German Ifo sounds first note of caution

A first note of caution. German business confidence dropped in May, illustrating that the earlier hard-headed optimism is slightly crumbling. Germany’s most prominent leading indicator, the Ifo index, just decreased to 110.4, from 111.2 in April. Both the current assessment and the expectation component slowed down. Particularly the drop in current assessment component is noteworthy, as it was the first drop after four consecutive increases. The expectation component dropped to 106.2, from 107.3, and now stands at its lowest level since October 2013. The absolute level of the Ifo index is still high and no reason to panic. However, today’s drop combined with the earlier drop in the ZEW index and the PMI manufacturing confirms our view of an upcoming slowing of the economy. Earlier today, the statistical office confirmed the impressive growth comeback of the German economy in the first quarter of 2014. The economy grew by 0.8% QoQ, from 0.4% QoQ in the last quarter of 2013. In fact, the GDP components show that the German economy is already in the midst of a significant rebalancing as growth in the first quarter was exclusively driven by domestic factors. Private consumption was up by 0.7% and investments – to a large extent due to the positive impact of the mild winter weather on the construction sector – accelerated by 7.4% QoQ. Net exports actually shaved off 0.9%-points of GDP growth. Since the beginning of 2011, private consumption has actually outperformed net exports as the growth engine of the German economy. While private consumption has on average contributed 0.2%-points to GDP growth each quarter, the average growth contribution of net exports has been zero. So much for the criticism of an economy that is too dependent on exports. However, before getting too excited about the first quarter growth performance, the rebalancing and the prospects for the coming months, it’s time to sound a note of caution. Since late-2012, the Ifo index has had a mixed performance tracking German GDP growth. It is still very good in tracking the trend of the economy but not the level. Moreover, there are a couple of arguments in favour of a growth correction in the second quarter: the reversal of favourable one-off’s from the first quarter (ie the strong growth contribution of inventories in Q1 and the mild winter weather) as well as increasing headwinds for exports from the East. All in all, today’s data sent two messages: for the time being, the German economy it is still playing in a league of its own; at least in the Eurozone. Unfortunately, as a prominent German soccer team experienced recently, no economy and no soccer team is invincible forever.

