Back from the beach

August 26, 2013

Back from a two-week break, so what have I missed?

All the big and ghastly news has come from the Middle East but there have been interesting developments in the European economic sphere.
It seems safe to say that Britain’s economic recovery is on track, and maybe more broadly rooted than in just consumer spending and a housing market recovery (bubble?).

Slightly more surprisingly, the euro zone is back on the growth track too with some unexpectedly strong performances from Portugal and France in particular in the second quarter. Latest consumer morale data have been strong and as a result European Central Bank policymakers have begun downplaying thoughts of a further interest rate cut. However, it’s unlikely that all these countries will grow as strongly in the third quarter. Tuesday’s reading of German sentiment via the Ifo index will be key this week.

Perhaps the biggest surprise was Germany’s Wolfgang Schaeuble admitting what was widely known but hitherto unacknowledged – that Greece will need more financial help. The real shock was not the news but the source; the assumption had been that no one would whisper a word until the German elections are out of the way in four weeks’ time. Angela Merkel has been notably more circumspect about Greece than her finance minister.

The IMF estimates an 11 billion euros hole and Greek finance minister Stournaras came out over the weekend saying 10 billion euros may be needed. Having been leant more than a quarter of a trillion already that may be small enough beer to pass without protest. What would be politically more toxic would be a writedown on Greek bonds, most of which are now held by euro zone government and the ECB. That may be unavoidable eventually but remains a taboo for now, not least since Portuguese and Cypriot bailouts could have to be renegotiated over the next year too.

Some in Brussels are talking about lower interest rates or longer repayment terms on existing loans rather than cold, hard cash – but it amounts to the same thing. ECB policymakers Jens Weidmann and Erkki Liikanen are both speaking today. Bundesbank chief Weidmann has already declared a debt haircut would be a mistake and said the onus is on Athens to implement the required reforms.

The argument will centre around Stournaras’ insistence that any new money should not come with extra conditions. He is out again this morning saying Greece could test the bond market water with a small sale in late 2014 if Athens can achieve a primary budget surplus.

The most important conclusion from the last fortnight is that those optimists who thought the initial “taper tantrum” earlier in the summer around the Federal Reserve’s plan to wind back its bond-buying with new money would be a one-off were sadly mistaken. It’s been another torrid period for emerging economies and despite markets still turning this way and that on each piece of U.S. data (the latest being weak home sales leading to a guess that Bernanke and Co. may not move so soon) it seems an even bet that the Fed will begin putting its plan into action from next month.

September could be one hell of a month and not just because of the U.S. central bank. Germany’s election on Sept. 22 is widely expected to return Merkel to power but the make-up of her coalition will go a long way to dictate Berlin’s approach to the euro zone thereafter. Whether she can govern again with the FDP or have to turn to a grand coalition with the centre-left SPD is a big issue for Europe and could take weeks to sort out after polling day.

September could be crunch time for Italy too, the country labelled “too big to bail”. Members of Silvio Berlusconi’s centre-right party warned on Sunday they would bring down the government and trigger early elections if their centre-left coalition allies voted next month to expel the former prime minister from parliament, following the upholding of his conviction for tax fraud.

There are good reasons for Berlusconi’s PD grouping not to want early elections – not least that the last vote in February showed how unpredictable they could be. But whichever way this plays out, Prime Minister Enrico Letta’s fractious coalition is hamstrung in the meantime and still at odds over competing demands to cut taxes and meet debt-cutting goals.

If Italy ends up with an administration that turns its back on fiscal rectitude, the bond market could quickly take fright and hasten the need for a bailout. Today, Letta’s cabinet meets to discuss measures to cut public administration spending.

Israel, despite the continued absence of a central bank governor to replace Stanley Fischer, has largely escaped the market turmoil spreading from the Fed. If anything, its problem is that the shekel has been too strong in stark contrast to the likes of Turkey, India, Indonesia and Brazil who have scrambled to stem destabilising outflows that have slammed their currencies. Israel is expected to keep interest rates at 1.25 percent today with economic growth strengthening.

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