MacroScope

UK unemployment — the monthly monetary policy guide

Of the week’s economic data, today’s UK unemployment stands out since the Bank of England has pegged any move up in interest rates to a fall in the unemployment rate from 7.8 percent to below 7.0. The rate is forecast to have held at 7.8 percent in July.

Bank of England Governor Mark Carney has struggled to convince markets of his contention that interest rates are unlikely to rise for three years because the jobless rate will fall only very slowly. Interest rate futures – short sterling – spiked higher after last week’s policy meeting which offered no change of direction and no statement.

There are some key imponderables:
1. To what extent UK firms have kept workers on but worked them less (its certainly true that the jobless rate rose less than expected during Britain’s recession), leaving plenty of scope to ramp up as growth returns without hiring large numbers of new staff.
2. The economy is still three percent smaller than it was in 2008 but no one is quite sure how much activity has been permanently lost during the financial crisis so the size of the output gap is uncertain and therefore so is the level of output at which price pressures start to build.
3. Most importantly, with the Federal Reserve poised to act, can a country like Britain possibly divorce itself from the world’s economic superpower as it sets the global terms of monetary policy?

Carney and colleagues get another chance tomorrow to convince markets of their forward guidance when they testify to a parliamentary committee on their last quarterly inflation report. Monetary Policy Committee member David Miles speaks later today.

European Commission President Jose Manuel Barroso marks the end of the EU’s summer shutdown with his annual speech on the state of the bloc. It tends to be a tour d’horizon of what’s being done to overhaul economies, deepen integration and generally improve the lot of all member states, but it can include specific policy proposals.

Italy’s High Noon

Silvio Berlusconi’s political future – upon which both Italian and euro zone stability rest to varying degrees – is up for debate when a Senate committee meets on Monday to begin discussions that could end with formal procedures to expel him from the Senate. Talks could last for days.

Members of Berlusconi’s centre-right PDL have threatened to walk out of Prime Minister Enrico Letta’s coalition government if a final vote – due in the Senate in October or maybe November – bars him from political life, following the upholding of his conviction for tax fraud.

One of Berlusconi’s key allies says he has already prepared a video message that could announce a decision to bring down the coalition government.

Turning up?

Manufacturing PMI surveys for euro zone countries and Britain will be the latest litmus test of the durability of fledgling economic recoveries.

Even the readings from Spain and Italy have shown improvement over the summer so it may well be that they are the most interesting given we’ve already had flash readings for the euro zone, Germany and France which showed business activity across the currency bloc picked up faster than expected in August.

Having exited recession in the second quarter, further euro zone growth now looks likely in the third.
Britain’s recovery looks more solid still following a 0.7 percent leap in GDP in Q2. Its PMI will be augmented by Bank of England figures on its funding for lending scheme, whereby banks are offered cheap money on the proviso they lend it on to smaller companies.

Euro zone rate cut prospects evaporate

The euro zone is growing again and while its weaker constituents face plenty of tough times yet, it seems less and less likely that the European Central Bank will cut interest rates from their record low 0.5 percent. That illustrates the problems of the new fad of forward guidance.

The ECB deliberately stayed vaguer than most – a product of ripping up its custom of “never precommitting” – saying that rates would stay at record lows or even go lower over an extended period.
Its monthly policy meeting falls next week and in a parallel transparent world Mario Draghi could consign the “or lower” part of the guidance to history after just two months. Don’t bet on that happening but it shows how quickly things can move.

If anyone in Europe, Britain or elsewhere is hoping for a cast iron guarantee that rates won’t rise for two, three or more years, forget it.
Exhibit A today will be Germany’s Ifo sentiment index which has been coming in strong in recent months and is not expected to buck that trend.
It must be only a matter of time before the government and Bundesbank upwardly adjust their forecasts for a significant slowdown in the second half of the year, following 0.7 percent growth in the second quarter.

Back from the beach

Back from a two-week break, so what have I missed?

All the big and ghastly news has come from the Middle East but there have been interesting developments in the European economic sphere.
It seems safe to say that Britain’s economic recovery is on track, and maybe more broadly rooted than in just consumer spending and a housing market recovery (bubble?).

