MacroScope

The British government faces another potentially thorny day with the International Monetary Fund delivering its annual review of the UK economy. If David Cameron has a consistent policy, it’s that the only way to get Britain back on its feet is to cut spending and debt. Trouble is, we know the IMF doesn’t agree and advocates a more growth-fostering approach. Finance minister George Osborne has changed rhetorical tack in response but is walking a tightrope as a result.

This comes at a time when there are distinct signs that Cameron’s Conservative party is unraveling and not just over Europe. Unless he gets a grip soon, who knows what further concessions may be made on an EU referendum which could push Britain further towards the exit door. It remains unlikely that the coalition government will fall apart before 2015 elections, not least because the junior, pro-EU Liberal Democrat partners face electoral evisceration according to the polls. It’s even less likely that Cameron will be toppled by fractious members of his party. But it’s no longer impossible.

Britain’s LibDem deputy prime minister will take the unusual step of holding a news conference to say the coalition will hold together until 2015. Another big flashpoint looms this summer with the government’s spending review where hardline Conservatives will push for big welfare cuts and the LibDems will resist. Former foreign secretary Geoffrey Howe, the man who did more than anyone else to end Margaret Thatcher’s reign, says Cameron is losing control of his party. From the other side of the political divide, Peter Mandelson says he has to lead not follow. Hard to argue with either of them.

Monthly UK public sector debt and retail sales figures will give a snapshot of the state of the economy and minutes from the Bank of England’s last policy meeting will show if outgoing governor Mervyn King and a minority continued to press in vain for more money printing.

After a one-day EU summit in Brussels, Cameron will hold evening talks with France’s Francois Hollande. The latter has been calling for more euro zone leaders’ meeting to beef up a drive for united economic government. That would push Britain further to the margins of the EU. The pair have some hatchets to bury. France has sounded distinctly less conciliatory than Germany to Cameron’s stated intention of renegotiating Britain’s relationship with the EU, after which he is promising an in-out referendum.And Cameron’s offer to roll out the red carpet to French entrepreneurs who did not wish to pay Hollande’s 75 percent top tax rate still rankles in Paris.

European Central Bank chief Mario Draghi felt it necessary yesterday to depart from the script at a ceremony awarding an honorary degree to reiterate his message from last Thursday – that the ECB could cut interest rates again and was looking at pushing the deposit rate which it charges banks for holding their funds overnight into negative territory in an attempt to get them to lend again.

Nothing new in the message obviously but the fact he felt the need to repeat it at a forum at which nobody would expect him to could be telling. Draghi has form here. It was at a pre-Olympics conference in London last July that he delivered his “whatever it takes” to save the euro pledge that fundamentally shifted the terms of the currency bloc’s debt crisis.

That the recession-plagued euro zone economy could do with a shot in the arm is beyond question though Draghi insisted countries must not let up on their debt-cutting. Very different tone from the prime ministers of Italy and Spain who demanded action to cut unemployment though Italy’s Enrico Letta said growth could be boosted without increasing debt.

German newspaper Handelsblatt has got hold of a confidential Bundesbank report to Germany’s constitutional court, which sharply criticized the European Central Bank’s bond-buying plan. This could be very big or it could be nothing.

Bundesbank chief Jens Weidmann has made no secret of his opposition to the as yet unused programme and since the mere threat of massive ECB intervention has driven euro zone bond yields lower for months there is no urgency to put it into action. But the OMT, as it is known, is by far the single biggest reason that markets have become calmer about the euro zone, so anything that threatens it could be of huge importance.

The key point is not the Bundesbank’s stance but how the Constitutional Court responds. It is due to consider OMT in June. Through the three-year debt crisis, when Berlin has reluctantly crossed red lines it has had to get the court’s approval. So far, it has always been forthcoming, though sometimes with strings attached. But if it took the Bundesbank’s assertion that bond-buying could “compromise the independence of the central bank” at face value, it is almost certain to have a long hard look. We already know that the court is a potential stumbling block to banking union as it has ruled that any future euro mechanisms would only be in order if Germany’s maximum liability was clearly defined.

With debate about the balance between growth and austerity well and truly breaking out into the open, flash euro zone PMIs – which have a strong correlation to future GDP — are likely to show why a bit of fiscal stimulus is sorely needed. Talk of a European Central Bank rate cut is growing, euro zone policymakers at the G20 last week began to ponder loosening up on debt-cutting in an attempt to foster some growth and European Commission President Jose Manuel Barroso added his voice to the debate yesterday, saying the austerity drive had reached its “natural limit”.

Crucially, we haven’t heard similar from Germany but something is afoot, starting with the certainty that the likes of Spain and France will get more time to meet their deficit targets when the Commission makes a ruling next month. Portugal has already been given more leeway and today its finance minister will spell out new spending cuts which are required after the constitutional court threw out Plan A.

It’s a coincidence, but an interesting one, that this debate – frequently voiced in private over many months – has gone public just as THE academic study from 2010 which asserted that as soon as debt exceeds 90 percent of GDP growth is crushed, has been called into question.

