MacroScope

Banking — union or disunion

EU finance ministers face the mammoth task of finalizing everything on banking union that was set out in principle by their leaders at a December summit, since when not much has happened. Last night, the Eurogroup of euro zone finance ministers made little progress bar agreeing that they needed to agree quickly.

Intractable issues such as who decides when a bank is failing, how a decision is taken to wind down a failing bank, what is the precise role of the European Central Bank, European Commission and European Parliament and how long it will take to build up a fund from bank levies to pay for failing lenders all have to be sorted out.

Plan A was for the fund to be built up over 10 years and then be pooled but critics say that leaves the bloc’s governments exposed for too long.

European governments disagree not only amongst themselves on the details but also with the European Parliament, which must give its blessing before the project can become law.

Negotiations are set to stretch into Wednesday. If agreement is not reached this week the parliament will run out of time before May elections and then the project will face months of further delay.

Unsterilised ECB?

Foreign ministerial talks in Paris yesterday made little progress on Ukraine. Russia rejected Western demands that its forces in Crimea should return to their bases and its foreign minister refused to recognise his Ukrainian counterpart. Moscow continues to assert that the troops that have seized control of the Black Sea peninsula are not under its command. The West is pushing for international monitors to go in.

Today, at least some of the focus switches to Brussels where EU leaders will hold an emergency summit with a twin agenda of how to help the new government in Kiev and possible sanctions against Russia. On the latter, Europe has appeared more reticent than Washington not least because of its deep financial and energy ties, none more so than Germany and Britain.

The bloc yesterday offered Ukraine’s new government 11 billion euros in financial aid over the next two years, contingent on it reaching a deal with the IMF. It will also freeze the assets of ousted president Viktor Yanukovich and 17 others seen as culpable for violation of human rights – around 80 people were killed in the capital last month as they protested against Yanukovich’s rule. Kiev caused some market wobbles by saying it would look at restructuring its foreign currency debt.

Why UK rates are well below “normal” in one labour market chart

Much ink has been spilled over the past several months over when the Bank of England will eventually raise interest rates from a record low of 0.5 percent, and if they’ll do it before the Federal Reserve does. The pound is trading near a five-year high against a basket of currencies as a result.

BoE Governor Mark Carney and other Monetary Policy Committee members have tried to remind the public and businesses at every chance they are given that a rate rise is still a way off – likely at least a year – and that when it’s time for the central bank to lift rates, it will do so gradually.

Much of the focus until the BoE’s February Inflation Report, published last week, was on the jobless rate and how quickly it has fallen. The latest data show a slight rise to 7.2 percent, so a bit above the 7 percent rate the BoE said it would have to fall below to trigger discussions on rate rises.

Ukrainian tipping point

Violence in Ukraine has escalated to a whole new level. The health ministry says 25 people have been killed in fighting between anti-government protesters and police who tried to clear a central square in  Kiev. The crackdown, it seems, has been launched.

President Viktor Yanukovich met opposition leaders for talks last night but his opponents, Vitaly Klitschko and Arseny Yatsenyuk, quit the talks without reaching any agreement on how to end the violence and said they would not return while blood is being shed.

The opposition are pressing for changes to the constitution which would curb the powers of Yanukovich and allow for the appointment of a technical government. Yanukovich is yet to name a new prime minister. If he names a hardliner, that could prove incendiary.

High unemployment putting the ECB in isolation

 

Unemployment in the euro zone is stuck at 12 percent, an already high rate that masks eye-popping rates in many of its struggling member economies.

But in a press conference lasting one hour, European Central Bank President Mario Draghi mentioned the problem of high unemployment only a few times – satisfied with the central bank’s usual stance of imploring euro zone governments to implement structural reforms to their labour markets, on a case by case basis.

Draghi said:

 … although unemployment in the euro area is stabilising, it remains high, and the necessary balance sheet adjustments in the public and the private sector will continue to weigh on the pace of the economic recovery.   

