Moments difficiles

November 8, 2013

Breaking news is S&P’s downgrade of France’s credit rating to AA from AA+ putting it two notches below Germany. Finance Minister Pierre Moscovici has rushed out to declare French debt is among the safest and most liquid in the euro zone, which is true.

What is also pretty unarguable is S&P’s assessment that France’s economic reform programme is falling short and the high unemployment is weakening support for further measures. There’s also Francois Hollande’s dismal poll ratings to throw into the mix.

As a result, medium-term growth prospects are lacklustre. Euro zone GDP figures for the third quarter are out next week and France is expected to lag with growth of just 0.1 percent.

French bond futures have fallen though not dramatically. They shrugged off the loss of France’s ‘AAA’ status nearly two years ago; yields are significantly lower now than they were then.

Last week’s upgrade of Spain’s rating outlook by Fitch was seen by some as a harbinger of better times. And given the work Madrid has done to increase competitiveness and cut labour costs, exports at least are on the up. France has travelled only a very little way down that road and we know from people right at the top of Europe’s policymaking tree that it is high on their worry list.

It never rains… Data just out have shown showed French industrial output fell 0.5 percent in September, well below forecasts, while the trade deficit has deepened markedly. In contrast, Germany has just posted a record trade surplus for a September with exports rising to all corners of the world.

Washington has launched a broadside against Berlin for its huge surplus which it says unbalances the world economy. Berlin, despite the next coalition government under Angela Merkel considering a minimum wage which along with robust pay rises in a number of sectors could boost domestic demand, will not budge.

The trade data shows how far there is to go – imports dropped 1.9 percent so German consumers are hardly spending freely. Finance Minister Wolfgang Schaeuble is fond of likening the criticism to asking Bayern Munich to play less well to give others a chance. Yesterday, he said latest German tax revenue estimates would not permit a new public spending spree.

Chinese exports have also rebounded in October, pushing its trade surplus above $30 billion so Beijing’s efforts to redirect the economy so that it is driven more by domestic demand is also very much a work in progress.

For the markets, the big number of the day is U.S. non-farm payrolls which will spark a now customary bout of speculation about Federal Reserve tapering one way or the other after Q3 growth came in at an annual 2.8 percent lick, the fastest rate in a year.

After the European Central Bank upended markets with a surprise rate cut, both Joerg Asmussen and Yves Mersch are speaking today, two policymakers who lean towards the hawkish end of the ECB spectrum.

They will be particularly interesting since Mario Draghi divulged that not all of the 23-strong Governing Council wanted to ease policy at this point. Sources told us last night that about a quarter of the 23-man (they’re all men) Governing Council spoke out against a rate cut with Bundesbank chief Jens Weidmann leading the way.

There are numerous questions to ask:
– Was the rate cut purely down to the shock fall in inflation last month or does the ECB see a fledgling recovery grinding to a halt?
– More pointedly, does the ECB’s prediction of a modest recovery in the second half of the year and into 2014 still hold good?
– How much of a part did the euro’s exchange rate play? It remains a little too strong for comfort but has already been falling over the past week.
– Does Thursday’s decision make a further spraying of banks with long-term liquidity more or less likely?

One way of looking at it is that the extension of unlimited liquidity to mid-2015 was the more important measure, since it will tide banks over through the ECB’s health checks next year, which could turn up something nasty.

But with rates now perilously close to the “zero lower bound”, as the jargon has it, the question is what next if the euro zone economy doesn’t perk up and/or deflation becomes a real possibility. Another LTRO would probably be the first step but, while it would be politically difficult, outright QE is not completely out of the question.

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