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Thursday, 7 March 2013

There is an elephant in the room for Mario Draghi: Euro appreciation. Mario sees nothing and hears nothing!

Today was the day of the monthly ECB speech, concerning the most important European interest rates: the fixed rate for refinancing operations (refi rate) and the marginal lending facility. Both rates stayed unaltered, in comparison to the previous month; respectively 0.75% and 1.5% for the refi rate and the marginal lending facility. As most analists didn’t expect the rates to change, little was surprising in today’s interest event.

For this reason, the most important part of today was the speech by the chairman of the ECB, Mario Draghi, which accompanied the news on the interest rates: this speech could supply useful information on future rate changes.

Here are the pertinent snips of Draghi's speech combined with my comments:

… we decided to keep the key ECB interest rates unchanged. HICP inflation [harmonized consumer prices index- EL]  rates have declined further, as anticipated, and fell below 2% in February. Inflation expectations for the euro area remain firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. Overall, this will allow our monetary policy stance to remain accommodative.

My comments: Draghi states here in plain English: we maintain our policy of printing extra money, as long as the inflation rate allows us to do so.

Available data continue to signal that economic weakness in the euro area has extended into the beginning of the year, while broadly confirming signs of stabilisation in a number of indicators, albeit at low levels. At the same time, necessary balance sheet adjustments in the public and private sectors will continue to weigh on economic activity. Later in 2013 economic activity should gradually recover, supported by a strengthening of global demand and our accommodative monetary policy stance.

My comments: The distinguished economic trendwatcher and "Dutch Doctor Doom" Kees de Kort always states concerning this kind of fact-free predictions: “soon everything will be better (S.E.W.B.B)”. Where Draghi exactly sees the strengthening global demand is an enigma, but he sees it (presumably). Draghi: “By the way, did I tell you that we will print extra money”.

In order to support confidence, it is essential for governments to continue implementing structural reforms, to build further on the progress made in fiscal consolidation, and to proceed with financial sector restructuring. We are closely monitoring conditions in the money market and their potential impact on the stance of monetary policy and the functioning of the transmission of our monetary policy to the economy. Our monetary policy stance will remain accommodative with the full allotment mode of liquidity provision.


Let me now explain our assessment in greater detail, starting with the economic analysis. The GDP outcome for the fourth quarter of 2012 was weak, with Eurostat’s second estimate indicating a contraction of 0.6% quarter on quarter. The decline was largely due to a fall in domestic demand but also reflected weak exports. As regards 2013, recent data and indicators suggest that economic activity should start stabilising in the first part of the year. A gradual recovery should commence in the second part, with export growth benefiting from a strengthening of global demand and domestic demand being supported by our accommodative monetary policy stance.

My comments: Draghi hopes to spur investments with the extended money supply in Europe and fantasizes over a strengthening global demand in the second half of 2013. However, when you look really well at the latest, somewhat weakening American and Chinese fundamentals data, this strengthening global demand is not a dead-cert yet. And further, he states: “DIDN’T YOU PAY ANY ATTENTION, GUYS?!?! OUR PRINTING PRESS IS GOING BERZERK!!!!. YOU WILL HAVE MUCHO, MUCHO DINERO, IF YOU NEED IT!!” 

The Governing Council continues to see downside risks surrounding the economic outlook for the euro area. The risks relate to the possibility of weaker than expected domestic demand and exports and to slow or insufficient implementation of structural reforms in the euro area. These factors have the potential to dampen the improvement in confidence and thereby delay the recovery.

My comments: this part of the speech sums up nicely the downside risks of this year: disappointing exports and disappointing domestic demand all over Europe.  And last, but not least, a disappointing improvement of the monetary / economic situation in the Euro-zone, where things seem to be slightly better, but where the smallest shock (Italy) can cause the situation to deteriorate quickly again.

In the Governing Council‘s assessment, risks to the outlook for price developments continue to be seen as broadly balanced over the medium term, with upside risks relating to stronger than expected increases in administered prices and indirect taxes, as well as higher oil prices, and downside risks stemming from weaker economic activity.

My comments: Draghi is right here when he sees increased indirect taxes as an inflationary risk. A number of countries already increased the VAT-level (i.e. Value Added Tax), as well as the level of taxes and duties on products, like oil and gas derivatives and alcohol. 

While most European citizens are currently living a life of frugality, the tax-addicted governments still try to compensate for their decreased direct tax income by increasing indirect taxes. This indeed spurs inflation.

