 0.2% and looking like being around 0.2% in the first quarter of this year. Although he tried to downplay such thoughts yesterday it is hard not to think of this from Mario Draghi last November.

 I’ll be briefer than I would like to be, but certainly especially in some parts of this period of time, QE has been the only driver of this recovery.

Ironically he is avoiding the subject just as the evidence is pointing that way. For the moment monetary policy is to coin a phrase “maxxed out” although in this instance it is more timing than not being able to do more, as it would be an embarrassing U-Turn. So for now if Euro area government’s and especially Germany were to embark on a fiscal stimulus the ECB would turn its blind eye towards it I think.

 

 

Advertisements

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

 

Slowing growth and higher inflation is a toxic combination for the Euro area

Sometimes life comes at you fast and the last week will have come at the European Central Bank with an element of ground rush. It was only on the 30th of last month we were looking at this development.

Seasonally adjusted GDP rose by 0.2% in the euro area (EA19) and by 0.3% in the EU28 during the third quarter
of 2018,

Which brought to mind this description from the preceding ECB press conference.

Incoming information, while somewhat weaker than expected, remains overall consistent with an ongoing broad-based expansion of the euro area economy and gradually rising inflation pressures. The underlying strength of the economy continues to support our confidence ……..

There was an issue with broad-based as the Italian economy registered no growth at all and the idea of “underlying strength” did not really go with quarterly growth of a mere 0.2%. But of course one should not place too much emphasis on one GDP reading.

Business Surveys

However this morning has brought us to this from the Markit Purchasing Managers Indices.

Eurozone growth weakens to lowest in over two years

The immediate thought is, lower than 0.2% quarterly growth? Let us look deeper.

Both the manufacturing and service sectors
recorded slower rates of growth during October.
Following on from September, manufacturing
registered the weaker increase in output, posting its
lowest growth in nearly four years. Despite
remaining at a solid level, the service sector saw its
slowest expansion since the start of 2017.

There is a certain sense of irony in the reported slow down being broad-based. The issue with manufacturing is no doubt driven by the automotive sector which has the trade issues to add to the ongoing diesel scandal. That slow down has spread to the services sector. Geographically we see that Germany is in a soft patch and I will come to Italy in a moment. This also stuck out.

France and Spain, in contrast, have
seen more resilient business conditions, though both
are registering much slower growth than earlier in
the year.

Fair enough for Spain as we looked at only last Wednesday, but France had a bad start of 2018 so that is something of a confused message.

Italy

The situation continues to deteriorate here.

Italy’s service sector suffered a drop in
performance during October, with business activity
falling for the first time in over two years. This was
partly due to the weakest expansion in new
business in 44 months.

Although I am not so sure about the perspective?

After a period of solid growth in activity

The reality is that fears of a “triple-dip” for Italy will only be raised by this. Also the issue over the proposed Budget has not gone away as this from @LiveSquawk makes clear.

EU’s Moscovici: Sanctions Can Be Applied If There Is No Compromise On Italy Budget -Policy In Italy That Entails Higher Public Debt Is Not Favourable To Growth.

Commissioner Moscovici is however being trolled by people pointing out that France broke the Euro area fiscal rules when he was finance minister. He ran deficits of 4.8% of GDP, followed by 4.1% and 3,9% which were above the 3% limit and in one instance double what Italy plans. This is of course awkward but not probably for Pierre as his other worldly pronouncements on Greece have indicated a somewhat loose relationship with reality.

Actually the Italian situation has thrown up another challenge to the Euro area orthodoxy.

 

Regular readers will be aware I am no fan of simply projecting the pre credit crunch period forwards but I do think that the Brad Setser point that Italy is nowhere near regaining where it was is relevant. If you think that such a situation is “above potential” then you have a fair bit of explaining to do. Some of this is unfair on the ECB in that it has to look at the whole Euro area as if it was a sovereign nation it would be a situation crying out for some regional policy transfers. Like say from Germany with its fiscal surplus. Anyway I will leave that there and move on.

Ch-ch-changes

This did the rounds on Friday afternoon.

ECB Said To Be Considering Fresh TLTRO – MNI ( @LiveSquawk )

Targeted Long-Term Refinancing Operation in case you were wondering and as to new targets well Reuters gives a nod and a wink.

Euro zone banks took up 739 billion euros at the ECB’s latest round of TLTRO, in March 2017. Of this, so far 14.6 has been repaid, with the rest falling due in 2020 and 2021.

This may prove painful in countries such as Italy, where banks have to repay some 250 billion euros worth of TLTRO money amid rising market rates and an unfavorable political situation.

So the targets of a type of maturity extension would be 2020/1 in terms of time and Italy in terms of geography. More generally we have the issue of oiling the banking wheels. Oh and whilst the Italian amount is rather similar to some measures of how much they have put into Italian bonds there is no direct link in my view.

Housing market

If you give a bank cheap liquidity then this morning’s ECB Publication makes it clear where it tends to go.

The upturn in the euro area housing market is in its fourth year. Measured in terms of annual growth rates, house prices started to pick up at the end of 2013, while the pick-up in residential investment started somewhat later, at the end of 2014. The latest available data (first quarter of 2018) indicate annual growth rates above their long-term averages, for both indicators.

How has this been driven?

 In addition, financing conditions remained favourable, as reflected in composite bank lending rates for house purchase that have declined by more than 130 basis points since 2013 and by easing credit standards. This has given rise to a higher demand for loans for house purchase and a substantial strengthening in new mortgage lending.

Indeed even QE gets a slap on the back.

Private and institutional investors, both domestically and globally based, searching for yield may thus have contributed to additional housing demand.

It is at least something the central planners can influence and watch.

Housing market developments affect investment and consumption decisions and can thus be a major determinant of the broader business cycle. They also have wealth and collateral effects and can thus play a key role in shaping the broader financial cycle. The housing market’s pivotal role in the business and financial cycles makes it a regular subject of monitoring and assessment for monetary policy and financial stability considerations.

 

Comment

The ECB now finds itself between something of a rock and a hard place. If we start with the rock then the question is whether the shift is just a slow down for a bit or something more? The latter would have the ECB shifting very uncomfortably around its board room table as it would be facing it with interest-rates already negative and QE just stopping in flow terms. Let me now bring in the hard place from today’s Markit PMI survey.

Meanwhile, prices data signalled another sharp
increase in company operating expenses. Rising
energy and fuel prices were widely reported to have
underpinned inflation, whilst there was some
evidence of higher labour costs (especially in
Germany).

Whilst there may be some hopeful news for wages tucked in there the main message is of inflationary pressure. Of course central bankers like to ignore energy costs but the ECB will be hoping for further falls in the oil price, otherwise it might find itself in rather a cleft stick. It is easy to forget that its “pumping it up” stage was oiled by falling energy prices.

Yet an alternative would be fiscal policy which hits the problem of it being a bad idea according to the Euro area’s pronouncements on Italy.