Monday, March 25, 2013

Another Sunday night save

Early this morning, Eurozone finance ministers agreed on a revised bailout plan for Cyprus. The Eurogroup re-offered a €10bn package. Small savers will be saved and the burden of the bailout out will now be carried by a smaller number of bigger depositors and shareholders and senior bondholders of the two largest Cypriot banks.

After another extremely long meeting, preceded by other high-level meetings and endless rumors, Eurozone finance ministers agreed on the fifth bailout since the start of the crisis. After Greece, Ireland, Portugal and Spain, Cyprus will be the next official member of the bailout group. 

One week after the first bailout attempt, Eurozone finance ministers and Cyprus agreed on a new bailout. The size of the bailout remains at €10bn euro. The earlier Cypriot contribution of €5.8bn euro was replaced by a complex upfront restructuring of the Cypriot financial sector. The second attempt leaves deposits of less than 100 000 euro unharmed. Instead, the burden of the bailout will now be carried by a smaller number of bigger depositors and senior bondholders of the two biggest banks of the country. In detail, the Eurogroup and Cyprus agreed on the following:

·       The second-biggest bank of Cyprus, Laiki Bank, will be unwound, with full contribution of equity shareholders and bond holders. Viable assets and insured deposits will be put into a “good bank”; €4.2 billion worth of uninsured deposits would be placed into a “bad bank”, with no certainty that big depositors will get any money back.
·       The remainders of Laiki Bank, the good bank, will be merged with the largest bank of the country, the Bank of Cyprus (BoC). BoC will be recapitalised through a deposit/equity conversion of uninsured deposits with full contribution of equity shareholders and bond holders. How much uninsured depositors will eventually lose due to the restructuring remains unclear. According to wire reports, it could be around 30%.
·       All insured depositors in all banks will be fully protected in accordance with the relevant EU legislation.

A happy ending after all? At least a final agreement has come closer and a disorderly default of Cyprus has, at least for now, been avoided. According to the Eurogroup statement, the ECB would continue allowing ELA for Bank of Cyprus. However, a couple of short-term hurdles still remain: i) Will the Cypriot parliament agree on the deal? Probably it will as big parts of the bank restructurings had already been brought forward at the end of last week. ii) Will national parliaments of other Eurozone countries agree? Currently, the Eurogroup expects a formal green light for the bailout only in the third week of April. Still a long way to go. iii) As for the first time during the crisis, temporary restrictions on the movement of capital have been imposed, the question is when Cypriot banks be able to re-open and what will happen then. As more often during the crisis, a Sunday night save brings instant relief but is no guarantee for calmer waters.

More broadly speaking, the crisis in Cyprus, while (at least temporarily) neutralized after this weekend’s decisions clearly shows that the Eurozone still has not found a uniform model to guarantee financial stability in the future. The idea of a banking union to break the link between indebted sovereigns and weak banking systems is not accepted by the stronger countries when it involves burden sharing (which it sooner or later inevitably will have to do). At least not if the banking sector is suspected to be a money laundering place and/or the result of too much risk. The message is clear: the German-led bloc in the Eurozone pushes ahead with conditional solidarity and conditional integration but not with financial charity. As such, failing banks remain the problem of their home country, even if that cripples government finances for many years. Secondly, deposit guarantee schemes cannot be taken for granted. German finance minister Schäuble pointed out that these schemes are only reliable if a country’s public finances can afford them, again emphasizing the direct link between the sovereign’s and the banks’ solvency. On top of that, the challenge for the coming weeks will be how to get the genie - that a cash strapped sovereign may consider a levy on all deposits - back into the bottle. The exemption of small savers could help. However, as so often, it is much harder to restore confidence than destroying it. A recent survey in Spain indeed revealed that nearly 90% of Spaniards are worried that they might face a Cyprus like levy on deposits, while 62% claimed deposits were not safe in Spain. Finally, the decision to impose capital controls, even though loopholes in the Treaty would allow it, shows that the single financial market is far from being assured. The fragmentation of financial markets might be reinforced by the decisions of the last few days, further complicating the ECB’s job. More unconventional measures might be required to cure this.

