Tuesday, December 20, 2011

Faltering but not falling

German Economic Quarterly 1Q12

The debt crisis has finally reached the German economy. Strong fundamentals, however, should prevent the economy from falling off the cliff.

The German economy was one of the last strongholds of the Eurozone in the third quarter. The economy grew by 0.5% QoQ, from 0.3% QoQ in 2Q. Compared with 3Q 2010, the economy grew by 2.6%. Interestingly, growth was much more balanced than expected, with private consumption being the main growth driver. Remarkably, often despised private consumption has actually grown in six out of the last seven quarters. Even if the growth performance is still dwarfed by the impressive export sector, private consumption has almost unnoticed become an important growth driver of the German economy.

With the latest stage of the Eurozone debt crisis and fiscal problems in France and Italy, two important German trading partners, concerns about the strength of the German economy have increased. The strong third quarter defied these concerns for the time being but the continued drop of confidence indicators has not been boding well for the future. Again, looking ahead, the one-million-dollar question is whether the last stronghold of the Eurozone will also give in, eventually pushing the entire Eurozone into a recession?

Without any doubt, the German economy is cooling off. And indeed, there are at least three major risks for the German economy in the coming months. Obviously, the Eurozone debt crisis comes in at top of potential risks. With bigger trading partners having to engage in austerity measures, external demand looks set to weaken. Don?t forget that France is Germany?s single most important trading partner, accounting for roughly 10% of all German exports. Second, a further drop in sentiment, particularly by just recently awakened consumers, could lead to a significant loss of momentum. With external demand weakening, stable domestic demand will be crucial. Finally, bank recapitalisations and restructurings could lead to a credit crunch in the coming months. According to the last bank stress tests, the two biggest German banks, Deutsche Bank and Commerzbank, have to raise more capital than previously estimated. In total, German banks will have to raise 13bn euro, instead of 5bn euro to raise their Tier1 capital ratios to the required 9% by next year.

However, even at the risk of sounding like a lay preacher, repeating the same old story over and over again, the fundamentals of the German economy are still sound and while there are three major risks, there are at least six arguments in favour of strong fundamentals: i) the absolute levels of most confidence indicators are still above recessionary levels and some indicators even rebounded recently; ii) a further stabilization of the US economy could at least to some extent offset weakening Eurozone demand as the US, not China, was the most dynamic export destination for German manufacturers since the beginning of the year; iii) latest lending data do not confirm any credit crunch concerns, yet. In fact, credit to the private sector has actually increased over the last couple of months; iv) German companies are benefitting from low interest rates as the high dispersion of bond yields across the Eurozone is also reflected in bank interest rates; v) the strong labour market is supporting domestic demand and the lack of qualified workers should prevent unemployment from rising, even if growth was to deteriorate more than expected; vi) finally, the high backlogs of companies and low inventories put a strong safety net under the economy.

If all else fails, the German economy still has fiscal stimulus as the final trump card to cushion a worse-than-expected slowdown. At least as regards fiscal balances, the German government has become a model student of the Eurozone class. Strong economic growth of the last two years has created significant revenue windfalls, lowering the fiscal deficit to around 1.5% this year and close to 1% next year. Moreover, German public finances are also benefitting from the sovereign debt crisis. The safe-haven effect on German government bonds has provided a net profit of around 9bn euro to the German government.

Interestingly, in cyclically-adjusted terms, Germany will be close to fulfilling the new European debt-break rules in the next two years. Against this background of a favourable fiscal outlook, the German government agreed on a tax relief of around 8bn euro (0.3% of GDP) for 2013. Obviously, there would be room for more, particularly given the fact that the next federal elections will be held in late-2013.

At the end of 2011, the German economy is finally feeling the strong headwind from the Eurozone debt crisis. The German export-dependence is again showing its ugly face. It would need an unexpected consumption or production boom in the last two months of the year to prevent negative growth in the fourth quarter. In fact, the impressive growth rally with ten consecutive quarters with strong GDP growth has come to an abrupt end. At the current juncture, however, German fundamentals look too sound to fear a spreading of weak exports into other sectors of the German economy. Contrary to 2008, the economy should not fall off a cliff but rather re-emerge after a soft patch. The length of the soft patch will to a large extent be determined by the management of the debt crisis. The German economy should remain the stronghold of the Eurozone. It is faltering, but not falling.

Thursday, December 8, 2011

ECB meeting - Lender of last resort, but not for governments

The ECB cut interest rates by 25bp, lowering the refi rate to 1.0%. Within a month time, the new ECB president Mario Draghi has eradicated the hotly contested rate hikes of his predecessor. Ironic enough, the rate reversal was not the most sensational decision of today’s ECB meeting. With additional non-standard measures, the ECB took another unprecedented strike to tackle tensions in the money market.

The rate cut was motivated by a further worsening the economic outlook. As a tribute to the latest slowdown of confidence indicators and economic activity, the ECB considers risks to the economic outlook to be substantially to the downside. This downside risk is reflected in a significant downward revision of the ECB staff projections for GDP growth. For 2012, GDP growth is expected to come in at 0.3%, from 1.3% in September. For 2013, GDP growth is expected to pick up again to 1.3%.

On inflation, the ECB today sent a somewhat confusing message. As in November, the ECB still expects headline inflation to drop below 2% in the course of next year. However, the ECB staff projections were revised upwards to 2.0% for 2012, from 1.7% in September, and 1.5% in 2013. According to the ECB risks to price stability balanced. This was also reflected in Draghi’s comment that there was currently no risk of deflation.

The rate cut was one thing, liquidity measures were another thing. The ECB took another unprecedented attempt to tackle money market tensions. In more detail, the ECB presented five more measures: i) two 36-months LTROs at full allotment, with the first operation being allotted on 21 December 2011; ii) a reduction of the rating threshold for certain asset-backed securities (ABS) from AAA to A for ABS comprising residential mortgages and loans to SMEs; iii) national central banks will be allowed to accept as collateral additional performing credit claims (namely bank loans) that satisfy specific eligibility criteria; iv) reduction of the reserve ratio from 2% to 1%; and v) a temporary discontinuation of fine-tuning operations carried out on the last day of each maintenance period. Overall, the ECB tries almost everything it can to prevent a credit crunch in the Eurozone.