High importance but low interest - what to expect from the European elections

For financial markets, the direct impact from this week’s European elections should be limited. The indirect impact, however, should not be underestimated. Up to now, the interest for this week’s European elections remains very limited. Despite the fact that for the first time ever the biggest European parties each nominated a single front-runner to increase the ties with the voters (and Europe), the voter turnout will probably be lower than the 2009 all-time low of 43%. Since the first European elections in 1979, the importance and powers of the European Parliament has constantly increased, while at the same time voter turnout has plummeted. Back in 1979, the voter turnout was still 63%. Some commentators have argued that a further drop in the voter turnout could put the legitimacy of the European Union is at stake. At the same time, it has become an unpleasant tradition that European elections are often used as national protest votes. A closer look at the parties’ political manifestos shows that with the recent calm on financial markets and some improvement in peripheral countries, the economic crisis has not only disappeared from front page news but also seems to have lost importance to most political parties. Looking at the different party manifestos shows that on average the economic crisis is only the fourth or fifth important topic. Other topics like the environment or foreign policy often receive more attention. In short, the conservative parties propose a consolidation of the current crisis management, including the finalizing of the banking union. The Liberal Party has put forward more automatic sanction for the fiscal framework, while the Social-democrats are proposing the mutualizing of responsibilities in EMU but also an end to the Troika missions in its current set-up. The Green Party is still in favour of a debt redemption fund, Eurobonds and the separation of banks activities, while the left-wing socialists stand for the biggest u-turn in economic policies with debt forgiveness, an end to austerity and privatisation, direct government financing by the ECB and an end to the entire new fiscal framework. Obviously, in European elections, these manifestos and promises have to be taken with an even bigger pinch of salt than at national elections. First of all, the European Parliament has to confirm the next European Commission and its president but its influence on economic policies can be limited. Moreover, national party siblings do not necessarily subscribe to the European ideas of their same party family. This leads to a funny situation in which national party manifestos can differ from the European ones. From a financial market’s point of view, this week’s elections should have a first-round and a second-round impact. The first-round impact and markets’ main attention currently seems to focus on the results of the euro-sceptic parties at both the left- and right-wing political spectrum. Latest polls suggest that these parties altogether could take between 25% and 30% of the 751 European Parliament seats. Currently, it sometimes looks as if more attention is given to the smaller, extreme parties than to the others. In our view, it is also striking that political campaigns in Europe are often limited to whether to be in or out Europe or whether voters want more or less Europe than on details and policy options. Anyway, in our view, as long as euro-sceptic parties remain below or at the predicted 30% of all seats, the impact for markets and the European economy should be limited. Up to now, most euro-sceptic parties have not been able to develop a significant level of coordination, preventing them from having influence in actual policy decisions. Moreover, the remaining 70% of non-euro-sceptical parties will simply be forced to work closer together in the next mandate. In addition, let’s not forget that despite increased powers, the overall influence of the EP in the Brussels decision-making process is limited. While the first-round effects from this week’s election should be limited, the second-round effects could be more explosive. What are these second-round effects? In our view, these second-round effects are at least twofold. The first one could be an institutional clash. As often stressed during the election campaign, the next European Parliament will – for the first time ever – have to confirm the next president of the European Commission. This is why the big parties all nominated their own front-runner, who should then become the next Commission president. However, the Treaty text leaves some room for interpretation, stating that European governments nominate a candidate “taking into account the elections to the European Parliament”. This candidate will then be elected by European Parliament. Comments by some government leaders suggested that a compromise candidate should not be excluded, possibly leading to a clash between Parliament and the Council. The other second-round effect, and probably the biggest risk for the EU, markets and economic policies, will be indirect through the impact increasing populism has on domestic politics and, in turn, the position of governments towards Brussels. In this regards, the results in France, Italy and Greece will be very important as they could again derail national politics and policies, giving rise to renewed discussions and controversies about austerity, reforms and debt sustainability. All in all, in the near term, this week’s European elections should be a non-event for financial markets. However, the second-round and spill-over effects on national politics could bring back some shivers to Brussels and financial markets.

German economy booms on back of mild winter weather

As good as it can get? The German economy staged the expected impressive performance in the first quarter of 2014. According to the first estimate of the German statistical office, the economy grew by 0.8% QoQ, from 0.4% QoQ in 4Q13. On the year, German GDP is up by 2.3%, from 1.4% in 4Q13. The individual growth components will only be released at the end of the month but available monthly data and the statistical office’s press release suggest that growth was exclusively driven by domestic demand. Particularly the construction sector, driven by the mild winter weather, should have been an important growth engine. Looking ahead, two opposing trends will affect the future growth path of the economy. On the positive side, the elements of Germany’s economic success formula are almost unchanged: the strong labour market, wage increases and the construction sector should support growth in the coming quarter. Moreover, low inventories and richly filled order books should support industrial production, at least in the short run. On a more negative side, the weakening of Germany’s biggest trade partner, France, combined with the ongoing geopolitical crisis close to Germany’s backyard and the Chinese slowdown, the former growth engine exports is currently only running at half speed. The factor which could tilt the balance between positive and negative elements is investment. It’s the German growth wild card. Having been a drag rather than a push-factor for growth over the last years, domestic investment has started to gradually pick up last year. Gross operating surpluses at all-time highs, strong liquidity positions and some capital repatriation argue in favour of strong investment growth. On the other hand, however, capacity utilisation rates are only at, but not above, historical averages and recent surveys show that German companies hardly see equipment as a constraint for production. At the same time, credit growth is also shrinking, not growing. In our view, domestic investment should continue to pick up, but only at a subdued level. Investment growth this year should rather be a cyclical rebound than a structural shift, showing that creditless recoveries do exist. All in all, Germany has again cemented its role as the Eurozone’s economic powerhouse. The current growth pace can hardly be maintained and some slowdown to more normal growth rates is in the offing. However, any complaints about the upcoming slowdown would be complaining on a high comfort level.