The Cyprus bailout has been an unprecedented power struggle in the euro crisis. While Cyprus tried to call the Eurozone’s bluff, the Eurozone, led by Germany, wanted to make an example that the rescuers do not like to be blackmailed. Particularly the German government played hardball, based on the assumption that the consequences of a Cypriot “no” would be much graver for Cyprus than for the rest of the Eurozone. Germany won the bet as Cyprus eventually bended. However, this strategy is not risk-free and will hardly work with bigger countries with a broader economic business model than Cyprus. 

Friday, March 22, 2013

German Ifo drops in March

The month after. After last month’s “wow” effect, Germany’s most prominent leading indicator, the Ifo index, shows some downward correction of too optimistic business expectations. The Ifo index dropped in March to 106.7, from 107.4 in February. Both, the current assessment and the expectation component decreased. While the current assessment component dropped to 109.9, from 110.2, expectations fell to 103.6, from 104.6. Despite today’s drop, the absolute level of all components still points to growth in the first quarter.

The German economy started the New Year on a positive footing. Hard data for January basically sent two messages: i) the economy is recovering from the fourth quarter contraction; and ii) the often called for rebalancing of the German economy is materialising. The January acceleration of private consumption, construction and exports once again showed that the German growth model is more than a pure export-oriented beggar-thy-neighbor model.

Looking ahead, however, a good start is no guarantee for a happy ending. While the fundamentals of the German economy remain sound and financing conditions are very favourable, several factors are currently putting a speed limit on the economy. In the short run, new uncertainties and tensions from the euro crisis, the never-ending fiscal cliff in the US and, last but not least, the weather could dampen the recovery. Disappointing new orders in January were already a first warning. In the longer run, ageing and the lack of new structural reforms are likely to take a toll on the economy.

Over the last couple of months, businesses and consumers shook off typical German scepticism and turned out to be real optimists. The Ifo actually recorded its biggest four-months jump since early 2010. Maybe it is this rage of enthusiasm which is, at least partly, behind the German government’s tough stance in the Cyprus affair. In our view, today’s Ifo rather marks a small downward correction of last month’s enthusiasm than a new downward trend. Nevertheless, today’s drop also indicates that relying too much on the German economy’s invulnerability could be dangerous.

Wednesday, March 20, 2013


In een ver verleden deed ik nog enthousiast aan topsport. Een van de lessen van topsport is dat alles gericht is op het ultieme doel. De belangrijkste wedstrijd van het jaar of soms zelfs van jaren. Als topsporter leer je dan ook minstens twee dingen: één, heb een goed plan en hou eraan vast en twee, laat je niet afleiden door omstandigheden waar je zelf geen greep op hebt, zoals tegenstanders, scheidsrechters of het weer. In sommige Europese landen lijkt die topsportmentaliteit te ontbreken.

Blijkbaar geïnspireerd door de tiende verjaardag van de Duitse Agenda 2010 (het hervormingsplan van voormalig bondskanselier Schröder) afgelopen week, heeft de kritiek op de onwenselijke Duitse ‘loondumping’ een nieuw leven gekregen. De loonmatiging in Duitsland de afgelopen jaren heeft een belangrijke bijdrage geleverd aan het terugwinnen van internationale concurrentiekracht.

Sinds het begin van de Agenda 2010 zijn de lonen in Duitsland per jaar gemiddeld met 1,7 procent gestegen, reëel slecht met 0,1 procent. De grootste inhaalslag werd tussen 2003 en 2008 gedaan, toen de reële lonen met 0,3 procent per jaar daalden. De loonmatiging werd ook bereikt door een uitbreiding van de lagelonensector. Tussen 2003 en 2009 ontstonden nieuwe banen, bijna uitsluitend daar.

Economische groei door loonmatiging? Dit is een zeer kortzichtige kijk op de Duitse economie van de afgelopen jaren. De Agenda 2010 had als doel de arbeidsmarkt flexibeler te maken en het stelsel van sociale zekerheid op een houdbaar pad te krijgen. De belangrijkste pijlers van de hervormingen waren het verminderen van zowel de hoogte als de looptijd van de uitkeringen voor werklozen, de privatisering van de arbeidsbemiddeling en een verlaging van loonbelastingen.

