MacroScope

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.

Berlin says it has more than halved its current account surplus with the euro zone as a share of gross domestic product since 2007. But its global current account surplus is the biggest in the world as a percentage of GDP. It totalled 6.9 percent of GDP last year, higher than the 6 percent threshold that the Commission considers excessive.

One thing is sure; German policymakers will be furious at a time when they are still trying to construct a coalition under Angela Merkel.
As we’ve reported in recent days, the signs are that the next government in Berlin is already heading away from further surrenders of sovereignty. If an in-depth review concluded that the surplus is causing imbalances to Germany’s and Europe’s economy and Germany does not take the recommended steps to fix the problem, the final result can be a fine of 0.1 percent of GDP – which would enrage more than hurt.

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.

Strongly vigilant?

An alarming drop in euro zone inflation – to 0.7 percent from 1.1 percent – throws today’s European Central Bank policy meeting into very sharp relief. Not since the central bank cut interest rates in May has it been under such scrutiny.

No policy change is likely, and “sources familiar” are already talking down the threat of deflation. But the central bankers, who are mandated to target inflation at close to 2 percent, will be alarmed at the sight of price pressures evaporating. One need look no further than Japan to see the damage deflation can do, often for many years.

We reported last week that a strengthening euro has also come onto the ECB’s radar, given it could depress both growth and inflation, and that there are three camps – one wanting an interest rate cut (which we know was discussed at the last meeting), another preferring to keep the option open of another long-term liquidity flood for the banking system as was done last year, and a third wanting to do nothing.

Take-off has been delayed

Euro zone services PMIs and German industry orders data will offer the latest snapshot of the currency bloc’s economy which the European Commission now forecasts will contract by 0.4 percent this year and grow just 1.1 percent in 2014 – hardly escape velocity, in fact barely taxiing along the runway.

We know from flash readings for the euro zone and Germany that service activity expanded but at a slower rate last month. France’s reading crept back into expansionary territory for the first time since early 2012. Any revisions to those figures will be marginal leaving the focus more on Italy and Spain for which we get no preliminary release.

Italy’s service sector has been growing of late, according to the PMIs, while Spain’s has still been shrinking though at a slower pace. German industry orders posted a surprise 0.3 percent drop in August and are forecast to have grown by 0.5 percent in September.

It’s all Greek

The EU/IMF/ECB troika is due to return to Athens to resume a review of Greece’s bailout after some sparring over budget measures.

Greece’s president and prime minister have said they will not impose any further austerity measures and hope that their ability to run a primary surplus will persuade its lenders to cut it some more slack on its bailout loans to make its debt sustainable. The EU and IMF say there will be a fiscal gap next year that must be filled by domestic measures, be they further wage and pension cuts or tax increases.

We had a round of brinkmanship last week with EU officials saying they weren’t going to turn up because Athens had not come up with plausible ways to fill a 2 billion euros hole in its 2014 budget. But on Saturday, the European Commission said the review was back on after the Greek government came up with fresh proposals.

A question of liquidity

The Federal Reserve’s decision to keep printing dollars at an unchanged rate, mirrored by the Bank of Japan sticking with its massive stimulus programme, should have surprised nobody.

But markets seem marginally discomfited, interpreting the Fed’s statement as sounding a little less alarmed about the state of the U.S. recovery than some had expected and maybe hastening Taper Day. European stocks are expected to pull back from a five-year high but this is really the financial equivalent of “How many angels can dance on the head of a pin”. The Fed’s message was little changed bar removing a reference to tighter financing conditions.

However, the top central banks have sent a signal that they think all is not yet well with the world – the Fed, BOJ, European Central Bank, Bank of England, Bank of Canada and Swiss National Bank have just announced they will make permanent their array of currency swap arrangements to provide a “prudent liquidity backstop” indefinitely.

Stress, stress, stress

The European Central Bank will announce the methodology which will underpin the stress tests of about 130 big European banks next year.

It is caught between the devil and the deep blue sea. Come up with a clean bill of health as previous discredited stress tests did and they will have no credibility. So it is likely to come down on the side of rigour but if in so doing it unearths serious financial gaps, fears about the euro zone would be rekindled and there is as yet no agreement on providing a common backstop for the financial sector.

France, Spain and Italy want a joint commitment by all 17 euro zone countries to stand by weak banks regardless of where they are. Germany, which fears it would end up picking up most of the bill, is worried about the euro zone’s rescue fund, the European Stability Mechanism, helping banks directly without making their home governments responsible for repaying the aid.

Forever blowing bubbles?

UK finance minister George Osborne is speaking at a Reuters event today, Bank of England Deputy Governor Charlie Bean addresses a conference and we get September’s public finance figures. For Osborne, there are so many question to ask but Britain’s frothy housing market is certainly near the top of the list.

The government is extending its “help to buy” scheme at a time when house prices, in London at least, seem to be going through the roof (no pun intended). Property website Rightmove said on Monday that asking prices for homes in the capital jumped 10.2 percent in the last month alone.

The Royal Institution of Chartered Surveyors has suggested the Bank’s Financial Policy Committee should cap house price inflation at 5 percent a year. A Bank of England policymaker retorted that it wasn’t down to his colleagues to regulate prices.

Slow motion coalition

Angela Merkel’s CDU and the centre-left SPD will begin formal coalition talks in Germany this week after a meeting of 230 senior SPD members gave the go-ahead on Sunday.

To win the vote, the SPD leadership pledged to secure 10 demands it called “non-negotiable”, including a minimum wage of 8.50 euros per hour, equal pay for men and women, greater investment in infrastructure and education, and a common strategy to boost euro zone growth.

That means thrashing out a policy slate with Merkel’s party is likely to take some time so the betting is an administration won’t be in place until late November at the earliest. SPD chairman Sigmar Gabriel said the aim was to have a functioning government by Christmas.

Greek turning point?

Greece will unveil its draft 2014 budget plan which is expected to forecast an end to six years of recession.

The draft will include key forecasts on unemployment, public debt and the size of the primary surplus Athens will aim for to show it is turning the corner. The government has said any further fiscal belt-tightening will not bring cuts in wages and pensions and that savings will be generated from structural measures.

If even Greece has passed the worst then maybe the euro zone crisis really is on the wane. The FT reports that billionaire John Paulson and a number of other U.S. hedge funds are investing aggressively in Greece’s banking sector, expecting it to get off its knees – an interesting straw in the wind.