Slightly more surprisingly, the euro zone is back on the growth track too with some unexpectedly strong performances from Portugal and France in particular in the second quarter. Latest consumer morale data have been strong and as a result European Central Bank policymakers have begun downplaying thoughts of a further interest rate cut. However, it’s unlikely that all these countries will grow as strongly in the third quarter. Tuesday’s reading of German sentiment via the Ifo index will be key this week.

Perhaps the biggest surprise was Germany’s Wolfgang Schaeuble admitting what was widely known but hitherto unacknowledged – that Greece will need more financial help. The real shock was not the news but the source; the assumption had been that no one would whisper a word until the German elections are out of the way in four weeks’ time. Angela Merkel has been notably more circumspect about Greece than her finance minister.

Europe may still be ‘on path for a meltdown’: former Obama adviser Goolsbee

Reporting by Chris Kaufmann and Walden Siew

For all the enthusiasm about the euro zone’s exit from recession, many experts believe the currency union’s crisis is more dormant than over. That was certainly the message from Austan Goolsbee, former economic adviser to President Barack Obama and professor at the University of Chicago. He spoke to the Reuters Global Markets Forum this week.  

Here is a lightly edited excerpt of the discussion:

What is your biggest worry about the U.S. economy right now?

A nagging worry is that if we grow 2 percent, it’s going to be a hell of a long time before the unemployment rate comes down to something reasonable. The nightmare worry is that Europe is still basically on path for a meltdown and that it ignites another financial crisis.

In my view the root of the problem is that most of southern Europe is locked in at the wrong exchange rate and will not be able to grow. Normal economics says that with a currency union you can 1) have massive labor mobility, 2) subsidies, 3) differential inflation, 4) grind down wages in the low productivity countries. But those are the only four things.

Recalculating: Central bank roadmaps leave markets lost

Central banks in Europe have followed in the Federal Reserve’s footsteps by adopting “forward guidance” in a break with traditionBut, as in the Fed’s case, the increased transparency seems to have only made investors more confused.

The latest instance came as something of an embarrassment for Mark Carney, the Bank of England’s new superstar chief from Canada and a former Goldman Sachs banker. The BoE shifted away from past practice saying it planned to keep interest rates at a record low until unemployment falls to 7 percent or below, which it said could take three years.

Yet the forward guidance announcement went down with a whimper. Indeed, investors brought forward expectations for when rates would rise – the opposite of what the central bank was hoping for – although the move faded later in the day.

Silvio’s trials

Italy’s Supreme Court last night upheld Silvio Berlusconi’s conviction for tax fraud and a four-year jail term, to the fury of the man who has dominated Italian politics for 20 years and throwing a fragile coalition government into peril.

The markets have been sanguine about Italy, maybe with good reason, since its reform and debt-cutting programme is well in train and no one seems to want fresh elections. But that could change for a country that has always been viewed as “too big to bail” by the euro zone.

Italian bond futures have even risen a little, taking a wait-and-see view. There is of course the little matter of the U.S. non-farm payrolls report looming later, with markets still fixated on the chances of the Federal Reserve slowing its bond-buying programme this year.

Event risk

If you’re hankering after “event risk”, look no further. Europe can offer top central bank meetings, front line economic data, a debt auction and more political risk than you can shake a stick at today.

This could be almost a perfect storm of a day after the Federal Reserve said its bond-buying would continue unabated for now and gave no new firm steer as to when it might begin rowing back, although its choice of adjective to describe the pace of growth – modest rather than the previous moderate – could be a hint that it is in less hurry to taper.

Now, it’s the European Central Bank’s turn. Given its forecast for recovery in the second half of the year has some evidence behind it, an interest rate cut is unlikely. Instead, for the second month running, Mario Draghi may have to focus primarily on the backwash from the Fed.

A Marshall Plan for Greece

The spectacular failure of “expansionary austerity” policies has set Greece on a path worse than the Great Depression, according to a study from the Levy Economics Institute of Bard College.

Using their newly-constructed macroeconomic model for Greece, the Levy scholars recommend a recovery strategy similar to the Marshall Plan to increase public consumption and investment.

“A Marshall-type recovery plan directed at public consumption and investment is realistic and has worked in the past,” the authors of the report said.