Maar behalve de Agenda 2010 speelden ook andere factoren een belangrijke rol: geluk (de opkomst van de Chinese economie als belangrijke exportmarkt) en privé-initiatieven (herstructureringen en outsourcing in het bedrijfsleven).

Inmiddels is de Duitse economie niet alleen een groeimotor voor Europa, maar is sinds 2010 het aandeel van lagelonenbanen in de economie bijna constant gebleven. Werkgelegenheid ontstaat weer in de ‘normale’ arbeidsmarkt.

Ook het probleem van (te) lage lonen lijkt vanzelf te verdwijnen. Zonder buitenlandse hulp. De reële lonen stegen het afgelopen jaar met bijna 1 procent en zullen ook dit jaar verder stijgen. Bovendien zijn ondertussen alle politieke partijen voorstander van een vorm van minimumloon.

Als bedrijven zich niet aan Europese arbeidswetten houden, moet dat worden aangekaart. Of het nu in Duitsland is of elders. Duitsland nu van loondumping beschuldigen gaat echter te ver en is een te eenvoudige kijk op de Duitse hervormingen. Na jaren van ‘Reformstau’ en verschillende nominaties als ‘zieke man van Europa’ heeft Duitsland tien jaar geleden de schuld bij zichzelf gezocht. Net als een topsporter met een goed plan en een beetje geluk, is Duitsland uit de crisis gekomen.

Elk succes heeft schaduwkanten, maar een beetje meer topsportmentaliteit zou in sommige landen geen kwaad kunnen.

Deze column verscheen vandaag in het Belgische dagblad "De Tijd".

No bailout without bail-in for Cyprus?

Yesterday evening, the Cypriot parliament brought the euro crisis back to the centre stage. The “no” vote on the bailout plan could have marked a new and uncertain stage in the entire euro crisis.

In the end, no single Cypriot parliamentarian was in favour of the bailout package, decided last week by the Eurogroup and the Cypriot government. In last night’s vote, 36 members of parliament voted against the proposal and the other 19 members abstained. The most controversial part of the bailout is the levy on bank deposits. Even a slight revision of the original plan, namely an exemption of deposits below €20,000 did not change parliamentarians’ minds. With the “no” of the Cypriot parliament, there is no bailout for the time being.

So what is next? The ECB already stopped playing hardball and announced last night that it would provide liquidity to Cyprus “within existing rules”. This can buy time but will not solve the Cypriot problems. With the genie of the deposit tax out of the bottle, time is of the essence. Re-opening the banks without a solution would probably lead to a massive capital flight.

In fact, Cyprus has two main ways out of the current deadlock: i) a renegotiation of the current bailout terms with the Eurogroup; or ii) finding other financial sources to fund the required €5.8bn in the bailout.

At the current juncture, a softening of the bailout terms looks unlikely. The Eurogroup will want to keep maximum pressure on Cyprus, stressing that the ball is with Cyprus and that the Eurogroup’s offer for a bailout is still valid. However, let’s not forget that the Eurogroup statement from last week did not quantify any amount the deposit levy should yield but was kept rather general, saying that “the Eurogroup further welcomes the Cypriot authorities' commitment to take further measures mobilising internal resources, in order to limit the size of the financial assistance linked to the adjustment programme. These measures include the introduction of an upfront one-off stability levy applicable to resident and non-resident depositors. Further measures concern the increase of the withholding tax on capital income, a restructuring and recapitalisation of banks, an increase of the statutory corporate income tax rate and a bail-in of junior bondholders.” In European language this could eventually offer some room for manoeuvre.

Finding other financial sources seems to be the last straw in the eyes of the Cypriot government. There were several reports that Cyprus was trying to get financial support from Russia. Other options could be the increase of other taxes or privatisations. A combination of several options has recently been proposed by Russian energy giant Gazprom which according to media reports has offered Cyprus a plan in which the company will undertake the restructuring of the country’s banks in exchange for exploration rights for natural gas in Cyprus. Clearly an option with far-reaching geopolitical consequences.

