German inflation drops in November

Based on the results of six regional states, German headline inflation dropped to 0.6% YoY in November, from 0.8% in October. On the month, German prices remained unchanged. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation decreased to 0.5%, from 0.7% in October, and stands now at its lowest level since February 2010. A quick look at the available components at the regional levels shows that the drop in headline inflation was not only driven by lower energy prices but also some tentative second-round effects on consumer goods and a drop in prices for vacation destinations and package tours. Looking ahead, the recent drop in energy prices – if sustained and if not offset by strong currency weakening – could push German headline inflation further down. Corrected for the euro depreciation vis-à-vis the US dollar, oil prices have dropped by more than 15% since last November. Not all of this price drop has yet been passed through to consumer prices. However, as German employment just reached another record-high in October, this drop in inflation should be inflationary rather than deflationary. Just think of Draghi’s famous words “with low inflation, you can buy more stuff”. At the current juncture, price expectations of both consumers and producers remain solidly anchored in Germany. According to today’s economic sentiment indicators from the European Commission, price expectations by both consumer and producers have slightly come down in November but remain close to their respective historical averages. Interestingly, price expectations in the service sector have now increased for three months in a row and are close to all-time highs. This might be the result of higher wages and maybe also the introduction of the minimum wage. For next week’s ECB meeting, today’s German inflation data could be the prelude of another downward revision of the ECB’s inflation forecasts. Back in September, ECB staff had projected an average inflation rate of 1.1% for 2015 and 1.4% for 2016. Even without any significant changes to the growth outlook, the latest drop in energy prices should be sufficient to automatically lead to lower inflation forecasts. Remember that last month, ECB president Draghi had described two “contingencies” for further action: the current measures are not enough to reach the new (soft) balance sheet target, and a worsening of the medium-term outlook for inflation. Obviously, next week will be too early to give an assessment on the first contingency but with lower inflation projections, one of the two lights needed to start QE could already be lit green next week.

Abracadabra from Brussels?

Today, the European Commission will present its long-awaited investment plan. Risks are high that it will not be the big game changer.

It has probably been Brussels’ least guarded secret of recent weeks: Jean-Claude Juncker’s investment initiative is supposed to give the new European Commission and the entire European economy a kick-start. A ballpark figure of around €300bn has been circulating for a while. Today, the European Commission will present its plan on how to achieve the targeted amount.

Based on the available information circulating in the media, Juncker's plan should consist of a new investment fund that will give guarantees for private sector investors. The funds own financial means could be around €21bn, according to latest reports, €5bn from the EIB and €16bn from the EU. These guarantees should – in theory – attract almost €300bn of venture capital and private funds for projects identified by the European Commission. The focus of these project will be on infrastructure, energy and high-speed internet.

In our view, this means that hardly any new public money will be invested. The EU funds will very probably come from existing budgets and projects and whether the EIB’s €5bn will be new guarantees or only specially devoted funds remains unclear. Public funds will only be used as “first loss” guarantees. This means that without private sector money, not a single euro will be spent.

As regards the now known technical details, the biggest problem is of course the wished for multiplier. Making €315bn out of €21bn would make any magician jealous. The current construction would indeed cap the risk and therefore increase interest from private investors. However, the problem in our view is the expected return (or yield) on these investments. The identified projects are typical "public goods" projects, where it is hard to calculate an expected yield on the investment. However, this yield is what private investors will be looking for.

With the current low levels of interest rates, it might have been easier for governments to borrow money in the market rather than fixing and promising expected returns on investment for private investors. But to allow for that, one would need another change in the stability programme, effectively keeping investment expenditure outside the current expenditure budget, something Germany is most likely to resist.

