Euro zone ying and yang
The ying. Sources told us last night that Spain may recapitalize stricken Bankia with government bonds in return for shares in the bank. That would presumably involve an up-front hit for Spain’s public finances (it is already striving to lop about 6 percentage points off its budget deficit in two years) which might be recouped at some point if the shares don’t disappear through the floor. The ECB’s view of this will be crucial since the plan seems to involve the bank depositing the new bonds with the ECB as collateral in return for cash. If it cries foul, where would that leave Madrid?
Spain’s main advantage up to now – that it had issued well over half the debt it needs to this year – may already have evaporated after the government revealed that the publicly stated figure for maturing debt of the autonomous regions of 8 billion euros for this year is in fact more like 36 billion. Catalonia said late last week that it needed central government help to refinance its debt. If more bonds are required to cover some or all of Bankia’s 19 billion euros bailout, Spain’s funding challenge in the second half of the year starts to look very daunting indeed.
The yang. Latest Greek opinion polls, five of them, show the pro-bailout New Democracy have regained the lead ahead of June 17 elections although their advantage is a very slender one. If the party manages to hold first place, and secures the 50 parliamentary seat bonus that comes with it, then it looks like it would have the numbers to form a government with socialist PASOK which would keep the bailout programme on the road … for a while.
After a disastrous campaign first time around, maybe New Democracy has got its act together. Its leader, Antonis Samaras was out yesterday bluntly saying his anti-bailout SYRIZA opponents would leave Greece isolated for years and without food, drugs, fuel and power. Sobering stuff. Officials have already told us Greece will run out of money by July if outside money dries up.
Samaras is calling for Greece to be given four years rather than two to make the spending cuts demanded of it. PASOK’s Venizelos says it needs three. Could there be a deal to be done with Brussels and the IMF there? Maybe, but there does seem to be a distinct lack of sympathy from Athens’ international lenders. Over the weekend, IMF chief Lagarde effectively accused Greeks of being tax dodgers and said she was more concerned about the plight of deprived children in Africa. That caused a storm on her Facebook page, causing her to soften her tone a little. Germany’s interior minister chipped in, ruling out pouring money into a Greek “bottomless pit” and a senior Deutsche Bank executive said it was a failed state.
On the Greek exit contingency planning front, British interior minister Theresa May said work was under way to restrict immigration in the event of a financial collapse although she was later slapped down by deputy prime minister Nick Clegg. And the Lloyd’s of London insurance market said it had reduced its exposure “as much as possible” to the euro zone in preparation for a collapse of the single currency.
German Bund futures have slipped as a result of the latest Greek polls but traders said Spain was weighing heavily on the other side of the ledger. European stocks are up 0.7 percent.
All eyes on Wednesday EU summit
After last week’s hefty losses, European stock gained yesterday and are up up again this morning, denoting some optimism about the Wednesday supper summit of EU leaders, which might well be unrealistic.
The European growth measures that we know are in the works – boosting the paid-in capital of the European Investment Bank and plans for ‘project bonds’ underwritten by the EU budget to finance infrastructure – might help a little but will fall a long way short of turning the euro zone economy around, so unless we get something more, on either the growth or the building defences fronts, there’s scope for investor disappointment.
Europe’s international partners continue to demand more dramatic crisis action. After the G8 summit, President Obama was out last night with four demands: - firewalls to protect countries from Greek contagion (are the ESM and IMF funds now viewed as insufficient?), - recapitalization of banks that need it (Spain to the fore here presumably), - A growth strategy to run alongside tight fiscal measures (easier said than done), - easy monetary policy to help the likes of Italy and Spain keep cutting debt (the ECB thinks its 1 percent rate is very loose and is unlikely to cut soon with inflation above target and will only flood the system with more liquidity in utter extremis)
Nothing new there but it keeps up the drumbeat of pressure ahead of the EU get-together. We know French President Francois Hollande, with the backing of others, will press the case for common euro zone bonds at the summit and also know that German opposition will not weaken one jot on that score. Spain’s Rajoy is pressing for more ECB involvement, presumably by reviving its bond-buying programme. Given internal opposition to that within the ECB that is probably the least likely measure to be reactivated, yet anyway.