However, even if Cyprus were to find other ways to finance its own contribution to the bailout package, it is doubtful whether the Eurogroup would go along with it. Last night, German finance minister Schäuble reiterated on German television that according to him the business model of the Cypriot economy had failed and needed a make-over.

Another option for Cyprus could be to come up with an own alternative for a private sector involvement, by for example exempting all insured depositors from the tax and replacing uninsured deposits above €100,000 with so-called bank certificates of deposit, linked to future natural gas revenues.

Earlier in the euro crisis, Greece called Angela Merkel’s bluff and the threat of being expelled from the Eurozone. It looks as if Greece’s neighbours now think that they can also call the Eurogroup’s bluff. They might be wrong. Even if the Eurozone eventually will probably offer some room for manoeuvre, it is hard to see that the German government will give up the demand for private sector involvement and far-reaching reforms of the Cypriot economy.

Tuesday, March 19, 2013

German ZEW increases in March

The German ZEW index increased to the highest level since April 2010 in March. The ZEW index which measures investors’ confidence now stands at 48.5, from 48.2 in February; the fourth consecutive monthly increase. At the same time, investors have become somewhat more positive on the current economic situation. The current assessment component increased to 13.6, from 5.2 in February, its highest level since August 2012.

The positive contagion in financial markets continues to comfort financial analysts. Over the last four weeks, financial conditions for the German economy have improved further. Oil prices dropped somewhat, the euro weakened by more than 2% and the German stock markets increased by almost 4%. At least in Germany, Mario Draghi’s positive contagion seems to spill over to the real economy. The start to the year was still a bit jolty with retails sales and exports up but new orders down. However, the economy should gain further pace in the coming months.

The experience of the last years has shown that as long as the euro crisis is simmering on a low flame, the German economy remains a crisis beneficiary. However, as soon as the crisis boils over and German businesses and consumers start to worry about the future of the Eurozone, the economy also suffers. Judging from today’s ZEW reading, the Italian elections fell in the first category. Let’s now hope that Cyprus will not fall in the second.

Monday, March 18, 2013

Bailout with bail-in for Cyprus

With the principle agreement on a bailout, Eurozone finance ministers gave the green light to make Cyprus the fifth country receiving financial aid.

The real party only started after the end of last week’s EU summit. Earlier than expected, Eurozone finance ministers agreed on the conditions for a bailout for Cyprus. The bailout programme for Cyprus will be a fully-fledged one, aimed at stabilizing the financial sector, fiscal adjustments and structural reforms to “support competitiveness as well as sustainable and balanced growth, allowing for the unwinding of macroeconomic imbalances”. As announced earlier, there will be an independent evaluation of an anti-money laundering framework. Cyprus has agreed to do a lot to restructure its economy and to increase tax revenues. Probably the most important decision is the one-off levy on bank deposits in Cyprus. This deposit will be 6.75% on deposits with up to 100 000 euro and 9.9% on deposits with more than 100 000 euro. This tax should raise 5.8bn euro. However, measures like “the increase of the withholding tax on capital income, a restructuring and recapitalisation of banks, an increase of the statutory corporate income tax rate and a bail-in of junior bondholders” indicate that the country will get almost a complete overhaul. The size of the bailout package would, in principle, be 10bn euro. Now, the Cypriot parliament will have to agree on the terms of the bailout and other national parliaments will have to give the final green light.

This new bailout package is the result of balancing two – sometimes opposing – rationales: an economic and a political one. Politically, it would have been hard to sell a bailout for Cyprus in core Eurozone countries without some kind of bail-in. Economically, however, the bail-in of bank depositors has the potential to create new turmoil and possible bank runs in other peripheral countries if people start to fear similar treatment in the future. During the weekend, political doubts rose in Cyprus and the parliamentarian vote on the bailout was postponed to today. First smaller changes or fine-tunings to the depositor levy have already been announced. To avoid a bank run, depositors who keep their bank accounts for two years will receive securities linked to future revenues from the country’s gas reserves. Moreover, other options currently under discussions are the exemption of smaller deposits from the levy and other sweetener to encourage depositors keeping their money at the banks.

