Thursday, June 27, 2013

German labour market still solid as a rock

The success story continues. German unemployment dropped by a non-seasonally adjusted 72,200 in June, bringing the total number of unemployed to 2.865 million, the lowest level since December 2012. In seasonally-adjusted terms, unemployment dropped by 12,000, the first monthly drop since February. The seasonally-adjusted unemployment rate remained unchanged from a downwardly revised 6.8% in May.

As expected, the spring revival of the German labour market came with a delay. The high number of public holidays and the cold weather in May had blurred last month’s data. Today’s numbers show that it was far too premature to start singing Swan Songs on the labour market.

In fact, the German labour market remains the show case example for successful labour market reforms. The June revival was actually the strongest June revival since 2010. It seems as if earlier reforms are still paying off and that the German labour market needs less economic growth than in the past to create jobs. Up to the early 2000s, the German economy required growth of at least 1 ½ % to create new jobs. In recent years, GDP growth rates of less than 1% were sufficient for job creation. This bodes well for the near-term outlook, indicating that despite an expected GDP growth rate of only roughly 0.5% this year, the labour market should remain stable. At the Eurozone level, it is obvious that the success of its own structural reforms will further encourage the German government to continue hammering on structural reforms.

With yesterday’s strong consumer confidence and today’s good labour market report, domestic demand should continue being an important growth driver this year.

Monday, June 24, 2013

German economy cruises along smoothly

Nice and steady. The German economy seems to cruise along nice and steady, defying any growth concerns. Germany's most prominent leading indicator, the Ifo index, increased to 105.9 in June, from 105.7 in May. As expected, the current assessment component dropped slightly to 109.4, from 110 in May, while the expectation component increased to 102.5, from 101.6.

Since the start of the year, the German economy has gone through several ups and downs with an almost unprecedented dichotomy between soft and hard data. The harsh winter weather, the Cyprus bailout and now the floods have made it harder than usual to forecast the path of the German economy. Strong soft data at the beginning of the year was not followed up by strong growth. The external one-offs delayed the rebound of the economy. Judging from available hard data, this rebound should unfold in the second quarter. Industrial production surged, the construction sector more than offset the entire output losses caused by the harsh winter weather and exports regained momentum. Only private consumption seems to have taken a breather.

Looking ahead, main risks for the German economy come from the outside, not from the inside. Domestic demand has become something to fall back on and should remain solid this year, driven by low inflation, low interest rates and latest wage increases. The main risks for the German economy remain stagnating growth in its main Eurozone trading partners, above all France, and a hard landing of the Chinese economy. Contrary to common belief, even Abenomics and the recent depreciation of the yen hardly pose a risk for German exports. German and Japanese exports stiff differ significantly in terms of product and geographical specialisation. This is reflected in the very low weight of the Japanese yen (roughly 3%) in Germany’s nominal effective exchange rate against 41 major trading partners. Just to illustrate: while the euro gained more than 20% against the yen since December, Germany’s real effective exchange rate has appreciated by 0.5%. Admittedly, the weaker yen could put some pressure on some German exports to Asian countries but at the macro level Abenomics is no reason to change the German growth outlook.

In sum, it is not overly exciting anymore but today’s Ifo simply confirms the well-known story that the German economy is cruising along smoothly.

Friday, June 21, 2013

Another small step on the long and winding road towards banking union

Last night, Eurozone finance ministers agreed on the guidelines for the ESM’s possible direct bank recapitalisation.

Ahead of the big European Summer summit, Eurozone finance ministers tried to pave the way for their bosses last night. Next week’s summit will mainly be about three issues: how to tackle (youth) unemployment in Europe, how to kick-start lending to SMEs and how to get the banking union going. Particularly the banking union remains clear work in progress.

Last night, Eurozone finance ministers agreed on an important connecting piece of the banking union building blocks: direct bank recapitalisation through the Eurozone’s bailout fund, the ESM. Of course, this direct aid will only come under certain conditions. The first part of any bank recapitalisation would have to come from private investors, shareholders and creditors. Then, the government of the country where the bank is based would have to step in, contributing 20% of the needed capital injection. For the time being, the ESM’s firepower to recapitalise banks will be limited to €60bn.

