MacroScope

Euro zone inflation to fall further?

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Euro zone inflation is the big figure of the day. The consensus forecast is it for hold at a paltry 0.5 percent. Germany’s rate came in as predicted at 0.8 percent on Wednesday but Spain’s was well short at -0.3 percent. So there is clearly a risk that inflation for the currency bloc as a whole falls even further.

The Bundesbank has taken the unusual step of saying wage deals in Germany are too low and more hefty rises should be forthcoming, a sign of its concern about deflation. But the bar to printing money remains high and the European Central Bank certainly won’t act when it meets next week. It is still waiting to see what impact its June interest rate cuts and offer of more long-term cheap money to banks might have.

German retail sales, just out, have risen 1.3 percent on the month in June after a fall in May.

One problem for the ECB will be how to remain in ultra-stimulative mode once U.S. interest rates start to rise. The Federal Reserve is on course to end its QE programme in October and repeated its message yesterday that is in no hurry to raise interest rates.
No tightening is expected before mid-2015 but as the realization grows that it is coming, it could start to have an impact. Strong U.S. GDP data yesterday and the Fed’s upgrading of its assessment of the U.S. economy pointed in that direction. There is little chance of euro zone long-term interest rates decoupling from U.S. ones if they start rising.

UK consumer confidence fell for the first time in six months in July, according to an overnight survey from GfK. The Nationwide building society said UK house prices rose at their slowest pace in 15 months in July and Bank of England policymaker Ben Broadbent said the edge was coming off the housing market. But he said he saw a case for an earlier rate rise though any tightening cycle would be “limited and gradual”.

Fundraising for Kiev

If the hastily drawn up timetable is adhered to an interim Ukrainian government will be formed today. Whatever the line-up, it is likely to repeat its urgent call for aid.

The West, led by the EU, is trying to drum up support – Brussels has already talked with Japan, China, Canada, Turkey and the United States on possible help — but the signals are that big money will only flow after May 25 elections when a permanent government is in place. Can it wait that long? The IMF adds that conditions it imposed on a previous loan offer would still apply, strings that it would be tough for any government in Kiev to meet.

Russia’s next step is the great unknown question but it seems safe to presume that the $12 billion outstanding from its $15 billion bailout of Ukraine will not be forthcoming, at least for now. There is also the prospect of the cut-price charged for its gas zooming back up.

Can they kick it? Yes they can

Click here for suggested soundtrack to this blog 

During the recent round of financial crises, policymakers have done a whole lot of “kicking the can down the road”.

The latest is taking place in the United States where a fiscal stalemate between Republicans and Democrats has forced the first partial government shutdown in 17 years.  It has also raised concerns about a U.S. debt default, should the government not meet a deadline this week of raising the debt ceiling. That has kept short-term U.S. interest rates and the cost of insuring U.S. debt against default relatively elevated.

While markets remain convinced there will be a last-minute deal – because the consequences are far to dire for there not to be – their performance has ebbed and flowed with the mixed messages from Washington.

Economic damage from the shutdown? Small to start, say forecasters

The U.S. government shutdown probably won’t hit the economy too hard, say economists. Some point to the fact the shutdown has come right at the start of the fourth quarter, meaning there’s time before the year’s out for the economy to recoup some of  lost output resulting from the downtime. But, the longer it goes on, the worse it will be.

And there is always that debt-ceiling tail risk – the worst-case scenario being that the U.S. Treasury will default on one or more of its obligations. A Reuters poll on Monday put that risk at less than 10 percent.

Here’s a selection of comments from economists on the impact of the shutdown:

Bridge of Sighs

Greece announced late yesterday that it would need a bridging loan to tide it over until it finds the nearly 12 billion euros of spending cuts demanded by the EU/IMF/ECB troika of inspectors, after which the next tranche of bailout money can flow, probably in September. The troika is due to return next week. There’s no doubt Athens will get the interim money. Jean-Claude Juncker, who chairs the group of euro zone finance ministers, said last week that nobody should fret about Greece’s finances in August. They would be shored up.

Today, Finance Minister Yannis Stournaras is expected to put a draft list of cuts to the leaders of the three parties comprising the country’s ruling coalition, who are rather hemmed in by pledges to voters not to fire civil servants and shun sweeping pensions and public sector wage cuts.