The consequences of last Friday’s decisions are still hard to predict. Today, there will be a bank holiday but tomorrow could start with long queues in front of Cypriot banks. Will depositors in other peripheral countries believe that Cyprus is a special case or will they also run to their banks? Everything seems possible. Fact is that the financial rescue of an island with less than 800 000 inhabitants marks a next step in the euro crisis: after the haircuts on Greek sovereign bonds, there now is the depositor bail-in. A clear message that rescue actions exclusively funded by tax payers money are a thing of the past.

Thursday, March 14, 2013

Van Duitsers en kakkerlakken

Afgelopen zaterdag was het weer feest bij een voetbalwedstrijd van mijn zoon. Een sportieve match tussen 10-jarige jongens eindigde ei zo na in een gevecht. De ouders van de thuisploeg slingerden het bezoekende team vanaf de zijlijn vanalles naar het hoofd. De kinderen op het veld waren er duidelijk door geïntimideerd. Na een kort moment van verwondering probeerde ik de boel te sussen. En zoals dat gaat, werd ik zelf het nieuwe doelwit. 'De Duitser heeft het gedaan.'

Hoewel een vurige aanhanger van Die Mannschaft zal Angela Merkel, bij gebrek aan nageslacht, mijn ervaring bij het voetballen niet aan den lijve hebben ondervonden. Maar in Europa beleeft ze iets soortgelijks. Hier is vaak te horen dat bezuinigingen en structurele hervormingen alleen maar moeten vanwege Angela Merkel. Recessies, hoge werkloosheid en wanhoop. Allemaal de schuld van Angela Merkel? Een grote denkfout. Hervormingen en bezuinigingen zijn broodnodig om de eigen economie weer op orde te krijgen, niet om Frau Merkel gelukkig te maken. Haar persoonlijke geluk hangt niet af van de Spaanse of Nederlandse huizenmarkt, het gebrek aan internationale concurrentiekracht van de Italiaanse en Franse economie, of de Griekse overheidsfinanciën.

Volgens Nobelprijswinnaar Paul Krugman steunt Merkels beleid zelfs op kakkerlakkenideeën, onuitroeibaar en altijd terugkerend. Ongefundeerde kritiek. De eurozone bezuinigt zich niet kapot, maar heeft zich het afgelopen decennium wel tot over de oren in de schulden gestoken en kapot besteed. Op dit moment betekent 'kapot sparen' voor alle landen, behalve Duitsland, alleen maar: minder snel schulden maken. Ondanks alle kritiek moeten de regeringsleiders van de eurozone doorgaan op het ingeslagen pad. De gekozen aanpak is flexibel genoeg.

Deze week verschuiven de regeringsleiders de prioriteit officieel weg van nominale doelstellingen naar structurele inspanningen. Zo kan duidelijk worden gemaakt dat men niet de ogen sluit voor de moeilijke economische omstandigheden , maar ook de noodzaak van bezuinigingen en houdbare overheidsfinanciën niet loslaat. Tegelijkertijd is het hoognodig om de noodzaak van hervormingen te benadrukken en het tempo hoog te houden. In landen zoals Frankrijk en Italië moet dat tempo zelfs nog fors omhoog.

Altijd met het vingertje richting de Duitsers wijzen is niet correct. De Duitsers winnen toch altijd. In ieder geval mijn zoon, want zijn team won met 3-0.

Deze column verscheen vandaag in het Belgische dagblad "De Tijd"

Wednesday, March 13, 2013

Germany's structural reforms - Role model but not a blueprint

Ten years ago, Germany ended its reform deadlock. The reforms of the Agenda 2010 have contributed to the current strength of the economy but are no blueprint for the rest of the Eurozone.

Today, it is exactly ten years ago that then-chancellor Gerhard Schröder gave his blood-sweat-and-tears speech in the German Bundestag, preparing the country for a series of economic reforms, known as the Agenda 2010. The current strong economic performance of the German economy combined with a balanced budget has given rise to new celebrations of the Agenda 2010, proposing it as a blueprint for structural reforms in the rest of the Eurozone.