Despite money flowing out of Greek banks, and at least the threat of it spreading more widely if Greece bombed out of the euro zone, there is no hint yet of any planning for any scheme to underwrite bank deposits across the bloc, probably because the ECB and Germany will not countenance underwriting it. The golden rule of this crisis is that red lines have and will be crossed when it reaches breaking point. We’re not there yet.
With so much focus on Greece and Spain, Portugal has been somewhat overlooked in recent weeks but it will quite likely need a second bailout at some stage and if Greece prompts a wave of contagion, it will be firmly and instantly in the firing line.
Euro election fever
We will return on Monday knowing whether the Greeks have elected a pro-bailout government and probably to find socialist Francois Hollande – the man leading the growth strategy charge – as the new French president.
An Hollande victory could cause some jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than incumbent Nicolas Sarkozy would. Contrary to some reports, he is not intent on ripping up the EU’s fiscal pact and of course the bond market will only allow so much leeway.
The heavyweight Economist magazine may have labelled socialist Hollande “dangerous” but the reality is likely to be that he will rule from the centre and his demands for a dash for growth — and a change to the ECB’s mandate to aid it — will be tempered. Spain has shown everybody that too much fiscal loosening will be pounced upon by the bond market and while there is a lot of talk about a growth strategy for Europe, what we’ve heard so far amounts to tinkering.
While an Hollande victory looks priced in, Greece still has some power to shock the euro zone.
If the two main Greek parties – PASOK and New Democracy – fail to win enough votes to govern together, they may have to turn to a fringe anti-bailout party which would put a big question mark over Athens’ ability to stick with the austerity terms demanded by its international lenders. However, the threat of contagion, while still alive, has shrunk. With creditors already having taken a massive haircut, most non-Greek banks completely out or at least having written down anything they hold, a 500 billion euros rescue fund shortly to be in place and the IMF raising an extra $430 billion of its own, the power Greece has to start a domino effect in the euro zone is diminished. The caveat to that is, if it has to be cut some slack by the EU and IMF, Portugal and Ireland would presumably demand the same and then the whole austerity edifice starts to look wobbly again.
Despite the much vaunted growth strategy, the focus remains on structural reforms (which will take years to bear fruit) plus reconfiguring of some EU funds and a beefed up European Investment Bank. It will help, or at least can’t hurt, but what’s being discussed so far does not look like anything like a game changer, breaking the spiral of debt-cutting deepening economic downturns which in turn will make it yet harder to cut debt.
And those who really count — Merkel and Draghi at the top of the list — insist the austerity drive must not be dimmed. The markets would probably respond well to growth measures which did not undermine debt reduction. But that’s some trick.
“There are human beings involved” in austerity debate
The inventors of democracy and its greatest 18th century champions both go to the polls this weekend. Greek and French voters will try to elect governments they hope will help release their economies from the grips of the euro zone debt crisis.
While exercising their democratic vote, Europeans will also be contemplating another key issue: their basic economic survival.
That is why the debate about austerity versus growth has become so important.
Financial markets see fiscal discipline as crucial to get the euro zone’s debt burden back to sustainable levels. They are going into the Greek elections favoring triple-A rated bonds over peripheral counterparts.
The premium investors require to hold French debt over German Bunds has also risen in the run-up to the French vote as Francois Hollande became the favourite to win.
But as economies fall deeper into recession and double-digit unemployment hurts prospects for growth, the view that austerity alone will not solve the euro zone debt crisis, seems to be gradually winning over some investors in the bond market – the heart of the crisis.
Sanjay Joshi, head of fixed income at London and Capital, says:
Austerity light? Maybe a shade lighter
There is a groundswell building in the euro zone that austerity drives should be tempered.
France’s Francois Hollande, favourite to take the presidency next month, said last night that leaders across Europe were awaiting his election to back away from German-led austerity, and even ECB President Mario Draghi called yesterday for a growth pact.