Retroactive application of this direct bank recapitalisation was not excluded but will be decided on a case-by-case basis. Most importantly, however, this direct bank recapitalisation will only become effective once the Single Supervisory Mechanism is up and running and an agreement on a bank resolution mechanism has been reached. This still seems to take time.

As it currently looks, the easiest part of the three-pillared banking union, the single supervisory mechanism takes longer to become effective than initially thought. Last year, Eurozone leaders agreed that the ECB should take over the role as single bank supervisor in the Eurozone. The ECB itself declared that it would need around 12 months after all relevant laws were passed before it could start with its new tasks. The ECB needs a real legal basis before it can start hiring staff and start all other necessary preparations. Initially, all legislation was supposed to be ready by March this year. However, a series of power struggles between all stakeholders involved (European Parliament, ECB, Council, national parliaments) has stretched and delayed the process. It now looks as if the finalization of the legal process could take until September, possibly postponing the start of the single supervisory mechanism to September/October 2014.

As regards the bank resolution mechanism, the second pillar, discussions are still ongoing. The bank resolution mechanism is supposed to lay down clear rules for unwinding troubled banks, keeping taxpayers’ involvement as limited as possible. In this context, the guidelines on how the Eurozone’s bailout fund, the ESM, could directly offer financial support to banks gives more than only a clear hint at future bank resolutions. It looks as if any bank resolution mechanism will consist of a clear sequencing of bail-ins, followed by national government financial support and a possible new fund financed by the financial sector. European taxpayers’ money will only be the very last resort. As Germany is still blocking the idea of a new bank resolution authority, the mechanism could start with a system of national authorities and the ESM or another financial source as a backstop. Last night’s decision has increased chances that eventually the ESM could become the financial backstop for a real bank resolution mechanism.

Ideally, the final and third pillar of the Eurozone’s banking union is a common deposit insurance scheme to prevent bank runs. For the time being, this issue seems to be off the political agenda. Particularly the German government is rejecting it, as it could be considered another form of financial burden sharing. In this context, it is noteworthy that only one out of the four parties that realistically will form the next German government (in whichever combination) actually explicitly mentions a common deposit guarantee scheme in its election manifesto.

All in all, last night was another small step towards the Eurozone’s banking union. It also showed the political commitment across all Eurozone countries for a banking union. Fears that some (big) Eurozone countries would actually oppose the banking union look unjustified. However, given the fact that these steps are not exactly taken at lightening speed, the banking union should be up and running just in time to prevent the next crisis but clearly too late to make a difference in the current crisis.

Tuesday, June 18, 2013

ZEW points to robust growth

Today’s ZEW index adds evidence that the German economy is regaining momentum. The ZEW index which measures investors’ confidence increased in June to 38.5, from 36.4 in April. Its absolute level is clearly above the historical average. At the same time, investors have become somewhat more negative on the current economic situation. The current assessment component dropped to 8.6, from 8.9 in May; the third consecutive drop.

Recently, doubts about the strength of the German economy have emerged again. Several international institutions revised downwards their growth forecasts for this year, expecting almost no growth any longer. In our view, however, the German economy could surprise again. In fact, hard data available so far have been very promising: at the beginning of the second quarter, industrial production surged, the construction sector more than offset the entire output losses caused by the harsh winter weather and exports regained momentum. Only private consumption seems to have taken a breather.