The structural reforms were mainly aimed at making the labour market more flexible, creating more jobs and making social security systems more sustainable. The main tools were a reduction of unemployment benefits, privatisation of job agencies to bridge the mismatch between vacancies and job-seekers and tax reductions. In the first two years after the start of the reforms, German unemployment actually continued to increase and breached the 5-million mark. It took until 2006 before the economy started to accelerate again. The economic recovery, however, was not only the result of Schröder’s reforms. The reforms also coincided with wage moderation (even embraced by the unions), corporate restructurings and outsourcing, low interest rates and a favourable global economy with the emergence of the Chinese economy as an important trading partner. Interestingly, the first two years of structural reforms were accompanied by only mild fiscal austerity. Between 2003 and 2006, the German cyclically-adjusted deficit improved by roughly 0.5% GDP on average per year.

During the 2009-crisis, the labour market benefitted from earlier reforms but also – and probably even more – from fiscal stimulus (car scrap scheme) and the subsidised short-time work schemes.
The empirical success of Schröder’s reforms is still disputed. While proponents point to the new strength of the labour market and the economy, critics stress the increases low-wage sector and the growing phenomenon of working poor. Indeed, in the first years of the reforms, new jobs were almost exclusively created in the low-wage sector. This, however, has changed. Since 2010, employment growth has spread through the entire economy, starting to support private consumption.

For the German economy, Schröder’s Agenda 2010 was crucial – not only in terms of the actual but also in a broader meaning. The reforms ended a period of self-pitying about the German role as sick man of Europe and reform deadlock. However, while this symbolic impact can clearly be used as a role model for other Eurozone countries, the actual reforms should not necessarily be used as a reform blueprint. Each Eurozone country will have to find its own blood-sweat-and-tears Agenda 2020.

EU Summit - Don't miss the after-party

Today's and tomorrow's European Summit should leave financial market participants rather untouched. However, the after-party of Eurozone finance ministers Friday evening should be followed closely.

When European leaders meet in Brussels today and tomorrow, the sense of urgency and emergency has disappeared. It does not look to be another night-braking or even make-it-or-brake-it summit, but more like a conversational group therapy. However, while the summit should probably fall short in producing far-reaching results, it should at least pave the way for the first test case of the new fiscal framework.

In recent weeks, the discussion amongst policymakers and economists about the right policy mix has flared up again. While critics of the Eurozone’s mix of austerity and structural reforms cited cockroaches and hamsters to make their point, the proponents have pointed to reform progress in peripheral countries. This week’s European Summit should emphasise the need for reforms and austerity. However, the Summit could give the official green light for a shift of fiscal surveillance. Instead of focussing on nominal deficit targets, the new fiscal framework is likely to shift towards structural efforts, not to an overburdened, battered economy with additional austerity measures. Beneficiaries of this regime change should be France and the Netherlands. Both countries run the risk of receiving a fine for not bringing their fiscal deficit below 3% of GDP this year but have delivered the required structural efforts. These two countries should soon receive an additional year to achieve the nominal deficit target.

Next to the fiscal regime shift, record-high unemployment in the Eurozone will be on the economic agenda of EU leaders. The social and political impact from high unemployment could be the biggest threat to the survival of the Eurozone. European leaders could pick up earlier ideas for some kind of solidarity fund to tackle at least high youth unemployment.

And there is more. Yesterday, a special meeting of Eurozone finance ministers was announced for Friday evening. Obviously, the meeting will be on Cyprus and the unsolved issue of a possible bail-in. Several core Eurozone countries have been pushing for a bail-in of depositors as part of a bail-out package for Cyprus. A bailout without private sector involvement could have problems passing national parliaments, particularly the German Bundestag. German opposition parties already signaled that – contrary to earlier bail-outs – it would not support the government. For a private sector involvement, several options look possible: privatization of state assets, restructuring of the banking sector, a bail-in of depositors and/or bank bond holders or a sovereign haircut as in Greece. Obviously, any of these forms of private sector involvement (PSI) could have unwanted averse effects either on Cyprus (as a bail-in could lead to a wide-spread withdrawal of funds, eventually undermining the entire business model of the economy) or other Eurozone countries as the uniqueness of PSI in Greece would be more than only second-guessed.

