Tuesday, December 20, 2011

Faltering but not falling

German Economic Quarterly 1Q12

The debt crisis has finally reached the German economy. Strong fundamentals, however, should prevent the economy from falling off the cliff.

The German economy was one of the last strongholds of the Eurozone in the third quarter. The economy grew by 0.5% QoQ, from 0.3% QoQ in 2Q. Compared with 3Q 2010, the economy grew by 2.6%. Interestingly, growth was much more balanced than expected, with private consumption being the main growth driver. Remarkably, often despised private consumption has actually grown in six out of the last seven quarters. Even if the growth performance is still dwarfed by the impressive export sector, private consumption has almost unnoticed become an important growth driver of the German economy.

With the latest stage of the Eurozone debt crisis and fiscal problems in France and Italy, two important German trading partners, concerns about the strength of the German economy have increased. The strong third quarter defied these concerns for the time being but the continued drop of confidence indicators has not been boding well for the future. Again, looking ahead, the one-million-dollar question is whether the last stronghold of the Eurozone will also give in, eventually pushing the entire Eurozone into a recession?

Without any doubt, the German economy is cooling off. And indeed, there are at least three major risks for the German economy in the coming months. Obviously, the Eurozone debt crisis comes in at top of potential risks. With bigger trading partners having to engage in austerity measures, external demand looks set to weaken. Don?t forget that France is Germany?s single most important trading partner, accounting for roughly 10% of all German exports. Second, a further drop in sentiment, particularly by just recently awakened consumers, could lead to a significant loss of momentum. With external demand weakening, stable domestic demand will be crucial. Finally, bank recapitalisations and restructurings could lead to a credit crunch in the coming months. According to the last bank stress tests, the two biggest German banks, Deutsche Bank and Commerzbank, have to raise more capital than previously estimated. In total, German banks will have to raise 13bn euro, instead of 5bn euro to raise their Tier1 capital ratios to the required 9% by next year.

However, even at the risk of sounding like a lay preacher, repeating the same old story over and over again, the fundamentals of the German economy are still sound and while there are three major risks, there are at least six arguments in favour of strong fundamentals: i) the absolute levels of most confidence indicators are still above recessionary levels and some indicators even rebounded recently; ii) a further stabilization of the US economy could at least to some extent offset weakening Eurozone demand as the US, not China, was the most dynamic export destination for German manufacturers since the beginning of the year; iii) latest lending data do not confirm any credit crunch concerns, yet. In fact, credit to the private sector has actually increased over the last couple of months; iv) German companies are benefitting from low interest rates as the high dispersion of bond yields across the Eurozone is also reflected in bank interest rates; v) the strong labour market is supporting domestic demand and the lack of qualified workers should prevent unemployment from rising, even if growth was to deteriorate more than expected; vi) finally, the high backlogs of companies and low inventories put a strong safety net under the economy.

If all else fails, the German economy still has fiscal stimulus as the final trump card to cushion a worse-than-expected slowdown. At least as regards fiscal balances, the German government has become a model student of the Eurozone class. Strong economic growth of the last two years has created significant revenue windfalls, lowering the fiscal deficit to around 1.5% this year and close to 1% next year. Moreover, German public finances are also benefitting from the sovereign debt crisis. The safe-haven effect on German government bonds has provided a net profit of around 9bn euro to the German government.

Interestingly, in cyclically-adjusted terms, Germany will be close to fulfilling the new European debt-break rules in the next two years. Against this background of a favourable fiscal outlook, the German government agreed on a tax relief of around 8bn euro (0.3% of GDP) for 2013. Obviously, there would be room for more, particularly given the fact that the next federal elections will be held in late-2013.

At the end of 2011, the German economy is finally feeling the strong headwind from the Eurozone debt crisis. The German export-dependence is again showing its ugly face. It would need an unexpected consumption or production boom in the last two months of the year to prevent negative growth in the fourth quarter. In fact, the impressive growth rally with ten consecutive quarters with strong GDP growth has come to an abrupt end. At the current juncture, however, German fundamentals look too sound to fear a spreading of weak exports into other sectors of the German economy. Contrary to 2008, the economy should not fall off a cliff but rather re-emerge after a soft patch. The length of the soft patch will to a large extent be determined by the management of the debt crisis. The German economy should remain the stronghold of the Eurozone. It is faltering, but not falling.