All in all, it looks as if Juncker’s plan will not be the big game changer but rather a non-starter. Unless magic is joined by a miracle. As so often in the past, this would transform an excellent idea ultimately into a missed opportunity. To be clear, it should not be the Commission that has to be blamed, but the willingness of member states to chip in fresh money. As long as the Commission – or, for the sake of simplicity, Europe – does not have own funds, any financial attempts to revive growth are deemed to fail. This would be a pity as the underlying idea is good: find European projects and start investing to stimulate short-term growth but also, and more importantly, potential growth. This could have been the kick-start for the new Commission and the boost for new European growth visions, but instead Europe seems to have a new fund of hope rather than one of hard commitment.

Downward slide continues

Downward slide continues. German business confidence dropped for the sixth month in a row in October, illustrating the Eurozone’s biggest economy has reached a dangerous stage between soft spell and longer-lasting almost-stagnation. Germany's most prominent leading indicator, the Ifo index, just decreased to 103.2, from 104.7 in September. Both the current assessment and the expectation component slowed down. Particularly the weaker expectation component, which dropped to its lowest level since December 2012, is a reason for further caution. Latest soft data has rather increased than decreased the degree of diffusion, maybe even confusion. While last week’s PMI and consumer confidence indicator had given hope that the economy would slowly recover from the psychological shock waves from the summer, today’s Ifo index is less encouraging. Trying to get some grip on the current state of the economy requires a lot of instinctive feel. At the current juncture, it is still hard to tell whether solid domestic demand can offset weaker industrial activity; and if for how long. While the strong labour market and low interest rates are supporting private consumption and the construction sector, the export-oriented industry is still going through a dry spell. However, the latest reductions in backlogs and optimism stemming from new Chinese bulk orders show that the risk of drying-up is still relatively small. Looking ahead, Germany’s export industry will face several opposing trends in the next months: on the negative side, with France and Italy stagnating, demand from the Eurozone should remain weak. On the positive side, however, the strong US recovery and renewed demand from China bode well for exports. In our view, the German economy is neither near the abyss, nor close to a period of self-complacent honky-dory. It is in a longer-lasting transition period from the end of the positive reform cycle to the challenges an ageing economy is facing. Even if it is does not make sense to use single economic data as a barometer on whether or not the government will decide on growth-enhancing measures, the general need for more domestic investment in Germany remains. Last week’s European Summit, which took place off markets’ radar screens due to the stress test excitement, did not provide any further guidance. While statements in the final summit conclusions like “…the urgency of the prompt implementation of measures to boost jobs, growth, competitiveness…” sounded promising to those hoping for additional fiscal stimulus, the Germanic sentence “structural reforms and sound public finances are key conditions for investment” underlined that the face-off between Germany and the rest of Europe on how to revive the Eurozone economy is far from being solved. In the short run, lower energy prices and the weaker euro exchange rate are already a small stimulus package for the German economy. However, it is a package which will rather delay than advance new structural reforms.

Eurozone - Heading towards Animal Farm?

The latest announcements have shown that the Eurozone is heading towards another showdown on the right balance between austerity and growth.

The Eurozone is preparing for yet another showdown on the right balance between austerity and growth. Italy, but even more so France, laid down the gauntlet to EU partners in recent days, presenting fiscal plans which would clearly be in strong contrast with the Eurozone’s fiscal framework. In addition, the latest comments by the IMF, the ECB and the OECD, all basically calling for more active fiscal stimulus, have also heated up the debate. A new showdown between Italy and France on the one side and Germany plus some fiscal hardliners on the other side is clearly in the making.

The discussion on growth versus austerity has become an almost religious debate. Without choosing sides, let’s have a quick look at what wiggle room the strengthened fiscal framework is offering. For countries with a fiscal deficit below 3% of GDP, read Italy, the fiscal rules offer a decent portion of flexibility. Countries still have to reach balanced budgets in the medium-term and have to stick to their own national debt brakes (if they have implemented them already) but the adjustment pace can be flexible. The flexibility allows for government investments. At least if these are investments in projects co-financed by the EU under regional development policies for poorer regions, European networks, or the connecting Europe facility. Moreover, there is room for major structural reforms that have "direct long-term positive budgetary effects, including by raising potential sustainable growth”. However, the problem is that these reforms actually have to be implemented already.

As regards countries with a fiscal deficit above 3%, read France, the flexibility of the fiscal rules is very limited. As long as countries are still in the so-called excessive deficit procedure, flexibility is limited to extending the deadline to reach the 3%-deficit target. In the case of France, however, the deadline has already been extended twice; in 2009 and in 2013. According to the fiscal rules, such a deadline can only be extended in the case of unexpected adverse economic events. While the financial crisis qualified as such an event, it is hard to see that the failure to implement structural reforms or stagnating growth can be considered unexpected.

Today, everyone seems to talk about flexibility again. Obviously, some economic common sense should be welcome but at the same time let’s not forget that bending the rules in the early 2000s had laid the grounds for unsustainable and uncontrollable public finances almost ten years later. Of course, there is wiggle room in the new fiscal surveillance framework and it looks as if there is new momentum in the Eurozone to also support the demand side of the economy. However, it will not be an easy balancing act. In this context, the biggest challenge will be to treat Italy and France differently. Treating France differently than other countries in the so-called excessive deficit procedure could damage the long-term credibility of the fiscal framework and would clearly have the scent of Animal Farm: all (pigs) are equal, only some are more equal than the others.

In our view, the situation is more delicate than it looks like. However, the most probable outcome of the current controversy is still a bit of more accommodative fiscal policies, without letting austerity disappear, a bit of German goodwill topped with a bit of European investment (eventually maybe even supported by some ECB QE).

ECB shows some of the money

More questions than answers? At its meeting in Naples, the ECB unsurprisingly decided to keep interest rates unchanged. Moreover, the ECB presented some details of the already announced ABS and covered bond purchasing programmes. ECB president Draghi’s comments at the press conference have increased rather than decreased the likelihood of more action to come. The ECB’s assessment of the Eurozone economy remained unchanged and was almost a verbatim copy of the September assessment. The entire macro-assessment can nicely be summarized with Draghi’s own word: “I have always said that the recovery is weak, fragile and uneven”. Nothing to add here. In ECB language this means that risks to growth remain to the downside. As in September, the ECB stopped giving a direction for risks to the inflation outlook. As regards the ECB’s asset-backed securities purchase programme (ABSPP) and covered bond purchase programme (CBPP3), the ECB presented some technical details after the press conference. The ECB’s purchasing programmes will start in mid-October (covered bonds) and the fourth quarter (ABS) and will run for two years. The details of the ABS programme are limited to purchases of senior tranches and follow more or less the current principles or guidelines of the ECB’s collateral policies. The ECB decided to also accept assets from Greece and Cyprus, but only under certain caveats and additional conditions. In the press conference, Draghi suggested that the ECB would only accept assets from these two countries if they were running under (EU) programmes. This, however, was not reflected in the published texts. Consequently, this could clearly hinder the Greek government’s latest attempts to exit the second bailout programme without a follow-up. The most important issue of the ABS purchasing programme, however, remains unanswered. The controversy about the riskier ABS tranches has apparently not been solved, yet. Remember that several Eurozone governments, particularly France and Germany, had already given the ECB the cold shoulder, refusing to guarantee mezzanine tranches. However, without purchases of the riskier ABS tranches, the programmes will be handicapped before they start. In the official text, the ECB only said that details of purchases of mezzanine tranches will be published at a later stage. In general, the ECB refrained from answering two important questions on the ABS and covered bond purchasing programmes: will there be a country distribution and what will be the total volume? Regarding the volume of all purchases, Draghi made the latest new soft target, the size of the balance sheet, a bit softer. He said that the “potential universe” of all eligible ABS and covered bonds was 1 trillion euro. On top of that come the TLTROs. Returning the ECB’s balance sheet to its size of 2012 (which would require an increase of 1000 billion euro) was an instrument rather than a goal. The ECB obviously sticks to its current strategy of repairing the transmission channel of monetary policy. All measures are aimed at supporting the supply side of the credit economy, ie banks. At several occasions during the press conference, Draghi stressed that monetary policy alone could not restore growth in the Eurozone. He called several times for more (implementation of) structural reforms, the use of fiscal room for manoeuvre and demand-side policies. Whether this was another invitation for Eurozone governments to join another grand bargain, or just another desperate cry in the dark remains to be seen. The experience of the last years, however, tells us that the ECB’s advance payments have hardly ever been matched by equivalent government actions. In this context, the fact that Draghi mentioned the ECB’s unanimous commitment “to using additional unconventional instruments” three times compared with only one time last month is in our view a clear signal that the ECB is determined to do more and even bolder action if necessary.

The Inbetweeners - German Economic Update

The economy has been on a roller coaster ride for quite some time. In the short run, fundamentals remain strong but preparations for the longer run should start quickly. Only judging from German GDP data, the economy has been on a roller coaster ride for quite some time. The impressive first quarter performance was followed by a disappointing contraction in the second quarter. This contraction had given rise to new speculations that the German second Wirtschaftswunder might already be over. Is it? The answer to this question is not easy and not straight forward. There are currently several, partly opposing, trends and developments affecting the economy’s growth prospects. In many ways, Germany is currently inbetween. Here are at least three: i) inbetween strong domestic demand and weaker external demand; ii) inbetween strong short-term fundamentals but weaker long-term prospects; and iii) somewhere inbetween the sometimes religious debate on growth versus austerity. The composition of second quarter growth sent two opposing signals for the German economy’s prospects: the sharp drop in the construction sector should have been a weather-driven one-off and should be reversed in the third quarter. Demand for housing continues to be strong, backed by low interest rates and low homeownership ratios. The inventory build-up seen in the second quarter, however, was less encouraging for activity in the third quarter. Moreover, the only marginal improvement of new orders from other Eurozone countries shows downside risks for the German economy do currently not mainly come from geopolitical tensions but rather from longer-than-expected weak demand from Eurozone peers. It is still too early to tell which of these opposing trends will eventually predominate. This is why Germany is an inbetweener. In our view, the solid fundamentals, domestic demand and exports to the US still form a substantial safety net against widespread fear and a period of economic drought in Germany. Looking beyond the short term, however, the economy and policymakers face new problems. The current strength of the German economy is still the result of structural reforms from the early 2000s. In fact, the economy has reached the final stage of textbook business and reform cycle: from the sick man of Europe to structural reforms and wage moderation to regained competitiveness and increasing exports to dropping unemployment and strengthening domestic demand to wage increases and a fully self-sustained recovery. Additional stimulus will have to come from new structural reforms. Otherwise, Germany could have problems facing its long-term challenges like ageing, an investment gap and surviving global competition. One of the crucial questions for long-term growth prospects is how the industry will react to emerging market economies’ attempts to climb up the quality ladder. Or put differently, what will happen if and when emerging market economies are able to produce same quality products as the Germans. In this context, new developments and trends known as industry 4.0 are of high importance. To manage the transition from the rosy short-term to the rather challenging long-term, investments play an important role. Both public and private investments have remained sluggish in the current recovery. At the same time, however, several investment-intensive sectors offer an enormous potential to improve Germany’s long-term growth. Just think of infrastructure (rail, road but also internet), transition towards renewable energies and education. Up to now, the government has been reluctant to address this issue, giving the impression of some kind of complacency and refusing calls to use the still good (economic and fiscal) times and extremely low interest rates to tackle weak investments. This could change. In recent weeks, there has been anecdotal evidence of a slight, subliminal change within the government, with for example the start of an expert group on new investments. More emphasis on investment would be a shift in policymakers’ stance on austerity and structural reforms. In the European debate, German policymakers have been relatively quiet, hardly commenting on increased calls for more growth and demand-oriented policies. There are, however, some domestic signals that Germany is giving up its principle of leading by example. The German mantra of austerity and structural reforms seems to wobble; at least domestically. In the latest debate on how to reform the German system of transfers between the federal states, a proposal by finance minister Schäuble foresees that the debt brake for the states could be eased. Moreover, the issuance of common bonds of all federal states is also discussed. Last year, the federal government and some regional states issued already one common bond for the first time ever. Needless to say that these changes to the own transfer system would have a strong signalling effect to the rest of Europe. All in all, despite the still strong fundamentals, Germany seems to have reached an interesting transitional period in many different ways, making it the economy of the inbetweeners.

Vreemdeling in eigen land

Na ruim een week in de nieuwe oude heimat blijkt het wel weer wennen. Mijn zoon kreeg op de eerste training van zijn nieuwe voetbalclub te horen dat 'wij in Duitsland op tijd beginnen' nadat hij drie minuten te laat was omdat we de weg even kwijt waren. Mensen lopen niet bij rood licht over straat, ook al zijn er in geen velden of wegen auto's te bekennen. En in de supermarkt schallen reclamespots voor orthopedische inlegzolen en lijfrentes. Welkom in Duitsland, het land van regels, vergrijzing en slaapliedjes van gedroomde bestaanszekerheden. Het verbaast niet dat de Duitsers de ECB niet meer begrijpen. Na het laatste besluit van de ECB afgelopen week waren bijna alle Duitse economen in Mainhatten razend. Volgens hen was Mario Draghi echt te ver gegaan. Wat had het aankopen van privéschuldpapier nog met monetair beleid te maken? Veel. Na Draghi's whatever-it-takes om de eurozone bij elkaar te houden, is het nu een whatever-it-takes om stagnatie en Japanse toestanden in de eurozone te voorkomen. De strategie is duidelijk. De ECB doet er nu alles aan om de aanbodzijde van de kredietgroei op gang te krijgen. Met conditionele liquiditeit, het aankopen van ABS en pandbrieven en uiteindelijk ook de bankenstresstests is er geen excuus meer: aan de banken ligt het dan niet meer als de economie niet groeit. Maar wat als de oorzaak niet de banken zijn, maar de zwakke vraag naar kredieten? Dan helpt alleen nog de Draghi-bag. Betaal elke burger maandelijks 250 euro via de belastingdiensten van de verschillende lidstaten. De eurozone telt zo'n 330 miljoen inwoners, dus na een jaar heeft de ECB haar balans ook met 1.000 miljard euro vergroot. Dat is wat Draghi nu op een ingewikkelde manier ook probeert te bereiken. Gegarandeerd. Burgers zouden met dat geld schulden aflossen of meer besteden. Als de ECB dan ook nog zou aankondigen dat de maandelijkse overboekingen zo lang doorgaan totdat de inflatie weer boven 2 procent staat, gaat dat geld ook daadwerkelijk in de conjunctuur en niet alleen in de spaarpot. Vooral in Duitsland lijkt zo'n Draghi-bag een groot hersenspinsel. En ja, het is monetaire financiering, in strijd met de Verdragen en het vermindert de druk op regeringen om meer te hervormen. Maar wat als zo'n Draghi-bag wordt verbonden aan verplichte structurele hervormingen? Zou dat niet een onconventionele maar ook zeer controverse en efficiënte manier zijn om Japanse toestanden in Europa te bestrijden? Hardop roepen zal ik dat in Duitsland beter niet, anders sturen ze mij nog naar de kerkers van de Bundesbank met een prop in mijn mond. Misschien ben ik in België 'onDuitser' geworden dan ik eigenlijk zou willen toegeven. Maar ik voel steeds meer voor het inruilen van principes tegen pragmatische oplossingen. Ik vrees dat ik toch een beetje een vreemdeling in eigen land ben geworden. Deze column verscheen vandaag in het Belgische dagblad "De Tijd".