Apparently, a new proposal is currently circulating. Cyprus could levy a tax on deposits or increase other taxes to reduce the size of the required bailout package. While this could help improving Cyprus’ debt sustainability, it is questionable whether it would meet core countries’ political demand of some kind of private sector involvement. The discussions at Friday’s meeting will not be easy.

It is obvious: While the big summit could fall short on tangible decisions, the after-party should not be missed.

Friday, March 8, 2013

German IP points at bumpy industrial recovery

German industrial production remained unchanged in January, from an upwardly revised +0.6% MoM in December. On the year, industrial production is down by 1.3%. While production in the manufacturing sector dropped by 0.2% MoM, driven by a sharp decline in capital goods, production in the construction sector more than offset the December decline, increasing by 3% MoM.

The German industry has stabilised after the decline since late-summer. However, it is still not a sharp and healthy rebound. Looking ahead, production expectations and the Ifo index have increased to the highest levels since April last year and the industrial safety net of filling order books and inventory reduction has strengthened gradually since last summer. However, yesterday’s new order data illustrated that the way out of the contraction will not follow a straight line. The negative side-effects from the crisis in most neighbouring countries have become a speed limit to any industrial recovery. Finally, in the short term, there is even a risk that the harsh winter weather could delay the industrial rebound a bit further.

Soft data for the German economy has been more than encouraging for already several months. Now, the first batch of hard data for the start of the year sends mixed signals. While the solid labour market and a sharp increase in retail sales in January already confirmed the growth-supportive role of consumption, the strengthening of industrial activity remains a very gradual and choppy one. At least some kind of rebalancing of the German economy.

All in all, the German economy looks still set to leave the contraction of the fourth quarter behind, returning to growth in first quarter of 2013. However, it currently rather looks like a cosy ride on a country road than frantic ride on a German highway.

Thursday, March 7, 2013

ECB meeting – Draghi’s elegant interpretation of “we-never-pre-commit”

As expected, the ECB kept interest rates on hold. ECB president Draghi elegantly balanced between dovish and hawkish comments, keeping all options open. In our view, rates should remain on hold unless the economic recovery fails to materialise in the coming months. Non-standard measures remain the ECB’s most preferred policy option.

The ECB’s macro-economic assessment remained broadly unchanged compared with the February meeting. The ECB still witnesses a stabilisation of the Eurozone economy at a very low level and expects a gradual recovery in the second half of the year. ECB president Draghi stressed the current dichotomy between stabilising and even improving soft data on the one hand and disappointing hard data on the other hand.

The ECB’s macro-economic assessment was also reflected in the latest ECB’s staff projections. In these projections, GDP growth forecasts for both 2013 and 2014 were slightly revised downwards. The new mid-point projection is now -0.5% for 2013 (from -0.3% in the December projections) and 1% for 2014 (from 1.2%). As regards inflation, the projections for 2013 remained unchanged at 1.6% but were slightly revised downwards to 1.3% for 2014 (from 1.4%). These changes were mainly driven by the negative carry-over effect from weaker-than-expected GDP growth in 4Q12 and lower headline inflation rates at the beginning of the year. Broadly speaking, the underlying pattern of the future path of the Eurozone economy has remained unchanged since the December meeting. It looks as if it would need at least one or two months of disappointing hard data before the ECB would change its view.

With the almost unchanged macro-economic assessment, it did not come as a surprise that the ECB kept its risk analysis unchanged. Risks to the economic outlook are still to the downside, while risks to the inflation outlook remain balanced. Notably, the euro exchange rate has disappeared as a downside risk to inflation. Maybe a nice side-effect of the Italian elections and possibly signalling that the ECB is happy with the euro at 1.30 against the dollar.

Sluggish credit growth and, more particularly, the fragmentation of credit growth and credit access for SMEs seems to have become the biggest concern of the ECB. In fact, the Eurozone remains stuck in a double credit whammy, with both the supply and demand side being significantly suppressed. However, the ECB does not seem to have a plan how to tackle this problem.

Ahead of today’s meeting, there was some excitement in financial markets about the ECB’s possible reaction to the Italian elections and the lagging economic recovery. Draghi’s reaction to the Italian elections could become another magic wording. He called it the “angst of the week”. Fiscal reforms in Italy were on auto-pilot and would continue, according to Draghi. Moreover, he reiterated that the rules of the OMT were clear: first a bailout (light or fully-fledged) and then the ECB could consider starting OMT.