The annual growth rate of loans (adjusted for loan sales and securitisation) to non-financial corporations stood at -1.5% in January, after -1.3% in December 2012. The annual growth in MFI loans to households moderated slightly to 0.5%, from 0.7% in December. To a large extent, subdued loan dynamics reflect the current stage of the business cycle, heightened credit risk and the ongoing adjustment of financial and non-financial sector balance sheets. At the same time, available information on the access to financing of non-financial corporates indicates tight credit conditions for small and medium-sized enterprises.

My comments: While Draghi and his peers hope for economic stabilization in 2013HY1 and improvement in 2013HY2, the mentioned data on business and consumer loans seems to point in the other direction.

The euro area-wide general government deficit is expected to have declined from 4.2% of GDP in 2011 to 3.5% of GDP in 2012 and is projected to be reduced further to 2.8% of GDP this year. Governments should build on this progress with a view to further restoring confidence in the sustainability of public finances. At the same time, fiscal consolidation must be part of a comprehensive structural reform agenda to improve the outlook for job creation, economic growth and debt sustainability. In the view of the Governing Council, it is of particular importance at this juncture to address the current high long-term and youth unemployment. To this end, further product and labour market reforms are needed to create new job opportunities by supporting a dynamic, flexible and competitive economic environment.

My comments: It is very good that Draghi makes this point in red and bold: the European governments do their best to reduce the general government deficit, in order to stay in tune with the European Stability and Growth Pact (SGP). These governments seemingly do so successfully. 

However, the governments fail hopelessly at stopping the increasing  unemployment and especially the soaring youth unemployment. In my opinion, this is something to be ashamed about. Unfortunately, I don't see any improvements in this matter in the foreseeable future, as long as skinflints, like Olli Rehn, Angela Merkel and Mark Rutte and their misplaced frugality rule in the European institutions.

Perhaps even more important than what Draghi had to say today, was what he didn’t state. Today’s so-called elephant in the room was: the looming currency war. My interest for this ‘missing issue’ was provoked by the savvy Steve Collins aka @TradeDesk_Steve (on Twitter).

At this moment, there is an increased risk for a currency war between Japan and the United States/United Kingdom. Yet, the United States still allow Japan to expand its monetary supply, although the exchange rate of the Japanese Yen already declined by 10% since the highest position in 2012. However, soon there might be a moment that the United States becomes fed up with the consequences of this cheap yen. 

The chances for American exports to the Far East decline when the dollar becomes too expensive, compared to the yen and the yuan. In this situation, the American government (or in this case: the Fed) might decide to choose for a ‘more aggressive monetary policy’.

The odds for such a conflictuous situation increased strongly with the appointment of the new chairman of the Bank of Japan, Haruhiko Kuroda. He is not only a renowned advocate of an agressive monetary policy, but also a confident (and straw-man) of the Japanese Prime Minister, Shinzo Abe.

As the distinguished Dutch professor Sylvester Eijffinger already stated a few weeks ago (see the earlier mentioned link):

It is a mistake to think that the Bank of Japan is independent, like most of the other Central Banks in the western world. They receive their orders straight from the Japanese Finance Ministry. According to employees of the BoJ itself, it is nothing but an agency that must follow orders, concerning currency market issues.

Point taken…  

It has not so many consequences for Europe, when the Japanese yen drops a little more in value. Trade between Japan and Europe is much less intensive than trade between Japan and the United States, according to professor Eijffinger. However, when the United States and United Kingdom also get involved in such a currency war, then the consequences would be much worse for the European Union.

Again professor Eijffinger:

A currency conflict isn't a solution at all for Europe. When we look at the eurozone, to start with Germany: according to an investigation by Deutsche Bank, German exporting companies are competititve until €1 = $1.80.

French and Italian firms, however, start already to experience export problems at $1.20. That explains why François Hollande is banging the drum for monetary intervention.

This explanation describes exactly the split that Mario Draghi is in, currently: his 'Teutonic' brain tells him that entering a currency war is not in the interest of the strongest economies in Europe, like Germany, Austria, Luxemburg, Finland and The Netherlands.

However, his Southern-European heart tells him that the economic situation for the PIIGS-countries AND France could quickly deteriorate, when the dollar-rate drops in comparison to the Euro.

This split position between the Northern and Southern European countries forces Mario Draghi to assume the ostrich position, for the time being.

Mario Draghi: Currency war?! Between the US and Japan?! Never heard of!!!

I only hope that, when the US Dollar indeed starts to drop, in comparison to the Euro, Draghi at least HAS a strategy. 

Too often in Europe, it is almost forbidden to think about a certain issue, under pressure of the Germans. The Germans are still scared sh*tless about hyperinflation, in spite of the fact that this issue is farther away than in many other years. 

However, not having a viable strategy in such a situation, is almost economic suicide…

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