MacroScope

Data to shape ECB week

Euro zone service sector PMIs and German inflation (with the euro zone number to follow on Tuesday) will lay the ground for the European Central Bank’s first policy meeting of the year.

The surveys are likely to show the currency bloc ended the year on a reasonably robust note with Germany leading the way as always, Italy and Spain showing signs of life and France looking worryingly weak.

Ireland’s reading is already out and has posted its fastest services growth in seven years. Much more importantly for the world, growth in China’s services industries slowed in December, confirming that the world’s second-largest economy lost steam at the end of last year.

German inflation on the EU-compatible HICP measure is forecast to have fallen to 1.4 percent year-on-year in December, from 1.6 in November, not the sort of move the ECB will like to see. We’ve already seen Italian and Spanish inflation come in at just 0.6 and 0.3 percent respectively.

A shock fall in euro zone inflation to 0.7 percent prompted an interest rate cut to 0.25 percent in November (not much scope to lower from there) followed by a chorus of denials that deflation was a threat.

In euro bond markets, world still upside down

Corporate bonds normally yield more than sovereign debt since companies are seen as more likely than states to go bust. But during the euro zone debt crisis, when various governments had to be bailed out, that relationship broke down in Spain and Italy.

Click here for graphic by Vincent Flasseur.

Madrid and Rome are paying more to borrow in the market than similarly-rated companies generally. Ten-year Spanish and Italian sovereign bonds offer a comfortable premium of more than 60 basis points over a basket of BBB-rated corporate debt, even though that gap has more than halved from this year’s highs.

Spain and Italy are also paying more to borrow in the market than BBB-rated companies in their own countries. Calculations by Fathom Consulting using Thomson Reuters data show the average yield for 10-year Italian corporate debt within the euro zone basket is 2.4 percent versus 4.06 percent in the equivalent sovereign. For Spain, the average BBB corporate yield is 2.00 percent – also below a sovereign yield of 4.03 percent.

Banking disunion

The full Ecofin of 28 EU finance ministers meets after Monday’s Eurogroup meeting of euro zone representatives didn’t seem to get far in unpicking the Gordian Knot that is banking union. Ireland’s Michael Noonan talked of “wide differences”.

The ministers are seeking to create an agency to close euro zone banks and a fund to pay for the clean-up – completing a new system to police banks and prevent a repeat of the bloc’s debt crisis.

But a German official rejected a euro zone proposal unearthed by Reuters that would allow the euro zone’s bailout fund, the European Stability Fund, to lend and help finance the cost of any future bank rescues or wind-ups. Berlin does not want to end up footing the bill for failures elsewhere and is still constrained because a coalition deal to form the next government has yet to win final approval from the Social Democrats.

Banking union talks, storm allowing

The finance ministers of Germany, France, Italy and possibly Spain are expected to meet in Berlin to discuss banking union. Two sources told us Dutch Finance Minister Jeroen Dijsselbloem – who chairs the Eurogroup of euro zone finance ministers — should attend as will EU commissioner Michel Barnier and key European Central Bank policymaker Joerg Asmussen.

There is a possibility, however, that a violent storm that has hit Germany could prevent the participants reaching Berlin. If they make it, they will bid to come closer to a solution on a planned European resolution mechanism to deal with troubled banks ahead of a full meeting of euro zone finance ministers next week to help fashion a deal by the end of the year.

The last time the ministers met it didn’t go so well.  

Germany is cool to the original idea that the euro zone clubs together to tackle frail banks. Instead, Berlin wants losses imposed on bank creditors, including bondholders, once stress tests due next year expose any weak links.

ECB forecasts to contrast with Britain’s

The European Central Bank holds its last rates meeting of the year with some of the alarm about looming deflation pricked by a pick-up in euro zone inflation last week – though at 0.9 percent it remains way below the ECB’s target of close to two percent.

The spotlight, as always, will be on Mario Draghi but also on the latest staff forecasts. If they inflation staying well under target in 2015 (which is quite likely), expectations of more policy easing will gather steam again.

For today, another rate cut after last month’s surprise move would be a huge shock. Launching quantitative easing is anathema to much of the Governing Council unless it was clear a Japan-style downward price spiral was in the offing, which it isn’t. The bank’s vice-president, Vitor Constancio, has said the ECB would only cut the deposit rate it pays banks for holding their money overnight – now at zero – into negative territory in an extreme situation.

Putin’s Ukraine “victory” — pyrrhic?

Ukraine continues to top the European worry list.

Monday demonstrated how quickly the financial side of the equation can spiral out of control. The hryvnia currency slumped and the cost of insuring against Ukrainian default soared, forcing the central bank to intervene and urge its citizens not to spark a bank run.

Having turned its back on the EU, Kiev must find more than $17 billion next year to meet gas bills and debt repayments. Presumably Russia will have to help out if it is not to have a basket case on its doorstep.

Has Vladimir Putin factored that into his diplomacy? He is certainly concerned, describing the protestors who blockaded government buildings on Monday of pursuing pogrom – about as loaded a term as he could choose – engineered by “outsiders”, not revolution.

Crisis in Kiev

Ukraine’s shock decision to turn its back on an EU trade deal continues to reverberate with mass rallies on the streets of Kiev in protest at President Viktor Yanukovich’s decision.

To try to defuse tensions, Yanukovich issued a statement saying he would do everything in his power to speed up Ukrainian moves toward the EU. Is this another U-turn or mere semantics? The answer is important.

Kiev must find more than $17 billion next year to meet gas bills and debt repayments. Another sovereign meltdown is far from impossible.
Yanukovich is due to embark on a trip to China. Dare he go? And is the opposition cogent enough to threaten him? The call for a national strike will be an acid test.

Taking the union out of banking union?

Today’s meeting of EU finance ministers will grapple with banking union and next year’s stress tests though with no German government in place, a leap forward is unlikely.

One German official seemed pretty clear yesterday, saying: “We don’t want a mutualisation of bank risks.” That, some would argue, takes the union out of banking union and is certainly a very different approach to the one promised last year when EU leaders were scrambling to keep the euro zone together.

Some experts argue that with the European Central Bank pledging to support euro zone governments come what may, the urgency has been taken out of banking union and that next year’s health checks and cross-border supervision under the ECB is going far enough. Any holes in bank balance sheets can comfortably be filled by creditors and governments.

What is France to do?

It’s euro zone third quarter GDP day and Germany and France are already out of the traps with the latter’s economy contracting by 0.1 percent, snuffing out a 0.5 percent rebound in the second quarter. Growth of 0.1 percent was forecast, not just by bank economists but by the Bank of France too.

Germany failed to match its strong 0.7 percent growth in the second quarter, but expanding by 0.3 percent – in line with forecasts – it is clearly in much better shape.

The Bank of France has estimated stronger growth of 0.4 percent in the final three months of the year but the euro zone’s second largest economy is a growing cause for concern. An OECD report on French competitiveness, released overnight, said it is falling behind southern European countries that have bitten the reform bullet.

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.