He was rather opaque on how – although he was clear the European Central Bank would not be doing anything more — but his colleague Joerg Asmussen was a little more forthcoming, saying some EU structural funds could be funneled to countries in crisis to boost employment. These sort of ideas are actively part of the mix and could well be enacted at the June EU summit.
Thay also tally with some of Hollande’s policy slate. He is promoting joint European bonds to finance infrastructure projects, greater investment by the European Investment Bank more efficient deployment of EU regional development resources and a financial transaction tax levied help fund youth and education projects. Some of those options are quite likely to happen. Others much less so.
Reality check: The EU’s German paymasters and the ever-present bond market will only tolerate a marginal shift in direction – you need look no further than at what has happened to Spain and its borrowing costs since it upped its deficit target in March — so there will be not much let-up on the debt-cutting front. Nonetheless, there has been a distinct shift in the rhetoric. Even Angela Merkel is pushing for a more broadly-based minimum wage in Germany, which could be construed as a growth tactic.
Dutch finance minister De Jager says multi-party talks about the 2013 budget have been constructive. They will continue today.
The Netherlands is supposed to hand Brussels its budget deficit target next week – the government was targeting 3 percent of GDP but lost its coalition partners, who demanded a softer goal, and collapsed earlier in the week. With elections not due until September, a failure to cobble together a budget deal by the main parties would lead to a dangerous period of uncertainty.
ECB to the rescue? Hold your horses
ECB policymakers from Mario Draghi down will come at us from all angles today. Expect a united front on the main theme of the moment; calls for it to consider yet more liquidity operations essentially creating money and/or resuming its government bond-buying programme. That call was first heard at the IMF spring meeting over the weekend and the ECB president’s response could hardly have been clearer, saying: “None of the advice of the IMF has been discussed by the Governing Council, in recent times at least”.
Since then a number of his colleagues have followed up. The message: they are looking more to inflation now and banks and governments have to put their own houses in order after the ECB gave them time with its colossal three-year money-creating exercise. The ECB’s man in Spain, Gonzalez-Paramo, is already out this morning saying Spain will not struggle to meet its debt issuance target this year despite its rising yields.
The ECB will, of course, act if the crisis drives Europe right back to the brink, it’s mandate will pretty much demand it at that stage but we’re not anywhere near there yet – contrary to what many in the markets believe.
That things are not good is not in dispute.
The Netherlands pushed itself further into the mire yesterday when its opposition parties refused to back an austerity budget which the government collapsed over earlier in the week. That leaves the prospect of the Dutch failing to present the EU with a budget plan by an April 30 deadline and, more seriously, a period of policy paralysis stretching to elections which will not be held until September.
That vote is also quite likely to usher in an administration opposed to the austerity drive, a theme that is gathering pace within the euro zone, with socialist Francois Hollande, a warm favourite to take the French presidency next month, staking out similar ground and also suggesting the ECB should adopt pro-growth policies.
However, if there is any shift away from debt cutting – and as the IMF says, that is eminently sensible given many of these countries will drive themselves further into recession which would likely add to debt piles – it will be marginal. German opposition and the bond market will only allow a small shift in emphasis. The lessons are already there for all to see. Italy pushed back its balanced budget goal by a year, a small shift, and investors were not alarmed. Spain substantially cranked up its 2012 deficit target and has been slaughtered by the bond market ever since, to the point where many now expect it to need a bailout.
Spanish banks 1, Spanish mortgages 0
The trillion euros lent out by the European Central Bank for three years at a rock bottom interest rates were supposed to do two things – throw a comfort blanket around Europe’s wobbly banks and pump money into moribund economies. Some new data from struggling Spain confirms that while there may be a bit of a case for the former, the latter is still falling short.
Mortgage lending by Spanish banks had their largest annual drop in more than six years in February – coming in at essentially half of what they were a year earlier. There are all kinds of reasons for this, not the least being that large numbers of Spaniards are out of work and house prices are still tumbling with at least one estimate being that they remain as much as 30 percent overvalued.