Thursday, December 8, 2011

ECB meeting - Lender of last resort, but not for governments

The ECB cut interest rates by 25bp, lowering the refi rate to 1.0%. Within a month time, the new ECB president Mario Draghi has eradicated the hotly contested rate hikes of his predecessor. Ironic enough, the rate reversal was not the most sensational decision of today’s ECB meeting. With additional non-standard measures, the ECB took another unprecedented strike to tackle tensions in the money market.

The rate cut was motivated by a further worsening the economic outlook. As a tribute to the latest slowdown of confidence indicators and economic activity, the ECB considers risks to the economic outlook to be substantially to the downside. This downside risk is reflected in a significant downward revision of the ECB staff projections for GDP growth. For 2012, GDP growth is expected to come in at 0.3%, from 1.3% in September. For 2013, GDP growth is expected to pick up again to 1.3%.

On inflation, the ECB today sent a somewhat confusing message. As in November, the ECB still expects headline inflation to drop below 2% in the course of next year. However, the ECB staff projections were revised upwards to 2.0% for 2012, from 1.7% in September, and 1.5% in 2013. According to the ECB risks to price stability balanced. This was also reflected in Draghi’s comment that there was currently no risk of deflation.

The rate cut was one thing, liquidity measures were another thing. The ECB took another unprecedented attempt to tackle money market tensions. In more detail, the ECB presented five more measures: i) two 36-months LTROs at full allotment, with the first operation being allotted on 21 December 2011; ii) a reduction of the rating threshold for certain asset-backed securities (ABS) from AAA to A for ABS comprising residential mortgages and loans to SMEs; iii) national central banks will be allowed to accept as collateral additional performing credit claims (namely bank loans) that satisfy specific eligibility criteria; iv) reduction of the reserve ratio from 2% to 1%; and v) a temporary discontinuation of fine-tuning operations carried out on the last day of each maintenance period. Overall, the ECB tries almost everything it can to prevent a credit crunch in the Eurozone.

Prior to today’s ECB meeting, the optimal sequencing of the Eurozone’s final Grand Bargain was a rate cut and more liquidity measures from the ECB today, a ‘fiscal compact’ from political leaders with a clear roadmap towards more political integration and a fiscal union tomorrow and a clear signal from the ECB to do more after the EU summit. At today’s meeting, ECB president Draghi put a stick into the spokes of the Grand Bargain’s wheel. While Draghi had opened the door for more ECB support last week, he closed it again today. According to Draghi, it was up to politicians to solve the debt crisis. The ECB would not respond to a fiscal compact and would not increase its bond purchasing programme. Whether this clear-cut statement was for real and only part of the ECB’s poker game, only the coming days can tell.

All in all, the ECB delivered all it could without crossing the line of Germanic rules of central banking. The last trump card remains up the ECB’s sleeve. For the time being, the ECB does everything to be the lender of last resort for the economy and the financial sector but not for governments.

Wednesday, December 7, 2011

Under pressure

Onder druk kan veel gebeuren. David Bowie en Queen hebben er 30 jaar geleden al over gezongen. Onder druk gaan mensen op straat. Onder druk vallen gezinnen uit elkaar. Het lijkt dat 'Under Pressure' een van de meest gedraaide platen is in de werkkamer van de Duitse bondskanselier Angela Merkel.

De kritiek op de aarzelende houding van de Duitsers in de eurocrisis neemt toe. Te weinig en te laat, luidt het terugkerende verwijt. Het gebrek aan daadkracht van Merkel, ook bekend als 'Frau Nein' of 'Frau Klein-Klein', heeft de eurocrisis alleen maar verergerd. Ja, de crisis is erger geworden door het getreuzel, maar was er een alternatief? De grote, maar onbeantwoordbare vraag luidt of de Europese probleemlanden bij een sneller ingrijpen van Duitsland ook sneller de noodzakelijke bezuinigingen en hervormingen zouden hebben doorgevoerd.