Prior to today’s ECB meeting, the optimal sequencing of the Eurozone’s final Grand Bargain was a rate cut and more liquidity measures from the ECB today, a ‘fiscal compact’ from political leaders with a clear roadmap towards more political integration and a fiscal union tomorrow and a clear signal from the ECB to do more after the EU summit. At today’s meeting, ECB president Draghi put a stick into the spokes of the Grand Bargain’s wheel. While Draghi had opened the door for more ECB support last week, he closed it again today. According to Draghi, it was up to politicians to solve the debt crisis. The ECB would not respond to a fiscal compact and would not increase its bond purchasing programme. Whether this clear-cut statement was for real and only part of the ECB’s poker game, only the coming days can tell.

All in all, the ECB delivered all it could without crossing the line of Germanic rules of central banking. The last trump card remains up the ECB’s sleeve. For the time being, the ECB does everything to be the lender of last resort for the economy and the financial sector but not for governments.

Wednesday, December 7, 2011

Under pressure

Onder druk kan veel gebeuren. David Bowie en Queen hebben er 30 jaar geleden al over gezongen. Onder druk gaan mensen op straat. Onder druk vallen gezinnen uit elkaar. Het lijkt dat 'Under Pressure' een van de meest gedraaide platen is in de werkkamer van de Duitse bondskanselier Angela Merkel.

De kritiek op de aarzelende houding van de Duitsers in de eurocrisis neemt toe. Te weinig en te laat, luidt het terugkerende verwijt. Het gebrek aan daadkracht van Merkel, ook bekend als 'Frau Nein' of 'Frau Klein-Klein', heeft de eurocrisis alleen maar verergerd. Ja, de crisis is erger geworden door het getreuzel, maar was er een alternatief? De grote, maar onbeantwoordbare vraag luidt of de Europese probleemlanden bij een sneller ingrijpen van Duitsland ook sneller de noodzakelijke bezuinigingen en hervormingen zouden hebben doorgevoerd.

Zou de Franse president Nicolas Sarkozy zonder druk van de financiële markten en van een zwakke Franse economie deze week ook hebben ingestemd met de Duitse plannen? Waarschijnlijk niet. Zonder druk hadden Merkel en Sarkozy deze week niet uitgepakt met een grondwettelijke schuldenrem en automatische sancties. Wie nog twijfels had over de leiderschaps- kwaliteiten van Angela kan gerustgesteld zijn. Een jaar geleden moest Merkel op de kwestie van de automatische sancties nog toegeven aan Sarkozy en werd ze door haar Europese collega's met haar Euro Plus-plannen wandelen gestuurd. Nu krijgt Merkel eigenlijk alles wat ze al vanaf het begin wilde. Het leek afgelopen maandag tijdens de persconferentie in het Parijse Elysée eventjes alsof Merkel stilletjes 'Under pressure' ging zingen.

De druk komt niet alleen van de Duitsers. Druk kwam er deze week ook nog van de Amerikaanse kredietbeoordelaar Standard & Poor's. Natuurlijk kunnen we opnieuw klagen dat alles een Amerikaans complot is en dat de timing van S&P verdacht is. Maar verdacht of niet, S&P's dreigement om de AAA-status van de eurozone te verlagen is een pijnlijke waarschuwing dat ook de beste jongetjes van de Europese klas in de problemen kunnen komen. S&P verhoogt niet alleen de druk op de regeringsleiders om meer te bezuinigen, maar toont ook dat het Europese noodfonds EFSF een te fragiele constructie is. Want als landen als Frankrijk en Duitsland hun AAA-status verliezen, verliest ook het EFSF zijn hoogste kredietwaardigheidsscore en worden de leningen voor de landen in nood duurder. De politicus die dacht dat het noodfonds het ultieme vangnet zijn kon, moet nu beter weten.

David Bowie en Queen willen de liefde een kans geven om de wereld te veranderen. Dat zal helaas niet volstaan om de euro deze week te redden. Natuurlijk kost het enige moeite om kanselier Angela Merkel en president Nicolas Sarkozy als opvolgers van David Bowie en Freddy Mercury te zien. Maar als de komende dagen en uren goed aflopen, zal de eurozone net dankzij de enorme druk overeind zijn gebleven. Dan kan Angela Merkel thuis tevreden naar haar favoriete plaat luisteren.

Deze column verscheen vandaag in het Belgische dagblad De Tijd

Tuesday, December 6, 2011

German IP rebounds in October

German industrial production increased by 0.8% MoM in October, from a 2.8% drop in September. On the year, industrial production is up by more than 4%. The increase was mainly driven by the production of capital goods and durable consumer goods.

The fourth quarter started on a positive note for the entire German economy. New orders surged, the Ifo index rebounded, retail sales increased and now industrial production is picking up again. Nevertheless, even if today’s numbers are good news, they are still too weak to exclude negative growth in the fourth quarter.

Of course, it is too early to give the all-clear but latest developments indicate that the weakening of the German economy in August and September was not the prelude to a gloom-and-doom scenario. The current growth episode increasingly looks like a soft patch, not a recession.

Monday, December 5, 2011

Merkozy take headstart in week of truth

At their preparatory meeting, German chancellor Merkel and French president Sarkozy just announced their common position for this week’s EU summit. No written statement was issued but during a press conference, the Eurozone’s leading political couple, also known as Merkozy pushed for far-reaching Treaty changes.

The main elements of the German-French plan to save the monetary union are automatic sanctions for deficit violators, an earlier start of the European Stability Mechanism (a kind of European IMF, the Eurozone’s permanent crisis resolution mechanism), a balanced-budget rule implemented in all national constitutions and monthly Eurozone meetings at the heads of state level. The European Constitutional Court should investigate whether national balanced-budget rules can be implemented. More generally, sanctions should – if needed – be enforced by the European Court. In addition, a single European country should not be able to block decisions on bail-outs under the framework of the ESM. On regards the issue of Eurobonds, Merkel and Sarkozy reiterated the well known “no”.

The new rules of the game should be applied to all European countries. However, as Merkel said, if need be, the Eurozone countries should go along alone, irrespective of non-Eurozone countries.

At first glance, today’s plans should give the Eurozone a clear headstart in maybe the final week of truth. Now, the big challenge will be to put everything on paper and to convince the European partners. Not an easy one but if Merkozy really want to deliver a ‘fiscal compact’ on Friday, they will have to put their money where their mouth is.