But given that Spanish lenders were among the biggest taker of the ECB’s largesse (officially known as LTROs, a name only a central banker’s mother could love) the lack of trickle down is less than bracing. The suspicion is that Spain’s banks are holding back on lending because of their wonky balance sheets, which is of course a good thing in itself it it keeps the financial system on its feet.
This would fit with data from the ECB itself showing banks in general are so flush with money they don’t know what to do with it. Tuesday’s ECB’s overnight deposit facility showed banks parking 768 billion euros there. In normal times the amounts are minimal.
So while the money may be helping bank’s rebuild their balance sheets (Goal 1), it is not yet getting into the general economy (Goal 0).
Just ask a Spanish home buyer.
Roubini takes on the ECB
It was fun to watch. Nouriel Roubini, NYU economist and crisis personality, was one of just five carefully selected individuals at a large gathering in the International Monetary Fund HQ1 building’s towering atrium who actually got to ask questions of the policymakers on stage.
Roubini was characteristically biting in his critique of conventional orthodoxy, singling out the European Central Bank for not having done enough to stem the euro zone’s two-year financial crisis. He challenged the notion that the ECB is powerless to boost growth further, suggesting — to the clear discomfort of some policymakers in the room — that measures to weaken the currency could provide a badly-needed boost to exports:
I saw that on the panel there are four central bankers and the panel is about fiscal policy and sovereign debt. So the natural question is then to think maybe about what could be the contribution of central banks in resolving sovereign debt issues. Now, one simple answer would be to just monetize very large budget deficits and I understand why a central bank would say that’s a no-no.
But there’s a more subtle argument and it’s the following one: we know that while fiscal austerity is necessary, in the short-run, as even Christine Lagarde said and the IMF’s work suggests, that has a net recessionary effect on the economy. You’re raising taxes, you’re reducing transfer payments, you’re reducing government spending, so you’re reducing disposable income, you’re reducing aggregate demand. It makes the recession worse and you can get a vicious circle. Not only do you have deleveraging of the public sector but the raising of taxes and cutting of transfer payments induces also deleveraging of the private sector.
So if domestic demand is going to be anemic and weak in this fiscal adjustment because of private and public sector deleveraging you need net exports to improve to restore growth. That’s what happened in emerging market crises. But in order to have an improvement in net exports you need a weaker currency and a much more easy monetary policy to help induce that nominal and real depreciation that is not occurring right now in the euro zone. That’s one of the reasons why we’re getting a recession that’s even more severe. So, can’t we think of monetary policy as helping to induce the change in relative prices that’s necessary to have a restoration of growth if domestic demand is weak through net export improvements?
Roubini was not alone in his critique either, with the ECB coming under pressure from the IMF itself to lower rates further.
ECB Vice President Vítor Constâncio responded by stressing the institution’s price stability mandate as well as the difficulties of synchronizing policy for a group of nations growing at different speeds:
We have only one monetary policy for the average of the euro area. Headline inflation is now at 2.7 (percent). We anticipate, and we have reasons to trust the forecast that inflation in the euro area will be below 2 at the beginning of next year. Nevertheless it’s about 2. Even if you consider core inflation, it’s now at 1.6 – so it’s clearly not in any way a deflation risk. And this would be the reason for us to have a different monetary policy than the one we have now, because that would be directly connected with our mandate regarding price stability in both directions. But that’s not the case right now.
So your implicit view, or recommendation if I may draw that from your question, really would fit much better, even appropriately, with the mandate of the Fed but it’s not what we have in the ECB.
Nevertheless we are doing a lot in view of the situation that inflation expectations are very firmly anchored. That has allowed us to do lots of things. We rely and trust that in the present situation with a weak economy we can be sure of complying with our primary objective so we can do other things and we have done that – but not what you hinted at.
Bank of France Governor Christian Noyer, who was hosting and moderating the event, had spoken about that very same subject earlier during the panel discussion. Like Constâncio, he argued markets should not expect central banks to shoulder too great a burden:
A curate’s egg — good in parts
An action-packed weekend with both good and bad news for the euro zone, which may — net — leave its prospects little clearer.
