MacroScope

Stress, stress, stress

The European Central Bank will announce the methodology which will underpin the stress tests of about 130 big European banks next year.

It is caught between the devil and the deep blue sea. Come up with a clean bill of health as previous discredited stress tests did and they will have no credibility. So it is likely to come down on the side of rigour but if in so doing it unearths serious financial gaps, fears about the euro zone would be rekindled and there is as yet no agreement on providing a common backstop for the financial sector.

France, Spain and Italy want a joint commitment by all 17 euro zone countries to stand by weak banks regardless of where they are. Germany, which fears it would end up picking up most of the bill, is worried about the euro zone’s rescue fund, the European Stability Mechanism, helping banks directly without making their home governments responsible for repaying the aid.

The pecking order is clear – a bank’s shareholders, creditors and large depositors would get hit first with national governments picking up the slack thereafter. But if it stops there, the “doom loop” of weak sovereigns propping up stricken banking sectors and each dragging the other down will be unbroken.

Moreover, ECB chief Mario Draghi has intervened to say bondholders shouldn’t be hit in all circumstances, for fear of investor flight.

Forever blowing bubbles?

UK finance minister George Osborne is speaking at a Reuters event today, Bank of England Deputy Governor Charlie Bean addresses a conference and we get September’s public finance figures. For Osborne, there are so many question to ask but Britain’s frothy housing market is certainly near the top of the list.

The government is extending its “help to buy” scheme at a time when house prices, in London at least, seem to be going through the roof (no pun intended). Property website Rightmove said on Monday that asking prices for homes in the capital jumped 10.2 percent in the last month alone.

The Royal Institution of Chartered Surveyors has suggested the Bank’s Financial Policy Committee should cap house price inflation at 5 percent a year. A Bank of England policymaker retorted that it wasn’t down to his colleagues to regulate prices.

How many politicians does it take to change a government?

Talks between Angela Merkel’s CDU and the centre-left SPD will resume on forming a German grand coalition but any agreement is probably weeks away yet.

With the Greens having bowed out at least we now know it will be a joint administration of the big two parties or fresh elections. The former remains odds on.

The SPD is scarred by its experience of coalition in the last decade, when its support slumped, but it’s probably the lesser of two evils for the party since a new vote would be quite likely to increase Merkel’s support. She only just missed out on a rare overall majority first time around.

This little piggy went to market

Italy and Spain are both set to launch syndicated bond sales today, taking advantage of temporarily benign market conditions and maybe with a weather eye on the U.S. debt stalemate which could soon throw the world’s markets into turmoil with an Oct. 17 deadline fast approaching.

After Silvio Berlusconi’s failure to pull down the government, Italy’s political crisis is in abeyance for now and its bond yields have eased back. Spain has issued nearly all the debt it needs to this year already.

It’s not quite “crisis what crisis” but the news flow has been largely positive:
- Portugal (after its own self-inflicted  political crisis over the summer) has seen its borrowing costs fall to their lowest in more than a month after its EU/IMF lenders said it was meeting its bailout goals.
- Greece is predicting an end to six years of recession in 2014 and, just as importantly, a primary surplus.
- And the IMF yesterday predicted Italy, Spain, Portugal, Greece and Ireland (which will soon become the first euro zone member to exit its bailout programme) would all grow next year.

Right time to pump up UK housing market?

The British government is poised to announce the extension of its “help to buy” scheme for potential home owners.

As of today, any buyer(s) of a property up to a value of 600,000 pounds ($960,000) who can put up a five percent deposit, will see the government guarantee to the lender a further 15 percent of the value so a bank or building society will only be lending on 80 percent of the property’s value. Until now, demands for cripplingly large deposits have shut many prospective buyers out of the market.

The big question is whether now – with property prices rising by around 3 percent nationally and by a heady 10 percent annually in London – is a sensible time to be doing this given Britain’s long history of housing bubbles.

Italian market test

Italy will auction three different bonds, aiming to raise 7.5 billion euros against a volatile domestic backdrop.

A sale of one-year bills on Wednesday saw yields rise, this after the Treasury asked parliament to raise the ceiling on this year’s net debt issuance to 98 billion euros from 80 billion, given the struggle to rein in public finances and a government commitment to pay outstanding bills to firms, which at least could give the economy a boost.

Parliamentarians have a bigger fish to fry in the form of Silvio Berlusconi. A cross-party Senate committee that must decide on whether to bar him from political life drew back from the brink on Tuesday but has caused growing tension between the coalition parties with some of Berlusconi’s allies threatening to pull the shaky government down.

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?

Norway shifts tack

Norway’s centre-right swept to power last night, ousting a centre-left government that couldn’t capitalize on a solidly performing economy which escaped the world financial crisis largely unscathed (uncanny echoes of Australia’s weekend election here). The popular feeling seems to have been that a decade of strong growth was wasted and is now slowing.

Erna Solberg, Norway’s second woman premier, will have to govern with the anti-immigration, anti-tax Progress party which could be problematic. But they seem at one on the need for lower taxes at least.

Solberg also wants to revamp the $750 billion oil fund, the world’s biggest sovereign wealth fund. Changes could include breaking it up and requiring it to start investing in Norway, forbidden until now.

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.

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.