Wednesday, November 30, 2011

Compulsory exercise

Eurozone finance ministers’ agreement on the leverage options for the EFSF did
not bring any surprises. The work is not over, yet.

Eurozone finance minister did what they had to do. Yesterday evening, finance ministers approved the next installment of the Greek bailout loan (8bn euro). Without that money, Greece would have run out of cash before Christmas. Moreover, ministers agreed on the two leverage options for the EFSF. The exact size of the leverage remains unclear. As EFSF chairman Klaus Regling said yesterday evening, it will depend on the interest of foreign investors.

Two options will be available to achieve the leverage. 1) A credit enhancement to primary sovereign bonds issued by Eurozone countries. This is the so-called sovereign insurance mechanism in which 20 to 30% of a potential loss could be guaranteed by the EFSF. 2) The creation of Co-Investment Funds (CIF) to purchase bonds in the primary and/or secondary market. There would be three separate "tranches" of this CIF: the EFSF would contribute to the private investors could invest in a "participating" tranche, and the IMF could provide funding for the last tranche.

The weaknesses of these two options are well-known. The success of the EFSF leverage
is highly dependent on investors’ appetite. Moreover, only the CIF option could eventually take countries off the market. With the latest increases in government bond yields for most Eurozone countries, even a successful leverage could be too little to calm markets.

With yesterday’s decisions, Eurozone finance ministers did what they had to do. Nothing more and nothing less. They framed out the leverage option as decided at the October summit. However, with yesterday’s decisions, discussions on further ECB involvement have not been hushed. The search for a credible and loaded bazooka will

Friday, November 25, 2011

Frau Nein? No, it is Ms Conditionality

Yesterday’s meeting with Sarkozy and Monti did not change German chancellor Merkel’s mind. She remains opposed to Eurobonds.

Merkozy has turned into M&MS. At yesterday’s regular meeting between French president Sarkozy and German chancellor, new Italian Prime Minister Monti joined the high-level lunch. Unlike before, this entre-nous of the biggest Eurozone countries’ political leaders did not produce any new initiatives. It was a quite prelude to a probably summit- intense month December. After the meeting, chancellor Merkel stressed her opposition to Eurobonds, while the two gentlemen remained politely silent. All three European leaders agreed to give no more comments on the role of the ECB. This does not mean that the ECB will refrain from more bond purchases. It only means that politicians will not ask for it or comment on it.

With Merkel’s or better the German strict “no” against the ECB as a lender of last resort and common Eurobonds, “Frau Nein” or “Madame Non” has staged a comeback. Even if some market participants argued that the disappointing bond auction on Wednesday could lead to German reconsiderations, the German position will not change easily. Why is “Frau Nein” so unbending?

The answer to this question is not only the German obsession with central bank independence, hyperinflation or ruthlessness. The core of the German opposition is a different one: it is all about conditionality. Chancellor Merkel is not willing to open German taxpayers’ pockets without quid pro quo. This is not new. The principle of conditionality has dominated the German crisis management since the beginning of the crisis. In fact, the Eurobond-type bailout packages for Greece, Ireland and Portugal were constructed with a high degree of conditionality. No money without austerity measures and structural reforms. At the current juncture, the German government is afraid that more ECB bond purchases would lead to moral hazard and so reduce the pressure on peripheral countries to reform. Eurobonds would, in the German view, create the same moral hazard problem.

Does the return of “Frau Nein” mean that Eurozone crisis management has again entered a dead end? No, not necessarily. Reading between the lines shows that the German “no” is not a categorical rejection. It is all about the sequence of events and decisions. The German government does not believe in a quick fix of the crisis, only in structural changes. In fact, chancellor Merkel has recently made several pleas for more political integration in the Eurozone. However, it is obvious that the German government first wants to see more political integration before it would give structural access to German money. This explains the German emphasis on Treaty changes.

Recent weeks have shown that chancellor Merkel is in favour of a fiscal union, not a transfer union. If the Eurozone succeeds in agreeing on more political integration with clear consequences for breaching fiscal and economic rules, the German government should eventually give up its resistance to Eurobonds. Maybe recent developments have not marked the return of Frau Nein but rather the emergence of Ms. Conditionality.

Thursday, November 24, 2011

Ifo surprises in November

Last crisis antagonist? Today’s Ifo index illustrates that German crisis resistance is stronger than expected. In November, the Ifo index increased surprisingly to 106.6, from 106.4. While the current assessment remained unchanged from October, expectations rebounded to 97.3, from last month’s 97. Particularly the small increase of the expectations component bodes well for our main scenario that the German economy is not falling off a cliff.

The Ifo increase comes after a longer period of market worries about the strength of the German economy. In fact, with yesterday’s disappointing bond auction, some market participants already welcomed Germany in the debt crisis club. The lack of investor’s appetite for German government bonds was by some market participants even considered as a vote of no confidence against Germany. Time to put things into perspective.

Without any doubt, the German economy is cooling off. Most confidence indicators are pointing southwards. And indeed, there are at least three major risks for the German economy in the coming months. Obviously, the Eurozone debt crisis comes in at top of potential risks. With bigger trading partners having to engage in austerity measures, external demand looks set to weaken. Don’t forget that France is Germany’s single most important trading partner, accounting for roughly 10% of all German exports. Second, a further drop in sentiment, particularly by just recently awakened consumers, could lead to a significant loss of momentum. Finally, bank recapitalisations and restructurings could lead to a credit crunch in the coming months.

However, on a more positive note, even after yesterday’s bond auction, absolute rate levels are historically low, the absolute levels of most confidence indicators is still above recessionary levels, a further stabilization of the US economy could at least to some extent offset weakening Eurozone demand and latest lending data show do not confirm any credit crunch concerns, yet. In fact, credit to the private sector has actually increased over the last couple of months. Moreover, German companies are benefitting from low interest rates as the high dispersion of bond yields across the Eurozone is also reflected in bank interest rates. Finally, with the strong labour market and high backlogs for companies, economic fundamentals still put a strong safety net under the economy.

The debt crisis has sent the Eurozone economy into recessionary territories. The German economy will not be able to escape these general recessionary tendencies. However, today’s Ifo index shows that if policymakers get a grip on the crisis management, Germany could get off more lightly than most other countries. Thanks to sound fundamentals, any growth slowdown in Germany should feel like a soft patch, rather than recession.

Last golden memories?