Obviously, it is too early to give the official all-clear for a growth sprint of the economy in the second quarter but the ingredients are definitely there. The combination of sound fundamentals and a weather-driven catching up of the construction sector should boost growth. Looking further ahead, the German economy should cruise along rather smoothly, driven by the solid labour market, recent wage increases, low interest rates and a gradual recovery of external demand. The main risks for the German economy remain stagnating growth in its main Eurozone trading partners, above all France, and a hard landing of the Chinese economy. Contrary to common belief, even Abenomics and the recent depreciation of the yen hardly pose a risk for German exports. Why? German and Japanese exports differ significantly in terms of product and geographical specialization. This is reflected in the very low weight of the Japanese yen (roughly 3%) in Germany’s nominal effective exchange rate against 41 major trading partners. Just to illustrate: while the euro gained more than 20% against the yen since December, Germany’s real effective exchange rate (our favorite measure for export competitiveness) has appreciated by a meager 0.5%. Admittedly, the weaker yen could put some pressure on some German exports to Asian countries but at the macro level Abenomics is no reason to change the German growth outlook.

Doubts about the strength of the German economy have almost become a new ritual at the beginning of each year. Indeed, over the last couple of years, the economy has often had a rusty start. Sometimes due to the euro crisis, sometimes due to the weather. In the end, however, the economy always managed to leave (almost) all problems behind, defying critics and concerns. Of course, all good things come to an end at some point in time. For the time being, however, Germany’s economic growth seems to be like an old rock star: it can't get enough of comebacks.

Thursday, June 13, 2013

German government agrees on emergency fund against flood damages

Yesterday, the government agreed on an €8bn emergency fund to tackle the damages from the severe floods. Despite individual tragedies, the overall impact from the floods on the entire economy should remain limited.

For more than two weeks, Germany has been suffering from flooding of several rivers which have devastated parts of southern and eastern Germany. The extent of the flooding seems to exceed the so-called “100-year flood” which hit the country in 2002. As so often in these moments of human tragedies, the question of the macro-economic impact of such natural disasters pops up.

The answer is almost always the same and bare statistics tell a rather heartless story: the macro-economic impact of most natural disasters remains rather limited. Looking at industrial production and GDP growth during the floods in 1993, 1997, 2002 and 2010, it hardly shows any abnormal developments that could be related to the floods. In our view, the macro-economic impact of major floods in Germany over the last 20 years has been close to zero. This can mainly be explained by two factors: i) floods in Germany mostly hit rural and agricultural regions but not the backbone of the economy, the industry; and ii) natural disasters have a negative one-off impact on the wealth and/or the capital stock of an economy, which does not show in the GDP data. Subsequent reconstruction works, however, often lead to a pick-up in economic activity.

Sometimes, the pick-up in economic activity is interpreted as the fact that natural disasters have a paradoxically positive impact on growth. This interpretation, however, should be taken with a pinch of salt as it does not take opportunity costs into account and ignores the fact that reconstruction works have to be financed.

Returning to the current floods, Germany’s federal and state governments agreed on an emergency fund to tackle the costs of the floods and to launch reconstruction works. The fund should reach €8bn (around 0.3% of GDP). Officially, the financing of the fund has not been decided, yet, but judging from official statements, the €8bn should be financed by new debt and not by new taxes. In fact, the floods could prevent Germany from recording the second consecutive year with a fiscal surplus. In addition, Germany can also hope for some aid from the European Investment Bank, which earlier said it would consider loans to countries affected by the flooding amounting to around €1bn.

All in all, as in the past, the current flood will not come without costs and individual tragedies. Lost homes, production facilities or damaged infrastructure will trigger damage claims for insurance companies, wealth losses for households and companies and/or reconstruction work. The growth path of the total economy, however, should hardly be affected.

Wednesday, June 12, 2013

Soepelheid boven regels

Mijn typisch Duitse gedrag wordt mij vaak aangewreven door mijn Nederlandse vrouw. Als goede Duitser hou ik van structuur, discipline en P├╝nktlichkeit, regels boven alles. Zegt zij. Dit regelgedreven Duits gedrag kan dus niet alleen in bilaterale Europese relaties leiden tot wrijving.