Item 1: The IMF came up with $430 billion in new firepower to contain the euro zone-led world economic crisis, although some of the money will only be delivered by the BRICS once they have more sway at the Fund. Nonetheless, the figure at least matches expectations and could give markets pause for thought. The official line is that it is for non-euro countries caught up in the maelstrom but no one really believes that. If a Spain is teetering, IMF funds will be there. Together with the 500 billion euros rescue fund set up by the euro zone, there is still barely enough to ringfence both Italy and Spain if it came to it. But will it come to it?
Item 2: Socialist Francois Hollande came out top in the first round of the French presidential election and is now a warm favourite to win. Some fear that could weaken the Franco-German motor which must be humming smoothly if further crisis-fighting measures are to be convincing. Others say he is essentially a centrist who, either way, will be constrained by the realities of the euro zone situation. Domestically, his focus on tax rises over spending cuts and a slower timetable for cuts could drive up French borrowing costs. Attempts by Hollande and President Nicola Sarkozy to woo the substantial votes that went to the far right and far left could lead to some nerve-jangling campaigning messages for the markets to swallow in the run-up to the May 6 second round.
Item 3: The left-field event of the weekend was the collapse of the Dutch government over budget plans. The hawkish Dutch could now delay ratifying the EU’s new fiscal pact. Finance minister De Jager, a hardliner, promises to try and cobble together enough support in parliament for a tough budget but there is absolutely no certainty he will succeed. The standoff raises the prospect of a rating cut and an even smaller band of top-rated euro zone members. Early elections, and a period of limbo, are quite likely – a negative for the euro zone which could well balance out the progress made at the IMF. And polls suggest popular support for austerity is waning in even this “core” euro zone member.
The euro is on the back foot, getting limited support from the IMF deal, with looming Italian and Dutch debt auctions casting a long shadow. Safe haven German Bund futures are up at the open, French bond futures are down, which tells you something. Dutch debt will doubtless come under pressure. The main focus remains on Spain and Italy with the latter trying to sell a variety of debt through the week against an unfavourable backdrop. Concerns about Spain in particular are well justified but it is not yet close to the precipice. The banks are at the heart of the country’s problems and are carrying the biggest burden of bad loans since 1994. They will almost certainly need more capital at some point. On the other hand, the central bank points out that thanks to the ECB’s three-year money offer the banks have loaded up on cash to the extent that their funding needs are covered for this year, and maybe next too. Add to that the fact that Spain has shifted half its government debt issuance for 2012 in the first third of the year and it is clear it has some time to turn around market sentiment, which soured sharply when Madrid reneged on an agreed deficit target back in March.
The European Central Bank remains the key player. Weekly bond-buying data later on Monday are likely to show it remained inactive last week but with Spanish 10-year yields back above six percent, it’s a live issue again. Given the stiff opposition from Bundesbank chief Weidmann and others, who are actually pushing for an exit strategy from extraordinary measures, it is likely that things would have to get a helluva lot worse before the ECB would return to the fray.
The dangers of a bloated ECB balance sheet
Central balance sheets across the industrialized world have increased rapidly in response to the financial crisis, as recently noted on this blog. In Europe, the balance sheet of the ECB and the 17 national central banks that share the euro currency has grown to around 3 trillion euros after the ECB injected more than a trillion into the market in 3-year loans and loosened its collateral standards.
At above 30 percent of gross domestic product, the ECB’s balance sheet has overtaken that of the Bank of Japan, which has been grappling with deflation for some two decades and started from a much higher level. It is also bigger than that of the U.S. Federal Reserve, which has aggressively responded to two financial crises in five years by tripling the size of its balance sheet to nearly $3 trillion today.
Historically, a central bank’s job is to maintain price stability and the value of its currency. The ECB’s non-standard measures have aimed to do just that as the euro zone debt crisis threatened the viability of the euro currency. But a growing and deteriorating balance sheet also comes at a price.
Julian Callow, head of international economics at Barclays explains:
The more the balance sheet rises, the more the ECB has exposure to the euro zone banking system, particularly of course the banking system in countries which are having difficulty in generating private sector financing.