Italian Prime Minister Mario Monti threw in a curve ball last night, saying there was a real prospect that the autonomous island of Sicily could default. It accounts for about 5.5 percent of Italian GDP so shouldn’t wreck the country’s finances but it’s not a step in the right direction. If Italy’s debt mountain of 120 percent of GDP started rising rather than falling, it could be taken very badly by the markets.

Can Greek public opinion be turned?

So we’ve got the fresh Greek elections we expected and markets, despite the inevitability that we would get here, have reacted with some alarm. European stocks have shed  around 1 percent, and the harbour of German Bunds is pushing their futures price up in early trade. The Greeks will try to form a caretaker government today to see them through to elections expected on June 17.

The key question is whether the mainstream parties can mount a convincing campaign second time around, playing on the glaring contradiction in SYRIZA’s position (no to bailout, yes to the euro) and essentially turning the vote into a referendum on euro membership, which the overwhelming majority of Greeks still support. Don’t count on that. SYRIZA remains ahead in the polls.
To be able to pull it off, PASOK and New Democracy will need some help from Europe. There have already been hints from Brussels that if a pro-bailout government is formed, Athens could be given some leeway on its debt-cutting terms. But equally other voices are saying there is no more room for manoeuvre.

France’s Francois Hollande used his presidential debut to frame help for Greece within his push for a European growth strategy last night, saying he hoped that could also foster a return to prosperity there. He and Germany’s Angela Merkel are due in the United States for a G8 summit at the end of the week where doubtless they will come under heavy pressure to make sure Greece doesn’t bomb out of the euro zone or, if it does, that the effect is contained. Easier said than done. Given a Greek euro exit would probably require rapid concerted reaction from the EU, IMF (to shore up Spain?) and the world’s big central banks (remember the global monetary policy response after the collapse of Lehmans?), planning for that could well be bubbling below the surface at the G8.

CDS and the self-fulfilling default

Wall Street-made financial instruments purportedly created to protect investors against default actually hasten corporate bankruptcies, according to a new study. And it’s not Occupy protesters bashing these credit default swaps (CDS) –  the report comes from none other than the New York Society of Security Analysts. Its findings are as follows:

We present evidence that the probability of credit rating downgrade and the probability of bankruptcy both increase after the inception of CDS trading. […]

Lenders who insure themselves by buying CDS protection help push borrowers into bankruptcy, even though restructuring may be a better choice for the firm from the conventional (without CDS protection) lenders’ perspective.

Greek debt – remember the goats

Greece’s creditors have essentially let it off the hook by overwhelmingly agreeing to take a 74 percent loss.  So what better time to  remember  one of the first times Athens got in trouble with paying its debts.

In 490 BC, the bucolic plains before the town of Marathon were the site of a bloodbath. Invading Persians  lost a key battle against Greeks, who were led by the great Athenian warrior Kallimachos, aka Callimachus.

The trouble is, Kallimachos shares some of the difficulty with numbers that  modern Greek leaders appear to have.  Before launching himself upon the  Persians,  he  pledged to sacrifice a young goat to the Gods for every enemy that was killed.

Vultures swoop on Argentina

Holdouts against a settlement of Argentina’s defaulted debt are opening a new front in their campaign for a juicy payout more than a decade after the biggest sovereign default on record.

Lobbyists for some of the investors who hold about $6 billion in Argentine debt are in London to persuade Britain to follow the lead of the United States, which last September decided to vote against new Inter American Development Bank and World Bank loans for Buenos Aires.

Washington believes Argentina, a member of the Group of 20, is not meeting its international obligations on a number of fronts. Apart from the dispute with private bond holders, Argentina has yet to agree with the Paris Club of official creditors on a rescheduling of about $9 billion of debt. It has refused to let the International Monetary Fund conduct a routine health check of the economy. And it has failed to comply with the judgments of a World Bank arbitration panel.

Lessons for Europe from the U.S. single currency

The euro zone is not the only large currency union in the world.  There is also the United States. While it may be pushing things to see California as Germany and Mississippi as Greece, there is still a disparity in the potential of the economies of the U.S. States.

Harvard economics professor Martin Feldstein, the former chairman of  Ronald Reagan’s Council of Economic Advisors, reckons the dollar zone could offer some help to the euro zone. U.S. state deficits are minimal compared with Europe’s, he says in an op ed piece for The Washington Post. Even cash-strapped California’s is only about 1 percent of state GDP.

The secret, according to Felstein , is that all U.S. states have constitutions prohibiting borrowing for operating purposes. Bonds for infrastructure projects, yes. For salaries, services or transport payments, no.