Trade data mark weak end of a strong quarter

German exports dropped in March, confirming the shot-across-the-bow feeling from other industrial data earlier this week. As just reported by the Federal Statistical Office, German exports dropped by 1.8% MoM in March, the sharpest monthly drop since May 2013. At the same time, imports dropped by 0.9% MoM, narrowing the seasonally-adjusted trade balance to 14.9 bn euro, from 15.8 bn euro in February. As already reflected in other industrial data, the month March saw a stronger real economic impact from the Ukrainian crisis and the Chinese slowdown than confidence indicators had suggested. It seems as if recent events have only accelerated a trend that became already visible at the start of the year: German exports to Russia had already dropped to only 2.6% of total exports in the first months of the year, the lowest level since late-2010. Looking ahead, the destiny of German exports remains in the hands of its good old trading partners in the West outside of the Eurozone. The US and the UK remain Germany’s biggest non-Eurozone trading partners, with the share of exports to the UK recently rising to the highest level since 2005. All in all, with ongoing geopolitical problems and the slowing emerging economies, it looks as if Germany’s famous export engine could still be sputtering for a while. After today’s trade data, the bean counting for next week’s first quarter GDP release can start again. The available monthly data suggest another strong growth performance. The construction sector alone should already contribute some 0.4 percentage points to GDP growth. Add to this strong retail sales, low inventories and, despite the latest weakening, still slightly positive exports and all the ingredients for another acceleration of the German economy are there. We expect German Q1 GDP growth to come in at 0.7% QoQ.

Verbal acrobatics and a cliffhanger from Brussels

As expected the ECB kept its powder dry at today’s meeting. However, what started off as a rather dull meeting developed into a very exciting press conference. At some point in time, Draghi’s comments looked almost as acrobatic as many performances at Tuesday’s semi-final of the Eurovision song festival. However, in the end, Draghi had prepared everyone for new ECB action at the June meeting. The start of today’s ECB press conference was rather dull. The introductory statement was almost a verbatim copy of the one from the April meeting. According to the ECB, the gradual and weak recovery will continue, while at the same time inflation will remain low for a prolonged period of time. Interestingly, the ECB has put somewhat more emphasis on possible downward risks to the recovery. For the first time, the ECB mentioned private loan developments already in the part on the economic analysis and not only in the monetary analysis part. In addition, Draghi’s comments during the press conference on geopolitical risks also showed that the ECB has become somewhat more cautious. As regards the exchange rate, Draghi’s comments made listeners almost dizzy. Initially, Draghi defended the ECB against all external advice and criticism. He also said that the exchange rate was not a policy target. Later on, however, the exchange rate was called a “serious concern” for the ECB, which could not only have a negative impact on inflation but also on the recovery. Again the recovery. Looking ahead, Draghi gave the final goodbye to his predecessor’s famous “we-never-precommit”. The ECB’s forward guidance, which started last summer, had already been a first emancipation from the no-precommitment. Today’s statement that the Governing Council was dissatisfied with the current inflation path, was not accepting it as a fact of nature and was therefore comfortable with acting next month. Boom. This very last comment was supported by Draghi’s comment that “further information and analysis concerning the outlook for inflation and the availability of bank loans to the private sector will be available in June”. Moreover, Draghi stressed the next staff projections as an essential new piece of information in June. Of course, every next meeting will have new and more information than the previous one. However, with today’s press conference it will be hard for the ECB to take some “manana-manana” attitude. To the contrary, with his comments on the exchange rate and hints at possible June action, Draghi has pushed the ECB into a corner from which it will be very hard to escape. Nevertheless, in our view, it is not a given that the ECB will really act in June. In fact, on the back of better-than-expected Q1 GDP data, growth might even be revised upwards for this year. And what if the inflation forecast for 2015 and 2016 remains unchanged? And what if credit growth has improved slightly? It is exactly these uncertainties which kept the ECB from already acting today and might prevent it from acting in June. All in all, taking a step back and just looking at the facts, not a lot has changed with today’s ECB meeting. In our view, the real new thing is that the ECB has become more concerned about the strength of the recovery and has clearly put more emphasis on the exchange rate. . For the rest, any next steps remain conditional on the June staff projections. Admittedly, with today’s comments, Draghi has clearly presented a cliff hanger which makes it hard for the ECB not to come up with a brandnew episode of monetary action at the June meeting.