Zou de Franse president Nicolas Sarkozy zonder druk van de financiële markten en van een zwakke Franse economie deze week ook hebben ingestemd met de Duitse plannen? Waarschijnlijk niet. Zonder druk hadden Merkel en Sarkozy deze week niet uitgepakt met een grondwettelijke schuldenrem en automatische sancties. Wie nog twijfels had over de leiderschaps- kwaliteiten van Angela kan gerustgesteld zijn. Een jaar geleden moest Merkel op de kwestie van de automatische sancties nog toegeven aan Sarkozy en werd ze door haar Europese collega's met haar Euro Plus-plannen wandelen gestuurd. Nu krijgt Merkel eigenlijk alles wat ze al vanaf het begin wilde. Het leek afgelopen maandag tijdens de persconferentie in het Parijse Elysée eventjes alsof Merkel stilletjes 'Under pressure' ging zingen.

De druk komt niet alleen van de Duitsers. Druk kwam er deze week ook nog van de Amerikaanse kredietbeoordelaar Standard & Poor's. Natuurlijk kunnen we opnieuw klagen dat alles een Amerikaans complot is en dat de timing van S&P verdacht is. Maar verdacht of niet, S&P's dreigement om de AAA-status van de eurozone te verlagen is een pijnlijke waarschuwing dat ook de beste jongetjes van de Europese klas in de problemen kunnen komen. S&P verhoogt niet alleen de druk op de regeringsleiders om meer te bezuinigen, maar toont ook dat het Europese noodfonds EFSF een te fragiele constructie is. Want als landen als Frankrijk en Duitsland hun AAA-status verliezen, verliest ook het EFSF zijn hoogste kredietwaardigheidsscore en worden de leningen voor de landen in nood duurder. De politicus die dacht dat het noodfonds het ultieme vangnet zijn kon, moet nu beter weten.

David Bowie en Queen willen de liefde een kans geven om de wereld te veranderen. Dat zal helaas niet volstaan om de euro deze week te redden. Natuurlijk kost het enige moeite om kanselier Angela Merkel en president Nicolas Sarkozy als opvolgers van David Bowie en Freddy Mercury te zien. Maar als de komende dagen en uren goed aflopen, zal de eurozone net dankzij de enorme druk overeind zijn gebleven. Dan kan Angela Merkel thuis tevreden naar haar favoriete plaat luisteren.

Deze column verscheen vandaag in het Belgische dagblad De Tijd

Tuesday, December 6, 2011

German IP rebounds in October

German industrial production increased by 0.8% MoM in October, from a 2.8% drop in September. On the year, industrial production is up by more than 4%. The increase was mainly driven by the production of capital goods and durable consumer goods.

The fourth quarter started on a positive note for the entire German economy. New orders surged, the Ifo index rebounded, retail sales increased and now industrial production is picking up again. Nevertheless, even if today’s numbers are good news, they are still too weak to exclude negative growth in the fourth quarter.

Of course, it is too early to give the all-clear but latest developments indicate that the weakening of the German economy in August and September was not the prelude to a gloom-and-doom scenario. The current growth episode increasingly looks like a soft patch, not a recession.

Monday, December 5, 2011

Merkozy take headstart in week of truth

At their preparatory meeting, German chancellor Merkel and French president Sarkozy just announced their common position for this week’s EU summit. No written statement was issued but during a press conference, the Eurozone’s leading political couple, also known as Merkozy pushed for far-reaching Treaty changes.

The main elements of the German-French plan to save the monetary union are automatic sanctions for deficit violators, an earlier start of the European Stability Mechanism (a kind of European IMF, the Eurozone’s permanent crisis resolution mechanism), a balanced-budget rule implemented in all national constitutions and monthly Eurozone meetings at the heads of state level. The European Constitutional Court should investigate whether national balanced-budget rules can be implemented. More generally, sanctions should – if needed – be enforced by the European Court. In addition, a single European country should not be able to block decisions on bail-outs under the framework of the ESM. On regards the issue of Eurobonds, Merkel and Sarkozy reiterated the well known “no”.

The new rules of the game should be applied to all European countries. However, as Merkel said, if need be, the Eurozone countries should go along alone, irrespective of non-Eurozone countries.

At first glance, today’s plans should give the Eurozone a clear headstart in maybe the final week of truth. Now, the big challenge will be to put everything on paper and to convince the European partners. Not an easy one but if Merkozy really want to deliver a ‘fiscal compact’ on Friday, they will have to put their money where their mouth is.