ECB – stick or twist?

 

The European Central Bank meets today with emerging market disorder high on its agenda.

It’s probably  too early to force a policy move – particularly since the next set of ECB economic and inflation forecasts are due in March – but it’s an unwelcome development at a time when inflation is already uncomfortably low, dropping further to just 0.7 percent in January, way below the ECB’s target of close to but below two percent.

If the market turbulence persists and a by-product is to drive the euro higher, which is quite possible, the downward pressure on prices could threaten a deflationary spiral which ECB policymakers have so far insisted will not come to pass.

A week before emerging-market turmoil, a prescient exchange on just how much the Fed cares

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The last seven days has been a glaring example of fallout from the cross-border carry trade. That’s the sort of trade, well known in currency markets, where investors borrow funds in low-rate countries and invest them in higher-rate ones. Some $4 trillion is estimated to have flooded into emerging markets since the 2008 financial crisis to profit off the ultra accommodate policies of the U.S. Federal Reserve, Bank of Japan, European Central Bank and the Bank of England. Now that central banks in developed economies are looking to reverse course and eventually raise rates, that carry trade is unraveling fast, resulting in the brutal sell-off in emerging markets such as Turkey and Argentina over the last week.

The Fed’s decision on Wednesday to keep cutting its stimulus effectively ignores the turmoil in such developing countries. And while the Fed may well be right not to overreact, it makes one wonder just how much attention major central banks pay to the carry trade and its global effects — and it brings to mind a prescient exchange between some of the brightest lights of western economics, just a week before emerging markets were to run off the rails.

On January 16, minutes before Ben Bernanke took the stage for his last public comments as Fed chairman, the Brookings Institution in Washington held a panel discussion featuring former BoE Deputy Governor Paul Tucker, Harvard University professor Martin Feldstein and San Francisco Fed President John Williams. They were asked about the global effects of U.S. monetary policy:

Forward guidance is not fully living up to its name

Britain’s economy may have seen one of the fastest rebounds among industrialized nations last year, but half of 56 economists polled by Reuters think the Bank of England has lost some credibility over its handling of the forward guidance policy.

The policy – an advance notice that monetary conditions will not be tightened too fast or too soon – was a way of managing market bets, at a time when the scope for stimulating economies through conventional interest rate cuts was limited.  Many say it was a necessary transition from the ultra-loose rate policy of recent years to a more normal post-crisis one. Indeed, the use of verbal intervention to guide monetary policy has been on the rise in recent years, as shown by this graphic on the Federal Reserve. 

But the BoE’s forward guidance has come under a lot of criticism and its results have been mixed, as highlighted by this Reuters story  and FT blog.

Shock now clearly trumps transparency in central bank policymaking

The days of guided monetary policy, telegraphed by central banks and priced in by markets in advance, are probably coming to an end if recent decisions around the world are any guide.

From Turkey, which hiked its overnight lending rate by an astonishing 425 basis points in an emergency meeting on Tuesday, to India which delivered a surprise repo rate hike a day earlier, central banks are increasingly looking to “shock and awe” markets into submission with their policy decisions.

A wide sample of economists polled by Reuters on Monday already expected a massive rise of 225 basis points by Turkey’s central bank to stop a sell-off in the lira. Instead it doubled the consensus and opted for the highest forecast.

Ker-pow! Turkey leaps to lira’s defence

 

Turkey’s central bank bit the bullet last night, despite Prime Minister Tayyip Erdogan calling for it to hold firm just hours beforehand, and what a bite it was.

After months trying to avoid a rate rise it put 4.25 full percentage points on the overnight lending rate, taking it to 12 percent. No one can accuse Governor Basci of being under the government’s thumb now. The move vaulted expectations.

The big questions for Turkey are what such a magnitude of tightening, which the central bank said would persist, does to a faltering economy and how Erdogan, who is on a two-day trip to Iran, reacts.