MacroScope

New face at the ECB

The European Central Bank held a steady course at its first policy meeting of the year but flagged up the twin threats of rising short-term money market rates and the possibility of a “worsening” outlook for inflation – i.e. deflation.

The former presumably could warrant a further splurge of cheap liquidity for the bank, the latter a rate cut. But only if deflation really takes hold could QE even be considered.
Sabine Lautenschlaeger, the Bundesbank number two poised to take Joerg Asmussen’s seat on the executive board, breaks cover today, testifying to a European Parliament committee. A regulation specialist, little is known about her monetary policy stance though one presumes she tends to the hawkish.

Iran and the EU announced on Sunday that a deal between Tehran and six major powers intended to pave the way to a solution to a long standoff over its nuclear ambitions will come into force on Jan. 20. Thereafter, negotiations will begin on a final settlement. Brent crude has fallen in response. It’s early days but if oil falls significantly this year, that will factor into fears about deflation taking hold in Europe.

Francois Hollande is due to spell out tomorrow his New Year announcement that French companies who agree to hire more workers could pay lower labour taxes in return. Unemployment is running near to 12 percent and Hollande’s vow to get it falling by the end of 2013 fell short.

Unfortunately, his plan has been eclipsed by his threat of legal action after French magazine Closer alleged he was having an affair with an actress. France tends to overlook its politicians’ peccadilloes but with the economy in a hole, Hollande risks facing the charge that he should be focusing squarely on that. To complicate matters his partner, Valerie Trierweiler, has been admitted to hospital following the reports of his affair.

ECB rate cut expectations to be left deflated

Euro zone inflation has dropped to just 0.8 percent and the core measure is lower still – at 0.7 percent it has fallen pretty consistently over the last year.

Nonetheless, the European Central Bank is likely to sit tight at its policy meeting today. The Bank of England’s rate setters are also meeting but facing a very different set of problems.

It’s probably too early for any dramatic moves but the ECB may well be pushed into easing policy if inflation refuses to pick up and/or the banks clam up ahead of this year’s health tests. Today, Mario Draghi is likely to reaffirm its readiness to act.

Lew’s comes to Europe airing concerns

U.S. Treasury Secretary Jack Lew moves on to Berlin then Lisbon after spending yesterday in Paris. There, he urged Europe to do more to build up its bank backstops and capital, a fairly clear indication that Washington is underwhelmed by the German model of banking union which has prevailed.

Lew may also press for more German steps to boost domestic demand, after indirectly criticising Berlin for its policies during his last visit in April. If he does, he can expect a robust response from Schaeuble, at least in private.

Lew moves on to Portugal later in the day with Lisbon’s planned exit from its EU/IMF bailout presumably top of the agenda when he meets Prime Minister Pedro Passos Coelho.

S&P’s year-end broadside

Any sense of euphoria EU leaders felt about agreeing a plan to underpin Europe’s banks – which should have been muted anyway – may be tempered by S&P’s decision to cut the bloc’s credit rating to AA+ from AAA.

In global terms that’s still rock solid but the rationale – flagging “rising risks to the support of the EU from some member states” has some resonance. On the upside, the agency affirmed its rating of Ireland following its bailout exit and kept its outlook positive. Presumably, S&P is clearing the decks before Christmas because it also reaffirmed the UK’s top notch AAA rating, and reaffirmed South Africa too.

The EU quote packs a punch following a banking union deal where Germany successfully saw off plans for euro zone countries to help each other in tackling problem lenders.

Banking union … timber not steel

A day after she was sworn in for a third term and a day before she attends an EU summit in Brussels, Chancellor Angela Merkel delivers a speech in the Bundestag lower house. She will then head to Paris in the evening for a meeting with French President Francois Hollande. That bilateral could be the moment that the seal is set on banking union, in time for the Thursday/Friday EU leaders summit.

In parallel, the bloc’s 28 finance ministers will meet in Brussels to try and finalise a common position on the detail. “For the acceptance of the euro on financial markets, the banking union is very important,” Merkel said on Tuesday.

For the markets, it will be impossible to look beyond today’s Federal Reserve policy decision which might, or might not, start the process of slowing the pace of money-printing which has been churning out $85 billion a month. But banking union is hugely important too.
Euro zone finance ministers made progress overnight, essentially agreeing the blueprint Reuters reported exclusively over the weekend.

Game of chicken in Kiev

No sign of tensions calming on the streets of Kiev, in fact today we could have a new flashpoint.

Prime Minister Mykola Azarov’s cabinet is holding its weekly meeting in the government building which protesters have blockaded since Monday, paving the way for a possible showdown.

Popular pressure, following President Viktor Yanukovich’s decision to reject an EU trade deal and turn back to Russia, is being matched by the markets, and it is from there that the potential tipping point could come.

French travails

The Bank of France’s monthly report forecasts growth of 0.4 percent in the last three months of the year, up from an anaemic 0.1 percent in the third quarter. That still makes for a fairly doleful 2013 as a whole.

France is zooming up the euro zone’s worry list, largely because of its timid approach to labour and pension reforms. Spain has been much more aggressive and is seeing the benefits in terms of rising exports (and, admittedly, sky-high unemployment). So too has Portugal.

Tellingly, both the Iberian countries have had the outlook on their credit ratings raised to stable in recent days while S&P cut France’s rating to AA from AA+. It remains at a far stronger level but the differing directions of travel are clear.

A question of liquidity

The Federal Reserve’s decision to keep printing dollars at an unchanged rate, mirrored by the Bank of Japan sticking with its massive stimulus programme, should have surprised nobody.

But markets seem marginally discomfited, interpreting the Fed’s statement as sounding a little less alarmed about the state of the U.S. recovery than some had expected and maybe hastening Taper Day. European stocks are expected to pull back from a five-year high but this is really the financial equivalent of “How many angels can dance on the head of a pin”. The Fed’s message was little changed bar removing a reference to tighter financing conditions.

However, the top central banks have sent a signal that they think all is not yet well with the world – the Fed, BOJ, European Central Bank, Bank of England, Bank of Canada and Swiss National Bank have just announced they will make permanent their array of currency swap arrangements to provide a “prudent liquidity backstop” indefinitely.

Beware the bias in euro zone forecasts (again)

Next time you ask an economist a question about the euro zone, be sure to enquire where their head office is based.

London? New York? Expect a pessimistic response on euro zone matters.

Frankfurt? Paris? Happier days are coming soon for the currency union.

So that’s oversimplifying matters slightly – but as we’ve seen time over, institutions based outside the euro zone are likely to be gloomier about its prospects, and those based inside it are more likely to look on the bright side.

That pattern was clear to see in this week’s Reuters poll on the euro zone’s vulnerable quartet – Greece, Ireland, Portugal and Spain.

A jobless guide to interest rates

The Bank of England’s decision to peg any move in interest rates to the downward progress of unemployment has invested the monthly figures, due today, with huge importance.

In a nutshell, markets don’t believe the jobless rate will take the best part of three years to fall from 7.7 percent to below 7.0, the point at which the Bank said it could consider raising rates from a record low 0.5 percent. For what it’s worth, the consensus forecast is for the rate to be unbudged at 7.7 in August.

There are some reasons to think the Bank might be right – an ageing population working longer, slack within companies (such as part-time working) which can be ramped back up again before any new hiring takes place – but if markets continue to price in a rate rise early than the Bank expects, then it has de facto policy tightening to deal with.