In Duitsland belichamen twee instellingen deze typisch Duitse eigenschappen: de Bundesbank en het Constitutionele Hof. In de ogen van eigenlijk alle Duitsers staan ze voor de compromisloze uitvoering van regels en opdrachten. Ze zijn immuun voor politieke spelletjes. Dogmatisme op zijn puurst. Het verbaast dan ook niet dat de hoorzittingen van het Duitse Constitutionele hof van de afgelopen twee dagen vergezeld gingen van groot mediaspektakel. De klacht van een aantal eurosceptici tegen de aankondiging van de Europese Centrale Bank om indien nodig onbeperkt staatsobligaties van eurolanden te kopen, appelleert aan het negatieve onderbuikgevoel van veel Duitsers: 'mag dat zomaar?'. De Bundesbank heeft dat buikgevoel op tijd en stond gevoed met haar publieke oppositie.

Wat even werd vergeten was dat de ECB alleen landen ondersteunt die zich verbinden aan de voorwaarden van een hulppakket, zoals Griekenland, Spanje of Portugal. In de ogen van de klagers is de aankondiging van de ECB in strijd met de Europese verdragen en het verbod op staatsfinanciering. Het lot van de eurozone mag niet in handen liggen van de ECB, het moet in handen liggen van de politiek. Maar de ECB is net door de permanente eurocrisis in de rol van brandweer geduwd. Niet uit machtswellust, wel door het gebrek aan politieke sturing. De aankondiging van de ECB was dan ook de langverwachte 'gamechanger' in de eurocrisis. Ze heeft speculaties over het einde van de eurozone verdreven. In feite heeft de ECB bewezen dat pragmatisme het in de eurocrisis wint van dogmatisme.

Het hof komt met zijn uitspraak pas in de herfst, waarschijnlijk na de Duitse verkiezingen. Het valt niet te verwachten dat de rechters zich inhoudelijk zullen uitspreken over het beleid van de ECB. Als twee centrale banken het economisch al niet eens kunnen worden, hoe zou het Hof dan een economisch oordeel moeten vellen? Bovendien valt de ECB onder de Europese wet en niet onder de verantwoordelijkheid van het Duitse hof. Als er iemand de legitimiteit van het opkopen van staatsobligaties zou kunnen toetsen, is het hooguit het Europees Hof van Justitie. Eventueel komt er nog een laatste poging om de nationale instellingen te versterken, maar dat zal niet afdoen aan de belangrijkste boodschap: de Bundesbank is alleen nog een filiaal van de grote ECB.

Na bijna vijftien jaar heb ik geleerd dat voor een goed functionerende Europese samenwerking soepelheid soms te verkiezen is boven regels. Nu maar hopen dat het hof en de Bundesbank dat ook begrijpen.

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

Thursday, June 6, 2013

ECB leaves its tools on the shelf

Back on hold. As expected, the ECB kept interest rates on hold at today’s meeting. ECB president Draghi tempered expectations about a quick fix for SME lending but also made clear that the ECB stood ready to do more on the rate front if the economy does not bottom out in the near future.

As ECB president Mario Draghi said it himself: macro-economic developments since the last meeting did not change enough to trigger an additional ECB action. In fact, the ECB’s macro-economic assessment remained broadly unchanged from last month and showed many verbatim similarities. While confidence indicators have improved somewhat, the ECB remains cautious on the expected recovery. For the time being, the ECB continues to expect a bottoming out of the economy in the course of the year, followed by a very gradual recovery. This almost unchanged assessment is also reflected in the ECB staff’s latest projections. As regard growth, ECB staff revised its projections downwards for this year to -0.6% (from -0.5%) and upwards for next year to 1.1% (from 1.0%). Main drivers of the hoped for recession recovery remain external demand, low inflation and loose monetary policy. As regards inflation, ECB staff now expects 1.4% this year (from 1.6%) and 1.3% (unchanged) for next year.

As regards any future policy measures, ECB president Draghi kept all options open but also tempered expectations about a quick ECB fix for the real economy. According to Draghi, the ECB was technically ready for negative deposit rates. At the same time, however, he also stressed that negative deposit rates would have unintended consequences. For the time being, a negative deposit rate still falls in the category “OMT”: an announcement or threat which the ECB hopes will never have to be implemented.