Golden memories. Today’s second estimate of German 3Q GDP growth confirmed an excellent growth performance. The German economy grew by 0.5% QoQ, from 0.3% QoQ in 2Q. Compared with 3Q 2010, the economy grew by 2.6%. Today’s release also presented the growth decomposition, showing that the recovery is more balance than many people think. Third quarter growth was broadly balanced. In fact, private consumption was the main growth driver with a significant rebound of 0.8% QoQ. Net exports, government expenditures and investment also contributed to growth. Only the construction sector disappointed. However, there was one warning signal: the first inventory correction for more than a year, reflecting weakening new orders.

With the latest drop in confidence indicators and fiscal problems in France and Italy, two important German trading partners, concerns about the strength of the German economy have increased. Yesterday’s disappointing bond action added to these concerns. Nevertheless, the German economy should not fall off a cliff as it did in 2008. The economic fundamentals are solid and the combination of low inventories and high backlogs should put a safety net under the economy.

Despite all recent recession fears, today’s numbers should not mark the end of an almost golden period for the German economy. The economy should re-emerge after a soft patch. The length of the soft patch will to a large extent be determined by the management of the debt crisis. Let’s hope that today’s golden memories are sufficient to bridge the dire straits.

Monday, November 21, 2011

Eurobonds - next try

The European Commission looks determined to come up with a next attempt for a common Eurobond. It is still a long shot and will not alleviate the ECB any time soon, but it could play an important role on the road towards more integration.

Back again. According to media reports and leaked documents, the European Commission will present a so-called Green Paper on common Eurobonds on Wednesday. A Green Paper proposal will be followed by public consultations with relevant stakeholders and interested parties. This means, it is not a proposal that can be quickly adopted by Eurozone Member States.

Judging from the draft document, the European Commission has become more pragmatic and realistic, pointing to preconditions that have to be met before engaging in the now so-called Stability Bonds. According to the Commission, “additional safeguards to assure public finances would be warranted”. This could go beyond the recently adopted six-pack, with new rules on budgetary discipline and economic competitiveness.

The European Commission has come up with three proposals for a Stability Bond. Two options would carry “joint and several” guarantees, making Eurozone countries responsible for other countries’ debt. While option 1 foresees a full substitution of Stability Bond issuance for national issuance and would in fact deliver a fully-fledged single bond market (with the biggest moral hazard risk), option 2 only envisages a partial replacement of national bonds. The partial replacement in option 2 follows the well-known red-blue proposal, splitting the bond market into a Stability Bond market and a national bond market. A third option would be for the partial replacement of national government bonds with euro bonds carrying ”several” but not joint guarantees. In this approach, Stability Bonds would be underpinned by pro-rata guarantees of Eurozone countries and countries would retain liability for their respective share of Stability Bond issuances as well as for their national issuances. For all three options, no numerical ceilings have been proposed, yet.

Eurobond proposals have been presented more often over the last decade. Chances to actually get them have probably never been higher than currently. The biggest opponent of Eurobonds, Germany, is gradually changing its stance. In a reaction to yesterday’s reports, the German government did not come with its categorical rejection but with a milder “we will look into it”. In addition, the German council of economic advisers also endorsed a plan for a common Eurobond a couple of weeks ago. However, it was a Eurobond proposal for the “fiscally challenged” countries. In the German proposal, countries with government debt over 60% of GDP will be able to jointly finance the debt exceeding this level via a so-called European Redemption Fund. Joining the fund would require acceptance of certain automatic tax and spending restrictions and would require the country to put down 20% of its borrowing in gold or foreign exchange collateral.

The discussion has gained new momentum. Even if this time around chances for a successful Eurobond project are higher than with past attempts, it is still a long way to go and no quick fix for the current crisis. It is hard to see that the latest proposals can alleviate the ECB. Nevertheless, the latest Eurobond proposals have brought some new ideas as they clearly combine the lender of last resort function with anti-moral hazard measures. With such a construction, a common Eurobond could play an important and facilitating role on the way towards more political integration within the Eurozone.

Monday, November 14, 2011

Last sign of crisis resistance – German GDP grew 0.5 in 3Q

The last sign of crisis resistance. According to the first estimate of the German statistical agency, the Eurozone’s largest economy enjoyed an impressive comeback in the third quarter, growing by 0.5% QoQ. At the same time, 2Q growth was revised upwards to 0.3% QoQ, from 0.1% QoQ. Compared with 3Q10, the German economy grew by 2.6%. GDP details will only be published with the second estimate, but available monthly indicators point to widely spread growth in the third quarter. The months July and August were simply too strong to have disappointing September numbers spoil the growth party.

With today’s numbers, an annual growth rate of 3% for the entire year 2011 is still possible. Of course, third quarter numbers come after an exceptionally weak second quarter, in which the shutdown of eight nuclear power plants had probably shaved off some 0.3 percentage points from the quarterly growth rate. Nevertheless, even if strong 3Q growth is partly driven by a technical rebound, it also reflects the solid fundamentals of the German economy.

Looking ahead, sentiment indicators point to a significant growth slowdown, a contraction of the economy towards the end of the year is possible. The reason for this slowdown is the sovereign debt crisis. For a long while, the German economy has been one of the few beneficiaries of the sovereign debt crisis. A weaker euro, very accommodative monetary policy and low funding costs have contributed to strong and solid economic growth. With the latest stage of the debt crisis and France and Italy seemingly drowning in the maelstrom of the debt crisis, the German economy has lost its immunity. Austerity measures in France and Italy will also hurt German exporters.

Nevertheless, the German should not fall off a cliff as it did in 2008. The economic fundamentals are solid and the combination of low inventories and high backlogs should put a safety net under the economy. Moreover, there is a final trump card. Flight-to-quality in bond markets is still spoiling the German government with unexpected revenues. According to our own estimates, this flight-to-quality impact on German yields enabled the German government to save almost 9bn euro on its bond issuances of these two years. Interestingly, this is already more than the recently announced tax relief for 2013 and 2014.

With today’s numbers, the German economy has returned as the economic powerhouse of the Eurozone. Even if in the current circumstances skeptics could be tempted to call it one-eyed among the blind. Either way, one thing is clear: with the latest stage of the sovereign debt crisis, today’s numbers are as good as it gets for the German economy. At least for a short while.

