Yesterday saw much more excitement and interest at the press conference of the European Central Bank than you might expect after an announcement of unchanged policy. There was also some incredulity at the statement by ECB President and ex-Goldman Sachs employee Mario Draghi that he was unaware that the Group of Thirty forums that he attends are co-financed by Goldman Sachs! You have thought that his ex-colleagues might have bothered to tell him. However if we return to the economics we saw this from the ECB.
Compared with the September 2012 ECB staff macroeconomic projections, the ranges for 2012 and 2013 have been revised downwards.
Okay what are they then?
which foresee annual real GDP growth in a range between -0.6% and -0.4% for 2012, between -0.9% and 0.3% for 2013 and between 0.2% and 2.2% for 2014.
The real emphasis here was on 2013 where if you take the midpoint of the range for economic growth you see that it is -0.3% and this comes on top of a fall in 2012. So there is no relief in sight for the Euro area crisis as with negative economic growth then national debt to GDP ratios will get worse as plenty of nations still need to borrow substantially. I would not take too much notice of the 2014 figures where the ECB has followed my rule for official forecasts which is that you predict a return to growth as quickly as you feasibly can!
The inflation forecast
When I looked at this I immediately wondered what the ECB was really telling us.
This assessment is also reflected in the December 2012 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation of 2.5% for 2012, between 1.1% and 2.1% for 2013 and between 0.6% and 2.2% for 2014…. the projection range for 2013 has been revised downwards.
So if we concentrate on 2013 we see that the inflation forecast has been reduced and that its midpoint is 1.6%. We also see that 2014 has a midpoint of 1.4% and both of these are below the 2% inflation target.
In the language used by central banks weak growth which in this instance is likely to be so weak in 2013 it is negative combined with below target inflation means you can expect interest rate cuts. As someone who has been writing about the spread of negative interest rates you can imagine the bit below attracted my full attention. These are Mario Draghi’s words.
On the issue of negative interest rates on the deposit facility, there is nothing new to report. As Mr Praet recently has said we are operationally ready……
Did we discuss interest rate cuts?…….. There was a wide discussion but, in the end, the prevailing consensus was to leave the rates unchanged.
There are several important steps that have been taken here. Firstly it does matter that negative interest rates were mentioned and we got a hint from “wide discussion” that some had proposed them. If we project the expected economic weakness forwards then we can reasonable expect more to vote for them until a majority is reached. This would be quite a step into the unknown with many “unintended consequences” as Mario Draghi put it.
For those who are wondering why a 0.25% cut would take the official rate of 0.75% into negative territory plainly it would not. But the deposit facility rate is 0% and if it was cut then it would be -0.25%, and if it was cut then presumably the current account rate would be too. This matters as last time I checked they held 717 billion Euros between them.
Just to rub the matter in and reinforce it we were also told that some of the improvement in the Euro area money supply was technical.
The uptick in monetary aggregate (M 1) was mainly caused by one thing, the ESM paid their tranche and that increased the monetary aggregate by something like €30 billion
So some of the hopes from this were extinguished in what was a downbeat and grim summary.
The German economy is expected to weaken too
Even the Euro areas locomotive is expected to slow by its own central bank.
The cyclical outlook for the German economy has dimmed. Enterprises are cutting back their investment and hiring fewer new staff.
As we wryly observe that the slowdown is expected to be “temporary” -which now has the most number of entries in my financial lexicon- we have to consider that it might be anything but. This is something of a sea change as many of the recent numbers on the German economy have been okay to good.
If we look into the detail we see this.
following a rise of 0.7% in the current year (0.9% after adjustment for calendar effects), real gross domestic product (GDP) will grow by only 0.4% (0.5% after calendar adjustment) next year. In 2014 real GDP could go up by 1.9% if……
Again the real move here is in 2013 where the growth forecast has been slashed from 1.6% to 0.4%. If we put this year and next together this is a very anaemic rate of growth which will have consequences.
The unemployment rate could edge up to 7.2% in 2013
I can just imagine the German statisticians writing that with the enthusiasm of someone having a tooth pulled without anaestthetic! Although to be fair the Germanic nature seems very uncomfortable with producing rose -tinted 2014 forecasts as per my rule and has the decency to use words like “could” and “if”.
With forecasts like this the natural tendency of the German Bundesbank to resist negative interest-rates may not be at its peak. So today we have seen a reinforcement of yesterdays news and we have got even nearer to them.
What about the UK?
Yesterday on a dull and dank December day in London I passed a woman wearing sunglasses and was immediately reminded of this line from a song.
The future’s so bright I gotta wear shades
Unfortunately the numbers released today have not backed up her apparent optimism. In fact those of a nervous disposition might like to look away now as they are as Britney put it a rather toxic mix.
The seasonally adjusted Index of Production fell by 3.0 per cent in October 2012 compared with October 2011
The seasonally adjusted Index of Manufacturing fell by 2.1 per cent in October 2012 compared with October 2011
If these were not bad enough then we also saw this from the Bank of England inflation expectations report.
Median expectations of the rate of inflation over the coming year were 3.5%, compared with 3.2% in August
Indeed inflation is expected to be above target for the next five years! Please remember that the next time you hear someone from the Bank of England tells us that inflation expectations are “anchored”.
So will the UK take the path of negative interest-rates? Well firstly we have a base rate of 0.5% so there is room to cut first. But as the Bank of England’s preferred policy of Quantitative Easing becomes more and more discredited -many commentators are slow in this realisation and some have not got there even now- then it is likely to cut interest rates again.
Actually there is a gloomy scenario where they end up increasing the amount of QE and cutting interest rates…
Of course they should take note of rising inflation expectations but in the credit crunch era they have completely ignored them so far. More serious opposition comes from the fact that they fear interest rate cuts may adversely affect the UK’s banking sector which they regard with the same love that Gollum in the Lord of the Rings loves his “precious”.
My campaign against the “improvement” of the Retail Price Index
Support for my campaign against this came from the Bank of England’s own inflation expectations report.
Asked to give the current rate of inflation, respondents gave a median answer of 4.4%, compared with 4.1% in August
As 4.4% is above the 3.2% currently reported by the RPI you might reasonably wonder about why it is not being revised upwards! If there are Martians they may be confused by why you reduce a measure that on this basis looks too low.
Or,of course you can take the view advanced by proponents such as David Smith of the Sunday Times that nobody -presumably apart from him- has any real idea of the actual level of inflation which is in fact lower. Apparently the rest of us only register price rises and fail to register price falls.
Oh and just for clarity whilst I expect negative interest rates I do not expect them to make anything better. In fact I expect them to make things worse.