New face at the ECB

January 13, 2014

The European Central Bank held a steady course at its first policy meeting of the year but flagged up the twin threats of rising short-term money market rates and the possibility of a “worsening” outlook for inflation – i.e. deflation.

The former presumably could warrant a further splurge of cheap liquidity for the bank, the latter a rate cut. But only if deflation really takes hold could QE even be considered.
Sabine Lautenschlaeger, the Bundesbank number two poised to take Joerg Asmussen’s seat on the executive board, breaks cover today, testifying to a European Parliament committee. A regulation specialist, little is known about her monetary policy stance though one presumes she tends to the hawkish.

Iran and the EU announced on Sunday that a deal between Tehran and six major powers intended to pave the way to a solution to a long standoff over its nuclear ambitions will come into force on Jan. 20. Thereafter, negotiations will begin on a final settlement. Brent crude has fallen in response. It’s early days but if oil falls significantly this year, that will factor into fears about deflation taking hold in Europe.

Francois Hollande is due to spell out tomorrow his New Year announcement that French companies who agree to hire more workers could pay lower labour taxes in return. Unemployment is running near to 12 percent and Hollande’s vow to get it falling by the end of 2013 fell short.

Unfortunately, his plan has been eclipsed by his threat of legal action after French magazine Closer alleged he was having an affair with an actress. France tends to overlook its politicians’ peccadilloes but with the economy in a hole, Hollande risks facing the charge that he should be focusing squarely on that. To complicate matters his partner, Valerie Trierweiler, has been admitted to hospital following the reports of his affair.

The odds are this squall will blow over so the far bigger question is about Hollande’s appetite for economic reforms. He has attracted criticism from abroad for being too timid in his reform of the labour market and the welfare state and is hoping this policy will prove to be a game changer. It is risky. Giving a tax cut to companies means either raising taxes on ordinary people, cutting back state spending or both – not a vote winner any way round. But with his approval ratings at rock bottom, Hollande may feel he has little left to lose. He has already declared it time to stamp out abuses of France’s generous welfare state and cut public spending to create room for tax reductions after a series of rises.

Turkey is the story that keeps on giving and we may be approaching the point at which international investors get seriously concerned. Prime Minister Tayyip Erdogan has vowed to forge ahead with judicial reforms which prompted a full-on fist fight in parliament on Saturday. Ask investors for their minimum preconditions and rule of law comes pretty high. More important than the punch-up would be any attempt to exercise control over the judiciary – the government bill would give it more say over the appointment of judges and prosecutors.

Erdogan’s opponents view the bill as an effort to stifle a corruption scandal which has already claimed the scalps of three cabinet ministers. He has cast the investigation as an attempted “judicial coup” meant to undermine him in the run-up to elections this year. He has purged the police of several hundred officers. Today, parliament’s justice commission continues to discuss the draft bill. It is expected to approve the reforms in next 2-3 days.

Italy returns to the bond market for the first time in 2014 with peripheral euro zone bond yields enjoying a storming start to 2014. It will offer up to 8.25 billion euros of bonds maturing in 2016, 2021 and 2028 – a hefty amount. Spain’s Mariano Rajoy will hold talks with Barack Obama in the White House later. Spain’s 10-year yields fell to their lowest in four years after its first bond auction of 2014 sailed out of the door.

Under new EU rules requiring rating agencies to give a timetable for sovereign rulings, Moody’s was supposed to release its judgment on Portugal (potentially more good news) on Friday. It didn’t, so that is still to come.

Scotland’s independence referendum is starting to register on the markets’ radar. Today, the British government will announce it will take responsibility for all British government debt should Scotland vote to leave the United Kingdom, an attempt to ward off any worries on the part of gilt investors.

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