ECB remains involuntary fire brigade in euro crisis

Thread packing? The ECB continues its role of euro crisis fire brigade but only at half speed. According to its latest press statement, the ECB purchased government bonds for 4.5bn euro last week, down from 9.5bn euro one week earlier. This brings the total amount of purchased bonds since May 2010 to 187bn euro.

The ECB remains stuck in a catch-22 situation. As long as the official ECB stance gives the impression that the SMP is only implemented half-heartedly, the ECB might end up buying more bonds than if it would come out with a numerical target or fully-fledged commitment. However, an end to this catch-22 is not in sight. First of all, resistance from core Eurozone central banks, above all the Bundesbank, against the bond purchases is rather increasing than decreasing. Today, Bundesbank president Weidmann reiterated his criticism of the bond purchases and called the German public an ally of the Bundesbank. Moreover, even if theoretically, the ECB’s role as an unconditional lender of last resort for the Eurozone makes sense, it can only work if the economic governance is right. An unconditional lender of last resort would need a strong fiscal counterpart at the Eurozone level to ensure conditionality and to avoid moral hazard. The ECB is simply not a political institution that can enforce conditionality on member states.

Despite last week’s slowdown of bond purchases, the controversial debate on the ECB’s SMP will continue. The Eurozone is still in need of an unconditional lender of last resort. A possible short-term fix to take the burden off the ECB’s shoulders could be the European Stability Mechanism (ESM). With a credit line at the ECB, the ESM could impose conditionality on member states and would at the same time have the ECB’s fire power. However, any steps in this direction still need time. For the time being, the ECB remains the involuntary fire brigade of the Eurozone.

Saturday, November 12, 2011

De Kapla-blokken van de Eurozone

Ooit waren de Kapla-blokken een van de favoriete spelletjes van mijn kinderen. Met veel geduld en fantasie probeerden we bekende en onbekende constructies en gebouwen op te trekken, maar het leukste was de stabiliteitstest. Hoeveel blokken kunnen eruit zonder dat de constructie instort? Onlangs hebben we de blokken weer uit de kast gehaald. Ons nieuw Kapla-project heet de eurozone.

De jongste politieke ontwikkelingen in Italië en Griekenland hebben de markten opnieuw een sprankel hoop gegeven dat de eurozone toch een stabiel project kan worden. Maar let op, de kater na het feest komt bijna zeker. Griekenland moet nog steeds een hele lange adem hebben en ook met ex-ECB'er Lucas Papademos als premier wordt de schuld niet automatisch houdbaarder. En Italië moet eerst bewijzen dat het doortastender is zonder Silvio Berlusconi. Na een referendum dat er nooit een was, een dreigement dat slechts bluf bleek en het einde van het tijdperk van de crisispremiers, is de belangrijkste conclusie dat de spelregels veranderd zijn. Niet Frau Merkel, het Duitse grondwettelijk hof of het Duitse parlement beslissen over de toekomst van de eurozone, wel de Zuid-Europese, ontvangende, landen. Als de bereidheid om te bezuinigen en structurele hervormingen door te voeren een luchtspiegeling blijkt, kan Frau Merkel trapezeacts uitvoeren, maar zonder succes. 22 jaar na de val van de Berlijnse muur, krijgt 'wir sind das Volk' een nieuwe betekenis.

De eurozone heeft de afgelopen maanden veel nieuwe instrumenten voor de crisisbestrijding ontwikkeld. Toch is er geen instrument of middel om onwillige landen bezuinigingen op te leggen. Niemand kan voorkomen dat een land ervoor kiest volledig failliet te gaan in de eurozone. Waarom uit de eurozone, als het binnen toch veel warmer is met toegang tot het ECB-geld en de interne markt? Er is geen juridische mogelijkheid om een land aan de deur te zetten. Daarom was het dreigement van Merkel en Sarkozy grote bluf. Bij de Grieken heeft de bluf gewerkt, maar op een gegeven moment prikt een land daar doorheen. En wat dan?

De toestand van de eurozone blijft angstaanjagend fragiel. De eurozone lijkt zo steeds meer op de Kapla-torens van mijn kinderen. Waarschijnlijk blijft alleen nog de vlucht naar voren. De vlucht naar een politieke unie, met de exit uit de monetaire unie als ultieme straf en een wettelijke onvoorwaardelijke 'lender of last resort' in Frankfurt. Als dat niet lukt, blijft de toren uiterst wankel en wordt het aftellen naar wie het volgende blok eruit mag halen. En sinds deze week weten ook de landen uit de periferie van de eurozone dat ze aan de blokken mogen trekken.

Dit stuk verscheen vandaag in het Belgische dagblad De Tijd

Friday, November 4, 2011

German new orders disappoint

CGerman new orders dropped unexpectedly sharp by 4.3% MoM in September, from a 1.4% drop in August. It was the third consecutive monthly drop. On the year, new orders are only up by 2.4%. The drop was driven by both domestic and foreign demand, with demand from other Eurozone countries falling by a shocking 12.1% MoM. Looking at the different sectors, only demand for German consumer goods increased.

Today’s drop in German new orders completes a week of yet another rollercoaster ride in the Eurozone. The financial turmoil and the economic slowdown in other Eurozone countries have obviously spoiled the appetite for goods “made in Germany”. For the time being, the safety net for the German industry of high backlogs and low inventories is still holding but today’s numbers make it thinner. The German industry has finally caught the crisis virus.

Thursday, November 3, 2011

Super Mario jumps ahead of the curve

What a starter. Today, the ECB cut interest rates by 25 basis points to 1.25%. The worsened economic situation and the prospect of a mild recession were the main drivers of the ECB’s decision. Following the well-established tradition of his successor Jean-Claude Trichet, new ECB president Mario Draghi did not give any hints on further rate changes. The never-precommitment phrase is still around.

The biggest change in the ECB’s macro economic assessment was in the economic analysis. According to the ECB, there were signs “that previously identified downside risks have been materialising”. With a weakening of domestic and external demand and a worsening of hard and soft data, the ECB is now expecting a mild recession towards the end of the year.

Of course, the ECB’s main objective is to maintain price stability and not to support economic growth but at the current juncture, growth seems to be the main concern and inflation is considered to be a second-round effect. According to the ECB, the weaker economic prospects have reduced inflationary risks. For the first time in a long while, the ECB talked about inflation rates returning to levels below 2%. Nevertheless, at least after today’s cut, the ECB still (or again) considers the risks to the medium-term outlook for price developments as broadly balanced. All in all, there was probably no single event which triggered today’s rate cut. It looks as if the ECB already considered a rate cut last month and just needed more evidence of a weakening economy to walk the walk.