The big euro zone development over the weekend was the re-election of ageing Italian President Giorgio Napolitano for a second term. The presumption is that to put himself through this again he must have got pretty serious expressions of intent from the warring political parties that they will strive for some form of grand coalition. That may have been made easier by the resignation of centre-left leader Bersani who was in danger of splitting his own caucus.

If that comes to pass it should push back the timing of fresh elections until next year at least, a welcome turn for markets which feared a new poll could result in an even more fractured outcome and put more power in the hands of the anti-establishment Five Star movement. All that means we should see a significant rally in Italian assets today. That should also benefit other peripheral euro zone bonds. Safe haven German Bund futures have already dipped at the open, Italian bond futures have leapt almost a full point and European stock futures are pointing upwards.

87-year-old Napolitano will address parliament later and could either rush through consultations with the parties or skip that step altogether since he’s already heard from them ad nauseam.

The euro zone slipped deeper into recession than economists expected in the fourth quarter of 2012 as Germany and France– the region’s two largest economies – shrank 0.6 percent and 0.3 percent respectively on a quarterly basis.

The data is a reminder of the plight still facing the euro zone as it struggles to shake off a three-year debt crisis, which the region has sought to fight with harsh, growth-crimping austerity.

The European Central Bank’s promise to buy the bonds of struggling sovereigns has spurred investors back into those markets and helped reduce borrowing costs. While one trillion euros of cheap funding made available to banks in late 2011 and early 2012 also gave investors greater confidence, the benefits of such policies have yet to translate into improvements in the real economy.

How about living in a fast-growing economy with tame inflation, record-low interest rates, stable exchange rate and shrinking public debt. Sounds like paradise, doesn’t it? But Brazil may be starting to realize that this is also impossible.

Inflation hit the highest monthly reading in nearly eight years in January, rising 0.86 percent from December. It also came close to the top-end of the official target, accelerating to a rise of 6.15 percent in the 12 months through January.

That conflicts with key pillars of Brazil’s want-it-all economic policy. The central bank cut interest rates ten straight times through October 2012 to a record-low of 7.25 percent, saying Brazil no longer needed one of the world’s highest borrowing costs. The government also forced a currency depreciation of around 20 percent last year, aiming at boosting exports and stopping a flurry of cheap imports.

An exercise in divination using the entrails of last week’s U.S. international trade report shows signs of a move with larger implications than just the gaping deficit that caught analysts wrong-footed: the possibility of a persistent burden on the American economy caused by Japanese and German imports, like in the 80s.

The U.S. trade deficit widened 16 percent in November to $48.7 billion, the Commerce Department said on Friday, above the $41.3 billion expected. The negative surprise prompted economists to cut hastily their U.S. gross domestic product estimates for the last quarter to a negligible rate. The stock market took a hit.

The disappointment was limited, however, as analysts attributed the bulky import bill behind the deficit increase to a resumption of merchandise flows into the U.S. after Hurricane Sandy paralyzed port activity in the East Coast the previous month. Some economists still on yuletide mode are, apparently, missing the big picture.

Budget statements from Britain and Ireland take top billing today with UK finance minister George Osborne cutting an increasingly lonely figure in policymaking circles as an advocate of cutting your way back to growth. While the economic policy room for manoeuvre is limited this is a huge political moment. With elections due in 2015, a feeling of recovery must be entrenched in the public’s mind well beforehand if the Conservatives are to entertain hopes of governing alone next time. So measures now and in the 2013 budget in the spring are the best opportunity to change the game.

Osborne has already said he is sticking to his austerity plan – and having made it the government’s central policy plank he has little choice although the opposition Labour party have staked out the opposite ground and hopes to capitalise. Even so, Osborne is likely to have to admit that he will miss his debt-cutting targets so that the pain will have to last for longer, well into the latter part of this decade.

As the euro zone has shown, without growth cutting debt is nigh on impossible. Osborne came into government in 2010 saying the austerity drive would be complete by the time of the 2015 election. He is expected to say today that it will stretch to 2018. Labour’s significant opinion poll lead is widely seen as “soft” but it might not be for long.

A panel of economic luminaries took the stage in Chicago this afternoon to join in a tradition repeated this time of the year in cities across the country, opining on the outlook for the coming year.

Raghuram Rajan, a finance professor at University of Chicago’s Booth School of Business, began with a joke involving 973 sheep and a dog, the butt of which was the intellectual capacity of economic forecasters. He went on to predict slow world growth ahead, highlighting the geopolitical risks from conflict in the Middle East and Asia, and the limits of fiscal and monetary policy to turn things around.

Carl Tannenbaum, Northern Trust’s chief economist, focused on the still-troubled housing market and risks posed by the failure of European political leaders to resolve their financial crisis (he observed that Americans frustrated by the deadlock in Washington over resolving the U.S. fiscal cliff have only to look across the Atlantic for comfort that things, certainly, could be worse).