Category: eco

Eurozone headline inflation crept back up to 0.0%YoY in October, from -0.1%YoY last month. Oil continues to keep a lid on inflation. Today’s Eurostat flash estimate also shows core inflation at 1.0% (from 0.9% last month). Services inflation, the best gauge of domestically generated inflation pressures available at this stage, increased 0.1%-point to 1.3%YoY.

Today’s inflation figures are the first indication of price developments after Draghi last week worried about the “strength and persistence of the factors that are currently slowing the return of inflation to levels below, but close to, 2%”. These worries were his main justification for effectively pre-announcing more monetary fireworks in December.

But it is hard to find justification for the ECB’s apparently increasing worries in today’s inflation figures. Aside from headline inflation, which this year has been driven primarily by oil, services inflation has been moving sideways this year. Core inflation has even crept up rather than down, now trending around 0.9% versus 0.7% a year ago.

To be fair, Draghi’s worries concern the medium term. But even then, it is hard to escape the notion that inflation was merely an excuse to talk down the euro exchange rate last week. The Eurozone is adding jobs at a decent pace and wage growth in the first half of the year reached 1.8%YoY, suggesting that core inflation will trend up rather than down in the medium term.

Draghi’s inflation anxiety seems even more odd given his own comment, made in June 2013, that low inflation “is not, by itself, bad; with low inflation, you can buy more stuff”. This certainly applies today: with healthy Eurozone nominal wage growth and inflation around zero, real wage growth is now higher than in the run-up to 2008. The strength of Eurozone domestic demand is therefore in no small part attributable to the current low inflation environment.

Looking ahead, we expect inflation to remain around current levels for another month or two. After that, energy will become a less important factor for headline inflation due to ‘base effects’ (consumer energy prices started their steep decent last December). That should cause headline inflation to quickly recover to between 0.5% and 1.0%YoY, weakening somewhat the tailwind for household consumption.

Bank lending to Eurozone businesses fell back in September to 0.1%YoY, down from 0.4%YoY in August (net bank lending adjusted for sales and securitisation). This is disappointing: business borrowing had just turned positive a few months ago after three years of deleveraging. The weakening of business borrowing growth seems at odds with the continuing positive signals sent by soft indicators such as PMIs and last week’s Bank Lending Survey, where banks reported increasing demand for business loans. Chances are therefore that we are looking at a blip, and an upward trend will resume shortly.

In any case, the failure of bank business lending to accelerate looks less bad if one takes into account that bond issuance has been resilient this year. Taking bank lending and bond issuance together, the credit flow to non-financial business turned positive at the start of this year and remains on an upward trend:

Bank lending to households continued to accelerate. Low rates, solid consumer confidence and housing optimism underpin mortgage lending in many Eurozone countries. That said, credit developments continue to diverge markedly between countries. France and Belgium are seeing solid credit growth to both businesses and households. Developments in Germany are more moderate, although bank lending to households is gathering momentum. Net bank lending in the Netherlands is still negative, although housing optimism has returned (the strongly negative reading in business borrowing is almost certainly a glitch as this series is rather volatile month-on-month in the Netherlands). In Portugal, Spain and Ireland, deleveraging is still in full swing. In Italy however, deleveraging is slowly drawing to a close.

Meanwhile, M1-growth is holding well at over 11%YoY. M1 is one of the best leading indicators of the Eurozone business cycle, and its ongoing strength suggests that current consumption growth could well extend in the quarters ahead:

Overall, this M3-report shows a slowly but steadily improving credit environment in the Eurozone. The faltering of bank credit to non-financial business is an important dissonant however, one not (yet) mirrored in other indicators. This may be a glitch, so we’ll be closely watching next month. In any case, it seems difficult to point at this report, with its strong M1-growth, as convincing justification for further monetary easing in December. For that, ECB-president Draghi will have to look elsewhere.

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Hieronder mijn inbreng (schriftelijk en op video). Mijn belangrijkste kritiekpunt is dat de focus op geld eraan voorbij gaat dat krediet de belangrijkste drijver in het financiële systeem is, met geld als bijproduct. Om het financiële stelsel minder bubbelgevoelig te maken, is een directe focus op krediet in het economisch, monetair en toezichtsbeleid naar mijn mening effectiever dan het reguleren van geldschepping:

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Het volledige videoverslag is via deze link te zien. Hieronder mijn bijdrage:

And it’s back to deflation: after five months of readings slightly above zero, Eurozone headline inflation dipped into negative territory again in September. Today’s Eurostat flash estimate shows Eurozone inflation at -0.1%YoY, down from +0.1% in August. The decline is fully attributable to a fall in energy prices: September inflation excluding energy is unchanged at 1.0%. A litre of Euro95 gasoline at the pump fell from €1.43 in August to an average €1.37 in September. For now, Eurozone fuel prices remain above the January low of €1.30 though.

Outside of energy prices, there is little action in September’s inflation numbers. Core inflation held steady at 0.9%. Non-energy industrial goods inflation fell a tenth to 0.3%, while services inflation crept up to 1.3%.

ECB-president Draghi will have to tolerate inflation around zero for just a few more months, as low energy prices continue to drag down headline inflation. From December onwards however, energy will become a less important factor for headline inflation due to ‘base effects’ (consumer energy prices started their steep decent last December). That should cause headline inflation to quickly recover to between 0.5% and 1.0%YoY, where it will likely remain for some time. This may diminish the pressure on the ECB to expand its QE programme. But with continuing high unemployment (unchanged at 11.0% in August) guaranteeing little nominal wage pressure, core inflation looks set to remain well below the ECB’s comfort zone of just below 2% in the foreseeable future. Talk of QE expansion and extension will therefore remain with us for some time.

Eurozone Q2 GDP growth was adjusted upward to 0.4%QoQ in Eurostat’s 2nd estimate, up from 0.3% in the preliminary estimate – although rounding helped a hand here, as growth turned out at 0.36%QoQ. But The first quarter was revised up too, from 0.4% to a genuine 0.52%.

GDP growth was driven primarily by net exports, contributing 0.3%-point to quarterly growth. The fall of the euro in the preceding two quarters has likely contributed to that. As often happens, the jump in net exports ate into inventories, which in turn subtracted 0.1%-point from quarterly GDP. Household consumption remained a reliable growth engine, contributing 0.2%-point. Consumption did decelerate somewhat in Q2 compared to the previous quarters. Investment disappointed, subtracting 0.1%-point from quarterly growth, although that comes right after a strong and upwardly revised first quarter.

Looking at individual countries, the Q2 recovery was made in Germany, but just as well in Spain. Eurostat’s detailed GDP estimate shows that both countries contributed about 0.1%-point to the region’s GDP growth. Italy came in third, contributing 0.05%-point.

In sum, today’s figures show that the Eurozone economy was continuing its modest recovery in the second quarter. The first indications for the third quarter are more of the same. Employment is increasing. July retail sales were decent, showing that consumers continued to spend despite Greek and Chinese turmoil. Soft indicators such as the PMI and the European Commission sentiment survey have improved slightly in July and August, compared to Q2. Moreover, bank lending to non-financial businesses is finally recovering, suggesting that the third quarter may bring a pickup in investment. That would be an especially welcome sign of a broadening recovery.

With upward revisions to both the 1st and 2nd quarters, a 1.5% growth rate for 2015 comes back within reach. That said, risks to the Eurozone outlook remain tilted to the downside, as ECB-president Draghi was at pains to point out last Thursday. That is especially true for inflation: low commodity prices could push headline inflation back towards zero and in any case delays the recovery of inflation towards the ECB comfort zone. An intensification of the ECB’s QE programme is not off the table yet.

Immediate financial losses for Eurozone governments manageable

Although a deal on Sunday remains our base case, the risk of a Grexit is clearly very high. On economic grounds, Grexit should not be the preferred route for either Greece or its Eurozone creditors. There are three main sources of potential damage for creditors:

1. there is short-term economic damage throughout the eurozone as confidence likely gets hurt and a period of uncertainty follows, prompting investments to be postponed and consumers to exercise caution;
2. there is long-term damage to the credibility of the euro as it turns out to be reversible after all. This damage may not manifest itself until the next major economic or financial crisis. But when such a crisis hits, it will be much more difficult to soothe financial markets with a commitment to do “whatever it takes”, as ECB-President Draghi successfully did in 2012;
3. there are potential financial losses to stomach. Greek debt is unsustainable in any scenario, but in case of a Grexit creditors probably need to write off more, for both economic and political reasons. We refrain from estimating expected losses, but restrict ourselves here to setting out total current exposures to Greece in the table below.

1) EFSF-bonds are 165% overcollateralised, however maximum losses should not exceed 100% of EFSF exposure to Greece provided all guarantors pay up. 2) Losses on the €21bn IMF-loan are shared among IMF-member countries worldwide. 3) Actual Greek government bonds holdings per national central bank are unknown. Holdings are allocated to countries using their respective capital keys.
Source: Bloomberg, Macrobond, ECB, IMF, EFSF, Algemene Rekenkamer, ING-calculations

Total current Eurozone exposure in case of Grexit amounts to €316bn. This consists of bilateral loans, loans by the EFSF that are guaranteed by Eurozone sovereigns, and loans by the IMF. Furthermore, sovereigns are exposed to Greece through their national central banks. These hold a remaining €27bn of Greek government bonds, both directly and through the ECB’s Securities Markets Programme. Moreover, the Bank of Greece currently has a Target2-deficit of €100bn with the rest of the Eurosystem. In case of a Grexit, this becomes a Eurosystem claim on the Bank of Greece that the latter may be unable or unwilling to fulfil. Normal Eurosystem-loans and Emergency Liquidity Assistance (ELA) to Greek banks run through the Bank of Greece, and are not included in this table. The Bank of Greece’s Target2-deficit largely reflects these loans and ELA.

Eurozone governments will not immediately feel the consequences of these exposures in case of a Grexit. Firstly, it remains to be seen to what extent these exposures actually need to be written off. A lengthy negotiation process would likely follow Grexit to settle Greek outstanding government debts. Furthermore, bilateral loans and EFSF-loans are not due before 2023. Losses on these loans will therefore not materialise before then. Losses on IMF-loans will also not directly result in an obligation for IMF-member countries (including Eurozone sovereigns) to recapitalise the IMF. This leaves exposure through the Eurosystem, which is 40% of the total €316bn. To avoid doubts about its ability to conduct monetary policy, the Eurosystem might ask for immediate recapitalisation should its exposure prove difficult to recover in the foreseeable future.