While Draghi stubbornly tried to present his fair weather face regarding the economic outlook and the return of growth in the second half of the year, his between-the-lines comments were rather dovish. The introductory statement had the term “accommodative” five times compared with four times in the February statement, Draghi explicitly mentioned that the Governing Council had discussed a rate cut and also said that the “monetary policy stance will remain accommodative as long as needed”. Obviously, the ECB still does not pre-commit in any way but the last statement comes already very close to the Fed’s “rates will remain very low until late 2014”.

All in all, Mario Draghi today had a bit for everyone. A bit of dovishness to dampen the exchange rate and a bit of hawkishness and positivity to counter economic doom-thinkers. The door to a rate cut was not opened further, neither was it closed. It has become a revolving door. In fact, Draghi gave an elegant “we-never-pre-commit” show, keeping all options open.

Monday, March 4, 2013

Eurozone: Adjourned game – again

At last night’s Eurogroup meeting, Cyprus moved another small step closer to a bailout. The big issue of possible private sector involvement remains unsolved.
The relative calm in financial markets combined with some tender signs of economic stabilisation have taken the sense of urgency and emergency from most Eurogroup meetings. Contrary to many meetings over the last years, meetings of Eurozone finance ministers have been healthier for ministers who often suffer from too little sleep. Meetings lasting until the middle of the night have again become an exception and are no longer the rule. The fate of the Eurozone no longer depends on make-it-or-brake-it summits until sunrise. Still, several important fundamental issues, such as shaping the future of the monetary union, are still unsolved. Besides further steps towards a banking union (eg, the definition of legacy assets for possible direct bank recapitalisation through the ESM or a bank resolution mechanism) and the first test for the new fiscal framework, the pending bailout for Cyprus remains a crucial issue.
At last night’s Eurogroup meeting, Eurozone finance ministers confirmed its principal commitment to offer a bailout for Cyprus. In June last year, Cyprus had officially requested such a bailout. Now, with a new Cypriot government in place, the final agreement seems to be closer. Currently, the Cypriot authorities are still negotiating with the Troika on the details of the so-called Memorandum of Understanding. While initially the Cypriot government had tried to negotiate a Spanish-style bailout, only targeted at bank recapitalisation, the sharp deterioration of public finances seems to argue in favour of a fully-fledged bailout. Details of the negotiations were not revealed last night but the announcement that the new Cypriot government has agreed on an independent evaluation of the implementation of the anti-money laundering framework in Cypriot financial institutions shows the willingness to make further concessions. Eurozone finance ministers agreed to “target political endorsement of the programme around the second half of March”.
One of the crucial questions of the probable bailout package is not only its scope (bailout light vs fully-fledged bailout) but also its financing. In several Eurozone countries, concerns have increased that a bailout for Cyprus would see taxpayers’ money bailing out what some have called a money laundry paradise. A bailout without private sector involvement could have problems passing national parliaments, particularly the German Bundestag. For a private sector involvement, several options look possible: privatization of state assets, restructuring of the banking sector, a bail-in of depositors and/or bank bond holders or a sovereign haircut as in Greece. Obviously, any of these forms of private sector involvement (PSI) could have unwanted averse effects either on Cyprus (as a bail-in could lead to a wide-spread withdrawal of funds, eventually undermining the entire business model of the economy) or other Eurozone countries as the uniqueness of PSI in Greece would be more than only second-guessed. As so-often during the euro crisis, the eventual compromise will have to balance both political but also economic calculations.

ECB preview - The return of catenaccio?

The improved but still bleak economic outlook, lower inflationary risks and new euro crisis uncertainty since the Italian elections have given rise to new speculation about a possible ECB rate cut this week. True, a downward revision of the inflation outlook could open the door to a rate cut a bit further. However, new political uncertainty is rather an argument against than for a rate cut. We expect the ECB to keep rates on hold on Thursday. We might even see a tactical shift, with the ECB moving from “attack is the best defence” to good old Italian-style catenaccio, with a well-organised defence forcing the other team to take the initiative.

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