Of course, there is no ECB press conference without questions on the sovereign debt crisis. Asked to comment on recent developments in Greece and the Eurozone reply, Draghi said it was hard to comment on such a fast evolving situation. Moreover, Draghi recalled the European Treaties which do not provide for an exit from the monetary union.

Interestingly, Draghi drew a more distinct line between monetary policy and the sovereign debt crisis than his predecessor Trichet had done in the past. While Trichet sometimes had given rise to speculation that the ECB could beef up its bond purchasing programme, Draghi was more explicit in pointing to the limits of the programme. According to Draghi, the ECB’s bond purchasing programme followed three principles: it was temporary, limited and purely justified by the monetary transmission mechanism. He also remarked that the main responsibility was with national governments, not with any kind of external support. In Draghi’s view, it was also impossible to keep bond yields artificially low for a sustained period. Bottom line is that the ECB is not eager to take over the role of unconditional lender of last resort any time soon.

All in all, new ECB president Mario Draghi was not thrown in at the deep end but rather jumped with a lot of verve. The ECB has a new communication style but no new monetary policy strategy. It is obvious that the ECB has caught the crisis virus and is trying everything it can to prevent a full-fledged recession.

Saturday, October 29, 2011

Letter from Brussels – Brüsseler Zwei-Klassengesellschaft

Dieser Letter from Brussels erschien heute in der Euro am Sonntag.

Auch wenn es in Brüssel immer noch Idealisten gibt, die vom einheitlichen Europa träumen, haben die Gipfel der letzten Tage genau das Gegenteil deutlich gemacht. Jenseits von Hebeln, Banken, Schuldenschnitten und Milliarden hat sich nämlich noch etwas ganz anderes gezeigt: Europa wird zur Zwei-Klassengesellschaft.

Nein, nicht die Zwei-Klassengesellschaft zwischen Arm und Reich und auch nicht die Zwei-Klassengesellschaft zwischen Nord und Süd. Europa ist auf dem besten Weg zu einer Zwei-Klassengesellschaft mit Euro- und Nicht-Euroländern.

Die Zwei-Klassengesellschaft zeigt sich in kleinen Dingen wie offiziellen Abendessen des exklusiven Euroklubs, aber auch in großen Dingen, so wie den mit offenem Visier ausgetragenen Streit zwischen dem britischen Premier Cameron und dem französischen Präsidenten Sarkozy. Beim Gipfel letzter Woche hatte der französische Präsident den britischen Premier Cameron mit wenig französischem Charme höflichst aufgefordert, zur Euro-krise doch einfach mal die Klappe zu halten.

Ist es nun schlimm, dass kleine Länder wie die Slowakei oder Estland mehr zur Eurokrise zu sagen haben als Großbritannien? Nicht wirklich. Eine wichtige Lehre aus der jetzigen Krise ist, dass eine Währungsunion ohne politische Union über kurz oder lang zum Scheitern verurteilt ist. Der einzige Weg ist also die Flucht nach vorne zu mehr politische Integration. Mittlerweile haben die meisten Euroländer das verstanden. Großbritannien jedoch nicht. Ob zu den Regeln vom Stabilitätspakt, zur Finanzregulierung oder jetzt dem Rettungsfonds, Großbritannien hat seit dem Beginn der Währungsunion, milde gesagt, mehr Zusammenarbeit eher sabotiert als stimuliert.

Wie war das noch? Mittendrin statt nur dabei. Wenn man in den nächsten Jahren Europamitgestalten will, muss man im Euroclub sein. Wer draußen bleibt soll sich nicht beschweren und einfach mal die Klappe halten.

Monday, October 24, 2011

Eurozone: We'll be right back...

The super duper master plan is not ready, yet. Eurozone leaders took some steps
but spanners are still in the works.

The first three-day session of Eurozone and European leaders and finance ministers has not yet delivered the big, ultimate, super duper master plan. To be honest, this had almost been expected. Except for uplifting comments, no new facts or conclusions were presented. However, on a more positive note, reading between the lines, listening carefully to press conferences and assessing wire reports, the meetings seem to have delivered some more details of how the plan could look like. The four elements are still the same: a second Greek bailout package including a higher private sector involvement, bank recapitalization, EFSF leverage and more economic governance. Even if politicians tried to be uplifting, there are still some important unsolved issues.

As regards the second Greek bailout package, leaked reports from the Troika suggest
that a second Greek bailout package would require more than 252bn euro to finance
Greece until 2020, instead of the 109bn euro mentioned in July. According to the leaked documents, the 109bn euro package would only be sufficient if private sector bond holders would accept a haircut of 60%. Whether Eurozone politicians can achieve such participations on a purely voluntary basis is unclear.

As regards bank recapitalization, the new ballpark number is 100bn euro. Apparently,
troubled financial institutions must first attempt to raise fresh cash from markets. If unable to do so, national governments will then have to provide back-stops. Only if governments are too weak to be able to perform this task, the EFSF could step in. However, no final agreement has been reached, yet.

As regards leverage for the EFSF, this still seems to be the biggest unfinished
construction site. According to German Chancellor Merkel, leverage through the ECB is
not an option (anymore). It looks as if two options based on the German sovereign
insurance mechanism are currently discussed. One is the original German proposal
through the EFSF and another one could bring the IMF on board, using a special purpose vehicle.

As regards economic governance, this remains a long shot. European leaders officially
backed a "limited treaty change" that will involve tightening fiscal discipline and
deepening economic union. A new fiscal discipline 'super-commissioner' for the Eurozone will be created, although it remains unclear whether this could be done without Treaty changes. Let’s not forget, Treaty changes will have to be agreed by all 27 countries and not only the Eurozone countries.

It did not come as a real surprise: this weekend’s series of Eurozone summits and
meetings did not deliver concrete results. However, the contours of the big master plan have once again become a bit clearer. In a way, it is like in the good old US television cartoons: don’t go away, we’ll be right back after these messages. See you again on Wednesday.

