Thursday, November 27, 2014
Based on the results of six regional states, German headline inflation dropped to 0.6% YoY in November, from 0.8% in October. On the month, German prices remained unchanged. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation decreased to 0.5%, from 0.7% in October, and stands now at its lowest level since February 2010. A quick look at the available components at the regional levels shows that the drop in headline inflation was not only driven by lower energy prices but also some tentative second-round effects on consumer goods and a drop in prices for vacation destinations and package tours. Looking ahead, the recent drop in energy prices – if sustained and if not offset by strong currency weakening – could push German headline inflation further down. Corrected for the euro depreciation vis-à-vis the US dollar, oil prices have dropped by more than 15% since last November. Not all of this price drop has yet been passed through to consumer prices. However, as German employment just reached another record-high in October, this drop in inflation should be inflationary rather than deflationary. Just think of Draghi’s famous words “with low inflation, you can buy more stuff”. At the current juncture, price expectations of both consumers and producers remain solidly anchored in Germany. According to today’s economic sentiment indicators from the European Commission, price expectations by both consumer and producers have slightly come down in November but remain close to their respective historical averages. Interestingly, price expectations in the service sector have now increased for three months in a row and are close to all-time highs. This might be the result of higher wages and maybe also the introduction of the minimum wage. For next week’s ECB meeting, today’s German inflation data could be the prelude of another downward revision of the ECB’s inflation forecasts. Back in September, ECB staff had projected an average inflation rate of 1.1% for 2015 and 1.4% for 2016. Even without any significant changes to the growth outlook, the latest drop in energy prices should be sufficient to automatically lead to lower inflation forecasts. Remember that last month, ECB president Draghi had described two “contingencies” for further action: the current measures are not enough to reach the new (soft) balance sheet target, and a worsening of the medium-term outlook for inflation. Obviously, next week will be too early to give an assessment on the first contingency but with lower inflation projections, one of the two lights needed to start QE could already be lit green next week.
Wednesday, November 26, 2014
Today, the European Commission will present its long-awaited investment plan. Risks are high that it will not be the big game changer.
It has probably been Brussels’ least guarded secret of recent weeks: Jean-Claude Juncker’s investment initiative is supposed to give the new European Commission and the entire European economy a kick-start. A ballpark figure of around €300bn has been circulating for a while. