Friday, August 28, 2015

German inflation in August signals new headache for ECB

Based on the results of six regional states, German headline inflation remained unchanged at 0.2% YoY in August. On the month, German price development was flat. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation remained unchanged and stands now at 0.1% YoY. A quick look at the available components at the regional levels shows that low headline inflation is not only the result of lower energy prices but also some tentative second-round effects on consumer goods. At the same time, higher prices in the service sector indicate that there is clearly no risk of deflation for the German economy. Interestingly, the weakening of the euro exchange rate is still not visible in significantly higher import prices. To the contrary, import prices continue to fall, with latest data showing a 0.7% YoY drop in August. Looking ahead, the latest plunge in commodity prices should leave its marks on headline inflation in the coming months. Even a drop into negative territory cannot be excluded. Against this background, reaching the official Bundesbank projection of 0.5% annual inflation for the entire year 2015 has become highly unlikely. It would actually require headline inflation to average 0.9% in the remaining months of the year. In our view, headline inflation should stay close to but above zero for the post-summer months before gradually increasing towards 1% YoY. Consequently, these low inflation rates should continue supporting private consumption. While low inflation or even negative inflation rates are a blessing for German consumers, they could become a new headache for the ECB. As at the end of last year when the discussion about a possible QE started, the ECB is again confronted with deflationary forces. Or to be more precise, with disinflationary forces. With commodity prices now significantly lower than back at the end of 2014, the ECB will have to decide whether low or negative inflation rates are rather positive (ie strengthening purchasing power and domestic demand) or negative (ie contributing to dropping inflation expectations). This discussion should be sharpened by the latest round of ECB staff projections, which in our view should show a significant downward revision of the ECB’s inflation forecasts. The last edition of the ECB projections back in June included the technical assumption of an average oil price of 64 USD/b this year, 71 USD/b next year and 73.1 USD/b in 2017 (based on future contracts). Even if the cut-off date of the latest projection round was probably slightly before the peak of recent market turmoil, these oil price assumptions do now look very outdated. Just doing some quick back-of-the-envelope calculations suggests that the new commodity environment could lead to downward revision of the ECB’s inflation projections of between 0.4 and 0.6 percentage points for 2016 and 2017. In June, the ECB projected inflation at 1.5% in 2016 and 1.8% in 2017. Admittedly, the ECB projections are much more complex and sophisticated than our back-of-the-envelope calculations. However, anything else than a clear downward revision of the ECB’s inflation numbers next week would be a surprise. All in all, the latest plunge in commodity prices will clearly revive the good vs bad deflation debate in the EuroTower. For the time being, this should not yet lead to new policy action. However, recent comments by ECB chief economist Peter Praet confirm our view that latest market developments have rather increased than decreased chances for more QE.

Tuesday, August 25, 2015

German Ifo defies market and China woes

Just a transitional snapshot or a sign of absolute matter-of-factness? German companies remain unimpressed by the current series of uncertainties and turmoil. Neither the Greek crisis nor the new Chinese uncertainties and stock market turbulences have been able to dent German business’ optimism. Germany’s most prominent leading indicator, the just released Ifo index, increased to 108.3 in August, from 108.0 in July. While the current assessment component increased to its highest level since April 2014, the expectation component dropped marginally to 102.2, from 102.3 in July. There are two possible explanations for today’s surprise increase. Either the ongoing stock market turbulences came simply too late to have an impact on the Ifo survey and will therefore only unfold their full negative impact next month, or German businesses are a bunch of ice-cold realists, sticking to the pure facts. In our view, there are many arguments in favour of the latter. And, indeed, the pure facts clearly argue against panic. First of all, as illustrated by this morning’s second estimate of 2Q GDP data, the German economic model has become much more balanced than critics have been complaining about. GDP growth was confirmed at 0.4% QoQ, mainly driven by both net exports and consumption. At the same time, inventories and investment turned out to be a drag on growth. The bigger picture shows that over the last quarters, private consumption has been a stronger growth driver than net exports. While net exports contributed less than 0.2 percentage points to quarterly GDP growth rates, private consumption accounted for 0.3 percentage points. The renewed drop in energy prices should clearly support domestic demand in the months ahead. Secondly, a slowdown of the Chinese economy is not the same as a recession. After years of strong growth, it is somewhat normal that growth rates are coming down. Let’s not forget that at the current growth rate, the Chinese economy would still add the size of the Swiss economy every year. Thirdly, German exports to China have already slowed down in the first half of the year, without derailing the German recovery. The geographical diversification of German exporters should cushion any further weakening of Chinese demand. China currently accounts for less than 6% of total German exports. As long as other major export markets like the US, the UK, Eastern Europe and the Eurozone are continuing to grow or at least avoid a new slowdown, German exports should remain solid. Fourthly, the devaluation of the Chinese renminbi alone should not automatically crowd out German products. To the contrary, over the last five years, German exports to China had recorded growth rates of between 20% and 60%, with an exchange rate much stronger than currently. Last but not least, latest stock market turbulences, Chinese uncertainties and a marginally strengthening of the euro exchange rate have gone hand in hand with a sharp drop in commodity prices. This drop in commodity and energy prices is in our view the final argument against any panic as it should support domestic demand. All in all, it is obviously too early to give the final verdict on the economic fallout of the latest market turmoil and Chinese uncertainties. German businesses, however, are taking a rather benign stance, putting their money on the fundamental strengths of the German economy.