Friday, October 21, 2011

Ifo slows in October

And now for something completely different…While currently all eyes are on Sunday’s Eurozone summit, or better: an entire series of summits, there actually still is an economy to watch. Today’s Ifo index shows that at least the German economy is slowing, without falling off the cliff. In October, the Ifo index dropped to 106.4, from 107.5 in September. This is the lowest reading since June 2010, but still far above its historical average. The drop was almost equally driven by weaker current assessment and some further downward correction of expectations. The positive take is that the drop in expectations of latest months has slowed down.

Recent developments in financial markets and confidence indicators have brought back the bad memories of 2008 when the German economy fell into a deep black hole. Could Greece 2011 be the same as Lehman 2008? In our view, despite all similarities with 2008, there are currently important differences: orders at hand are much higher than in 2008 and inventories are much lower. While the Lehman crash hit German industry at a moment of overproduction, companies currently still have their hands full reducing the high order backlog. This time around, German companies look much better prepared to face a Lehman-type crisis. In addition, low interest rates, positive investment plans and the strong labour market should also cushion an eventual slowdown in the coming months.

For a long while, the Eurozone’s economic Superman looked invulnerable. However, with Italy and France starting to falter, Germany is now finally feeling the pain of the sovereign debt crisis. Fortunately, this is not 2008 and the economy should not collapse. Economic fundamentals are simply too sound. However, the Eurozone’s economic Superman may have finally met its kryptonite.

Thursday, October 20, 2011

Eurozone summit on Sunday

When Eurozone leaders meet on Sunday to (once again) solve the Eurozone crisis, expectations are high. Can Eurozone leaders deliver?

It is again the week of all weeks, the summit of all summits. It is again crunch time in Brussels on Sunday. Eurozone leaders will meet to present a new crisis resolution package. The framework of the anti-crisis package has become clearer in recent weeks. It is likely to consist of the following elements: bank recapitalisation, further Greek debt restructuring, leverage for the EFSF and new economic governance. However, as so often is the case, the devil is in the details – and it will be in each of these four elements.

The issue of bank recapitalisation has become the new buzz word of the euro rescuers. Bank recapitalisation should help to cushion the negative impact from a possible Greek debt restructuring and possible contagion. However, it is doubtful whether Eurozone leaders can come up with a detailed plan on Sunday, presenting single banks and required capital needs. The most likely outcome, in our view, is a rather general agreement on higher Tier 1 capital ratios (around 8% or 9%) with a timetable on how and when to increase capital.

A further Greek debt restructuring looks like the most tangible result from Sunday’s summit. A renegotiation of the July agreement could see an increase of the so-called voluntary private sector involvement from 21% to around 40%. Higher numbers were circulating initially but have become less likely. Nevertheless, even with a higher private sector involvement, Greece debt would not, yet, return to a sustainable path and Greece would still have a high fiscal deficit. Consequently, more debt restructuring or debt forgiveness is likely further down the road.

Leverage for the EFSF should have the biggest impact on financial market reactions to the Sunday package. The lack of an unconditional lender of last resort in the Eurozone is the biggest shortcoming of the current set-up of the monetary union. There is a growing awareness amongst Eurozone policymakers that even the just recently beefed-up EFSF is too small to fulfill such a role. The EFSF is still only a manual spray gun and not a big bazooka. Simply increasing the size of the EFSF by more state guarantees, however, is hardly possible in the current situation. More Eurozone countries could lose their AAA-ratings upon higher guarantees, thereby toppling the entire EFSF construction. Leveraging the EFSF could be an alternative but this is easier said than done. The currently favoured option by at least the German government is a so-called sovereign insurance mechanism. Eurozone countries could insure newly issued bonds at the EFSF against a loss of x-percent (probably 20%). This could make peripheral bonds more attractive but it still does not address the problem that there is not enough money to eventually bail-out Spain and Italy. Only if the bond insurance could bring peripheral yields down to the same level as EFSF loans and this is unlikely.

The final element of Sunday’s master plan should be a commitment to more political integration and stricter and more centralized economic governance. However, this takes time and requires Treaty changes – something the Sunday summit cannot deliver.

French president Sarkozy raised the bar for Sunday’s Eurozone summit to an impossible height. The current crisis is simply too complex and there are too many devils in the details to come up with a final, all-encompassing package with not a single question left unchanged on Sunday. However, even without the super-duper master plan, Sunday’s summit could bring new steps in the right direction.

Tuesday, February 1, 2011

German labour market remains strong

German unemployment increased by a non-seasonally adjusted 331,300 in January. In seasonally-adjusted terms, however, unemployment dropped to the lowest level since reunification, bringing the unemployment rate to 7.4%, from 7.5% in December.

Today’s numbers confirm the strength of the German labour market. Looking ahead, the good-news-show will continue. Recruitment plans are still improving and recently reached another record high. Moreover, the official index of vacancies increased again in January and is approaching its peak of the last business cycle. Strongest demand for labour is coming from temporary employment but also from the service sector, construction and manufacturing. With strong economic fundamentals and the first impact from the demographic change, the unemployment rate could drop below 7% already in the course of this year.

The only stain of the German labour market performance is the strong increase of the low-wage-sector. Total employment excluding the low-wage sector is currently still lower than in early 2003. Moreover, almost 50% of the newly created jobs since mid-2009 are low-wage jobs. In the short run, any employment growth should have a positive impact on private consumption. However, in the medium run, more is needed to substantially boost private consumption. Economic growth will not do the job alone.

Even if ECB policymakers will not like it: a substantial broadening of the German recovery will probably only emerge if and when the often accursed second-round effects of higher wages eventually materialise.

Monday, January 31, 2011

German retail sales drop

No quantum leap for German consumption, yet. This morning's data added to the latest disappointment on German private consumption. German retail sales, seasonally and inflation adjusted, dropped by 0.3% MoM, from -1.9% in November. With only one single month of growth, German retail sales have been on a downward trend since August.

With today's numbers, private consumption can hardly have been a growth driver in the fourth quarter. Nevertheless, despite recent disappointments, private consumption could become the growth surprise of 2011. Particularly wage developments could provide important tail wind. Last year, real negotiated wages only increased by 0.5% YoY. This small increase was probably driven by some fears of future job losses, short-time working schemes and the fact that many collective bargaining rounds were already finalized in 2009 or earlier. This year's collective bargaining will start soon and demands for wage increases range from 5% to 7%.

After today’s numbers it might sound like a whistling in the dark, but with increasing wages, dropping unemployment and pent-up demand, private consumption should become an important growth driver this year

Friday, January 21, 2011

Ifo at new record high

Boldly going where no Ifo has gone before. German business confidence surprised and continued its impressive performance of the last two years, increasing to a new record high. In January, the headline Ifo index increased to a smashing 110.3, from 109.9. While the current assessment weakened somewhat, expectations also hit a new record high.

The heaviest snowfalls in more than 40 years only weighed on companies’ current assessment but not on their optimism. Even if the strong weather winter was to return in the coming months, it would only delay but not stop economic growth. German fundamentals are currently simply too strong to derail the recovery any time soon. The diversified export mix, the labour market and a further strengthening of private consumption should put growth in 2011 on a broad footing. Moreover, Investment plans are back at their 2008-levels when the crisis stopped the recovery from broadening. Now, with interest rates at record-low levels and low credit hurdles (at least according to the latest Ifo surveys), the investment upswing should finally materialise.

Today’s Ifo sends a strong signal that the German economy will continue to power ahead. With a positive interplay between more investment and further job growth, the conditions to initiate a virtuous circle have hardly been better in the last fifteen years.

Thursday, January 13, 2011

Brand bij de brandweer

Tot nu toe was de Europese Centrale Bank de vliegende brandweer van de schuldencrisis van de eurozone. Noodlijdende banken? De ECB geeft ruimhartig bijna onbeperkte liquiditeit. Zwakke overheidsfinanciën? De ECB koopt staatsobligaties. Als er ergens een brand was, stond de ECB klaar om te blussen. Dit jaar kan het voor de Europese brandweer nog lastig worden. Er is namelijk vuur in eigen huis.

De inflatie is terug. In december steeg ze voor het eerst in meer dan twee jaar weer boven de magische grens van 2 procent. En het zal niet de laatste keer zijn. Sterk stijgende energie- en voedselprijzen kunnen de inflatie nog een tijdje boven 2 procent laten zweven. Daarbij komen stijgende inflatieverwachtingen en hogere looneisen in Duitsland. Het wordt moeilijk voor de ECB om haar onconventionele maatregelen te verkopen als deflatiebestrijding.

Natuurlijk volgt de ECB geen mechanisch inflatiebeleid, waarbij de rente automatisch stijgt zodra de inflatie boven 2 procent ligt. Een inflatie boven 2 procent is ook niets nieuws. Sinds 1999 stond de inflatie in de eurozone vaker boven dan onder 2 procent. Niets aan de hand, dus? Niet helemaal, want ook de inflatieverwachtingen lopen op en de loononderhandelingen in Duitsland kunnen de inflatie verder laten stijgen. Voldoende redenen voor hoofdpijn bij sommige centrale bankiers.

Een renteverhoging is nu niet aan de orde. De perifere landen van de eurozone staan er economisch nog veel te slecht voor. Een renteverhoging zou elk klein herstel in de kiem kunnen smoren. Voor de kernlanden van de eurozone is de rente misschien zelfs nu al te laag, maar de ECB zou een hogere inflatie kunnen tolereren als het vooral een hogere Duitse inflatie is. Dat zou deel uitmaken van de zogenaamde 'rebalancing' van de eurozone, met deflatoire trends in de periferie die leiden tot economische herstructureringen en meer export en inflatoire trends in de kernlanden die leiden tot meer consumptie en een verlies aan internationale concurrentiekracht. Maar leg dat eens uit aan een Duitse bevolking behept met het 'anti-inflatiegen'.

Als ook in Duitsland de inflatie boven 2 procent uitkomt (op dit moment staat ze nog op 1,7%), zal het anti-Europese sentiment weer opborrelen. Een stijging van de inflatie kan de laatste vonk zijn om de Duitse steun voor het europroject definitief te laten keren. Ook al lijkt het economisch niet zinvol de rente te verhogen, een symbolische renteverhoging voor de Duitse inflatiehaters in de loop van het jaar moet niet worden uitgesloten. Als het in het huis van de brandweer smeult, moet de brandweer eerst thuis blussen voor ze kan uitrukken om de rest te helpen.

Dit stuk verscheen eerder in het Belgische dagblad "De Tijd"

FIrst hawkish sounds from Frankfurt

The ECB just left interest rates unchanged. While Trichet was rather close-lipped on the sovereign debt crisis and possible new measures by EU leaders in the coming weeks, he sent a slightly more hawkish message on monetary policy. According to the ECB, interest rates remain “still” appropriate, suggesting that this is not self-evident anymore. Inflation will again be top of mind at the ECB in 2011.

The ECB’s macro-economic assessment has taken a shift towards more hawkishness. On growth, this shift was rather marginal and in the eyes of the Governing Council risks to growth are still “slightly” tilted to the downside. On inflation, however, the ECB sent a stronger message of hawkishness. The ECB now sees evidence of “short-term upward pressure on overall inflation, stemming largely from global commodity prices”. The phrase “while this has not so far affected our assessment that price developments will remain in line with price stability over the policy-relevant horizon, very close monitoring of price development is warranted” sends a clear signal that the ECB stands ready to scotch any pass-through of energy and food prices into the economy.

Trichet is not getting tired of repeating and stressing the ECB’s inflation track record. Since the start of the monetary union, average inflation was 1.97%, neatly in line with the ECB definition of price stability. This track record could keel over this year. Food and energy prices are not likely to drop significantly any time soon and if the impact of higher commodity prices in 2007/2008 is of any guidance, headline inflation could easily remain above 2% throughout the year. If headline inflation was to remain at its December-level throughout 2011, Trichet’s most favourite inflation track record would increase to 1.99%.

At the current juncture, a rate increase would still do more harm than good. The Eurozone periphery is economically still too weak to stomach higher rates, the sovereign debt crisis is far from over and a rate hike would not stop commodity prices from increasing. However, for the Eurozone as a whole, the monetary stance is increasingly becoming loose. Up to now, the ECB has been the first line of defense – the fire brigade – of the Eurozone’s sovereign debt crisis management. Low inflation gave the ECB ample room to implement non-standard measures. Today’s meeting clearly indicates that the ECB is reprioritizing and that inflation developments will be top of mind throughout 2011.

It looks as if we do not need to wait for Axel Weber to become ECB president to see a hawkish ECB. The ECB headed by Jean-Claude Trichet can also send hawkish statements. Of course, all will depend on commodity prices and their pass-through but with today’s meeting chances of an earlier rather than later rate hike have increased.