Ongevraagd advies

Druk werkt averechts. Dat heb ik bij de opvoeding van mijn kinderen uit eigen ervaring moeten leren. Op belangrijke momenten werkt het beter om vertrouwen te hebben in het gezond verstand van het kind, hopelijk versterkt door een goede opvoeding. Ook in Europa zien we dat patroon terugkeren. Alleen hebben sommige Europese politici geen vertrouwen in het gezond verstand van de Europese Centrale Bank. Telkens weer komen ze aandraven met 'goede adviezen en wenken'. En hopla, daar gingen ze weer. Franse politici vervielen weer in de oude nationale reflex. Als het niet goed gaat met de eigen economie en puinruimen moeilijk en pijnlijk is, roept Frankrijk graag de hulp van buitenaf in. De makkelijke weg is het laten oplopen van de overheids- tekorten en druk uitoefenen op de ECB om de munt te verzwakken. De Fransen zijn niet alleen. Het succes van de ECB als onomstreden crisismanager geeft velen een sinterklaas- gevoel. Nationale en Europese politici vinden blijkbaar dat de ECB de macht heeft om te geven en nemen. Politici becommentariëren op Twitter beslissingen van de ECB. In de campagne voor de Europese verkiezingen lijkt iedereen zijn wensen naar de ECB te sturen. Verzwak de euro, help de kmo's, koop overheidsobligaties en doe met een magische ingreep onmiddellijk de werkloosheid verdwijnen. Is dat kinderlijk geloof in de almacht van de ECB of een afleidingsmanoeuvre voor het gebrek aan eigen kracht, macht en visie? Wat politici, vooral in de media, graag vergeten, is dat artikel 130 van de Europese verdragen de ECB verbiedt om advies van regeringen, politici en andere instellingen te vragen of aan te nemen. Kwestie van de ECB te beschermen tegen sterk fluctuerende politieke wenslijstjes. Maar, eerlijk is eerlijk. De ECB heeft zelf bijgedragen aan het vol van verwachting kloppende hart van politici, het IMF en de OESO. Het aanwakkeren van speculaties over op handen zijnde nieuwe acties van de ECB deed de spanning stijgen. Daarbij moet de centrale bank oppassen niet méér te suggereren dan ze kan waarmaken. Alle mogelijke opties zijn op papier en in theorie sterker dan in de praktijk. Denk aan het opkopen van staatsobligaties. Frankrijk laat het begrotingstekort oplopen en de ECB koopt als beloning Franse staatsobligaties? Onvoorstelbaar. En als de ECB kmo-leningen van de banken of in de markt koopt? In theorie zouden dan de kredietvoorwaarden voor kmo's gunstiger moeten worden. Maar de markt voor die leningen is behoorlijk opgedroogd. Bovendien lijkt het onwaarschijnlijk dat de ECB - terwijl zij ze bezig is de risico's van de banken in kaart te brengen - die risico's zelf zou over- nemen. De ECB is zich goed bewust van haar zeer speciale verantwoordelijkheid. Nu politieke druk uitoefenen werkt eerder averechts en helpt niemand. Anders dan mijn kinderen is de ECB oud genoeg om helemaal zelf te beslissen. Deze column verscheen vandaag in het Belgische dagblad "De Tijd".