Tuesday, August 18, 2015

Eurozone: Behind the scenes of Germany's "yes"

Today’s vote in the German parliament will no doubt bring a “yes” for the third Greek bailout package. While the outcome of the vote might not be spectacular, the details are clearly explosive. Greece and the ongoing negotiations have been the dominant topics for German politicians and common people over the entire summer. With today’s vote in the Bundestag, the German parliament could end these discussions; at least for the time being. To be precise: 631 German MPs have returned from their summer vacation to vote on the third bailout package for Greece. Chancellor Merkel’s government holds 504 seats and, moreover, at least one opposition party – the Greens (holding 63 seats) – already announced it would also vote in favour of a third Greek package. Consequently, anything else than an overwhelming “yes” vote would be a surprise. Nevertheless, today’s vote will be a test for Angela Merkel’s leadership. While opposition from other German parties against the new Greek bailout package has been rather muted, it is Merkel’s own party – the conservative CDU – which is still struggling with support for Greece. When the German parliament voted on the start of the official negotiations with the Tsipras government, 60 members of Merkel’s party voted against. In recent days, the “no” voters have received increasing media attention in Germany. According to reports, Merkel’s chief whip, Volker Kauder, had threatened possible dissidents that they would face consequences, like losing posts and positions in the party, in case they do not stick to the official party line. Against this background, all eyes will be on the exact number of “no” votes from Merkel’s own party today. A number higher than the earlier 60 would not immediately be a problem for Merkel. There simply is no crown prince or princess in her own party, neither are there any signs of a palace revolution. However, in the longer run, a growing number of dissident votes would clearly weaken Merkel’s position in the government and might eventually even reduce her appetite to run for a fourth term in office in the 2017 elections. On a more substantial point, the German government will continue having a hard time, even after today’s vote. It’s the role of the IMF in the third Greek bailout package. German politicians have frequently said that there would be no new package for Greece without IMF participation. At the same time, however, IMF participation would mean debt relief or even debt forgiveness for Greece. At least the latter is something, the same German politicians have been strongly opposing for a long while. How the German government wants to square this circle is still unclear. In our view and judging from last Friday’s Eurogroup statement, a face-saving compromise could be that initially IMF participation would be limited to technical assistance, monitoring and surveillance of the Greek reforms. Later, probably in October after a first successful assessment of the Greek measures and their implementation, the Eurogroup could decide on debt relief measures and then bring the IMF on board with additional financial assistance. Such a scenario seems to be backed by Friday’s Eurogroup statement which said that “in line with the Euro summit statement of 12 July, the Eurogroup stands ready to consider, if necessary, possible additional measures (possible longer grace and repayment periods) aiming at ensuring that Greece's gross financing needs remain at a sustainable level. These measures will be conditional upon full implementation of the measures agreed in the ESM programme and will be considered after the first positive completion of a programme review.” All in all, today’s vote might not be as interesting as another episode of “House of Cards” but it has at least the potential to provide some explosives, even Francis Underwood would pay attention to.

Thursday, August 13, 2015

German growth - strong without being impressive

Neither Greece nor China were able to stop the German economy. According to the just released first estimate of the German statistical agency, GDP grew by 0.4% QoQ in the second quarter, from 0.3% QoQ in 1Q. Compared with the second quarter of 2014, German GDP increased by 1.6%. GDP components will only be released at the end of the month but available monthly data and the statistical agency’s press release indicate that growth was driven by exports and domestic consumption. Investment was a drag on growth. The Eurozone powerhouse has successfully defied external turbulences. Despite the Greek crisis, the Chinese stock market collapse and growth slowdown fears as well as continued weakness in many Eurozone countries, the German economy continued its latest stretch of four consecutive quarters with growth averaging 0.4%. Since the last technical recession in 2012, the economy has grown by an average of 0.3% each quarter. And there is more. Exports have returned as an important growth driver, showing that Germany indeed is one of the main beneficiaries of the weaker euro. Nevertheless, not all that glitters is gold. The fact that record low interest rates, low energy prices and the weak euro have not led to a stronger expansion in our view shows that the German economy has simply reached the end of its long positive virtuous circle of structural reforms and growth. Normally, such a cocktail of strong external steroids should have given wings to the economy. This is not the case. Looking ahead, mixed monthly data have made it difficult to get a good grip on Germany’s growth outlook. While industrial production disappointed in June, new orders were encouraging and soft indicators – despite some recent weakening – remained strong. Record high employment, low inflation and decent wage growth remain strong trumps for the domestic economy and bode well for the second half of the year. However, at the same time, it is not difficult to envision a cyclical cooling of Germany’s export-driven engine. The key buyer of German capital goods, China, is in the midst of a slowdown, while Germany’s service sector and domestic consumption – despite recent positive developments – are currently still not able to fully offset a possible strong hit to exports. After the rebalancing discussion as part of the euro crisis debate, China’s slowdown will now provide new arguments in favour of more domestic investment in Germany. Finally, although highly positive in the context of the euro crisis, the latest improvement in Eurozone periphery countries will not be able to compensate for the continued stagnation of the French economy and its direct impact for German exports. All in all, the first estimate of German Q2 growth just confirmed that the Eurozone’s economic powerhouse is cruising along nicely, despite several external turbulences. While the Eurozone economy seems to see some signs of rebalancing with the stagnation in France and strong growth numbers from Spain and Greece, Germany remains an almost boring beacon of reliability. Carsten Brzeski