In our view, the ECB will try to avoid negative deposit rates for as long as possible. In case the Eurozone economy does not bottom out in the next one or two months, another “traditional” rate cut seems to be the most preferred option. Given Draghi’s comments today, even a refi rate of 0%, while keeping the deposit rate also at 0%, should not be excluded if the economy falls short of stabilizing.

On the often-discussed stimulus for SME lending, Draghi clearly backtracked, remarking that the plan to support asset-backed securities was a medium to long-term proposition and nothing for the short term. Judging from his comments, we still think that the ECB would be willing to eventually purchase ABS in the market but only if and when (parts of) the risk have been taken over by for example the European Investment Bank or similar institutions. As any such plan still requires more negotiations between the European institutions, the only short-term relief the ECB could offer would be a relaxation of its collateral rules.

Over the last two months, the ECB had increased expectations that it would be able to present a new quick fix for the real economy by boosting SME lending. Today’s press conference shows that the ECB has returned into its garage, carefully studying what is left there. As ECB president Draghi said, there are still a couple of tools on the shelves. However, it is obvious that all of these tools have a “highly dangerous warning” sign on them. If need be, the ECB would use any of these tools. For the time being, however, the ECB looks happy keeping the dangerous stuff where it is: on the shelves.

Carsten Brzeski

Will Karlsruhe rock markets again?

While the German Constitutional Court kept almost the entire Eurozone and financial markets on tenterhooks last year, next week’s hearings on the ECB’s bond purchases should rather be a media showdown than a market shaker.

Last year, the German Constitutional Court kept almost the entire Eurozone and financial markets on tenterhooks with its verdict on the Eurozone’s rescue funds (the ESM). Next week, many market participants will again have a very close look at events in a small German city called Karlsruhe. On 11 and 12 June, following up on last year’s verdict, the German Constitutional Court will conduct a public hearing on several pending legal challenges regarding the ECB’s bond purchasing programmes (SMP and OMT) and its Emergency Liquidity Assistance (ELA). Just to be clear, it will only be a hearing. A date for the final judgments has not yet been announced. It will probably come in September. The legal issues at stake are highly complex. Obviously, we are no legal experts. Nevertheless, here is our take on the issues at stake and possible outcomes. Technically speaking, the German Court cannot render a judgment on the ECB. The ECB falls under the jurisdiction of the European Court of Justice. This means that the German Court cannot interdict the OMT. As a consequence, the worst-case scenario looks highly unlikely. A more plausible scenario is in our view that the Constitutional Court decides on the following: 1) whether any ECB action has endangered the budgetary prerogative of the German Bundestag; and 2) whether the ECB’s conducted (and potentially planned) bond purchases breach the German Constitution. This proceeding would be in line with earlier verdicts, including last year’s verdict on the ESM.

Just focusing on the above-mentioned two issues, a possible train of thought is that all ECB measures which implied more (temporary) risk-taking by the ECB could eventually and indirectly through the Bundesbank channel have an impact on the German budget While this could theoretically build the case for more parliamentary influence (as in the Court’s ESM ruling), the Bundesbank’s constitutional independence should make any changes (almost) impossible to implement. Therefore, a scenario in which the Constitutional Court tries to exempt the Bundesbank from participating in monetary policy operations which could lead to possible future losses looks unlikely. If the Court continues to have doubts about the legality of the ECB’s bond purchases, it could refer the case to the European Court of Justice. Something it has never done before.

All of this means that next week’s hearing of the German Constitutional Court should rather be a big media showdown, with both the Bundesbank and the ECB testifying in court, than a market shaker. Even looking beyond the hearing, the Court’s eventual final judgment should in our view hardly be anything to worry about. The Court is unlikely to intervene in the ECB’s day-to-day crisis management. Contrary to the ESM ruling, it does not seem to have a lot of legal leverage to strengthen the German influence in the ECB’s decision-making process. Maybe the Court’s final judgment could eventually even have a slightly bitter taste for some Germans if it directly or indirectly confirms an inconvenient truth: the fact that the German Bundesbank has become an “acting agent” – one among 16 other national central banks.