MacroScope

France, Italy compare notes

French President Francois Hollande is in Rome for talk with Italy’s Enrico Letta. Both have a lot on their minds.

The French economy contracted in the third quarter and Hollande faces a blanket of criticism over his timid economic reforms (although he has pushed through some labour and pension changes).

The French government announced yesterday an overhaul of a complex tax system, hoping it will douse a public backlash against high taxes (which have been favoured over spending cuts so far) which has led to back-pedalling on several plans this year. It will not lower the overall tax burden but is promising a fairer system to be enshrined in the 2015 budget. Whether that does anything to revive its rock-bottom popularity rating remains to be seen. Detail is scant so far.

Several of the big institutional investors featured at the Reuters Investment Summit this week have been distinctly gloomy about France.

Letta seems finally to have seen off Silvio Berlusconi after the media mogul’s party split and half of it pledged to continue supporting the coalition government. But there is still plenty of disagreement about the 2014 budget, let alone the deeper structural reforms that Italy’s economy needs to lift it out of a decade-long malaise.

ECB quandary

Another round of European Central Bank speakers will command attention today with disappearing inflation fuelling talk of further extraordinary policy moves.

Chief economist Peter Praet, who last week raised the prospect of the ECB starting outright asset purchases (QE by another name) if things got too bad, is speaking at Euro Finance Week in Frankfurt along with Vitor Constancio and the Bundesbank’s Andreas Dombret, while Joerg Asmussen makes an appearance in Berlin.

We know a quarter of the ECB Governing Council didn’t want to cut interest rates (a move which Praet proposed) two weeks ago and more glaring differences could be about to emerge. Printing money would be hugely difficult for German policymakers and their allies to countenance.

Italian shuffle

The decision by one of Silvio Berlusconi’s key allies to break from his party and back Prime Minister Enrico Letta’s fragile coalition appears to have shored up the Italian government with a final vote on expelling the media magnate from public life looming large.

Berlusconi said on Saturday his rump centre-right party had split from the coalition but did not have the numbers to bring it down.
Angelino Alfano, interior minister and deputy premier, said all five of the centre-right ministers under his umbrella would stay in the government but there is still plenty of disagreement within the coalition about the 2014 budget and doubts about Letta’s ability to push through meaningful economic reforms.

Letta is speaking at a conference “Charting the Way Ahead” today. On Sunday, economy minister Fabrizio Saccomanni said he wanted to accelerate public spending cuts following Friday’s criticism of the draft budget by the European Commission, which it said could break the bloc’s debt rules.

Taking the union out of banking union?

Today’s meeting of EU finance ministers will grapple with banking union and next year’s stress tests though with no German government in place, a leap forward is unlikely.

One German official seemed pretty clear yesterday, saying: “We don’t want a mutualisation of bank risks.” That, some would argue, takes the union out of banking union and is certainly a very different approach to the one promised last year when EU leaders were scrambling to keep the euro zone together.

Some experts argue that with the European Central Bank pledging to support euro zone governments come what may, the urgency has been taken out of banking union and that next year’s health checks and cross-border supervision under the ECB is going far enough. Any holes in bank balance sheets can comfortably be filled by creditors and governments.

What is France to do?

It’s euro zone third quarter GDP day and Germany and France are already out of the traps with the latter’s economy contracting by 0.1 percent, snuffing out a 0.5 percent rebound in the second quarter. Growth of 0.1 percent was forecast, not just by bank economists but by the Bank of France too.

Germany failed to match its strong 0.7 percent growth in the second quarter, but expanding by 0.3 percent – in line with forecasts – it is clearly in much better shape.

The Bank of France has estimated stronger growth of 0.4 percent in the final three months of the year but the euro zone’s second largest economy is a growing cause for concern. An OECD report on French competitiveness, released overnight, said it is falling behind southern European countries that have bitten the reform bullet.

Brussels looks warily at German surplus

Barring a last minute change of heart, the European Commission will launch an investigation into whether Germany’s giant trade surplus is fuelling economic imbalances, a charge laid squarely by the U.S. Treasury but vehemently rejected by Berlin.

This complaint has long been levelled at Germany (and China) at a G20 level and now within the euro zone too. Italian Prime Minister Enrico Letta urged Berlin this week to do more to boost growth.

Stronger German demand for goods and services elsewhere in the euro zone would surely help recovery gain traction. The counter argument is that in the long-run, only by improving their own competitiveness can the likes of Spain, Italy and France hope to thrive in a globalised economy.

French travails

The Bank of France’s monthly report forecasts growth of 0.4 percent in the last three months of the year, up from an anaemic 0.1 percent in the third quarter. That still makes for a fairly doleful 2013 as a whole.

France is zooming up the euro zone’s worry list, largely because of its timid approach to labour and pension reforms. Spain has been much more aggressive and is seeing the benefits in terms of rising exports (and, admittedly, sky-high unemployment). So too has Portugal.

Tellingly, both the Iberian countries have had the outlook on their credit ratings raised to stable in recent days while S&P cut France’s rating to AA from AA+. It remains at a far stronger level but the differing directions of travel are clear.

United on banking union?

Reuters reported over the weekend that Angela Merkel’s Conservatives and the centre-left SPD had agreed that a body attached to European finance ministers, not the European Commission, to decide when to close failing banks.

At the risk of blowing trumpets this will make the euro zone weather in the week to come and could open the way for agreement on long, long-awaited banking union by the year-end.

Up to now, Berlin has chafed against the European Commission’s proposal that it should be in charge of winding up banks and the path to a body to act on a cross-border basis looked strewn with obstacles.

Another backhand volley from forward guidance

Forward guidance is quickly proving to be rather backward.

While it’s a favourite game of every punter who’s not paid to make predictions to trash the track record of those who are, just about everyone who follows the European Central Bank was stunned by the timing of its decision to cut rates on Thursday.

In the days beforehand, a handful of forecasters began speculating after news of a collapse in inflation that the ECB might fire what could be their last shot on standard monetary policy using interest rates in a long time.

But the vast majority were caught off guard by the ECB’s refinancing rate cut to a record low of 0.25 percent. Even those who thought it might do so didn’t think it would until December. The quick, violent fall in the euro showed it.

Moments difficiles

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.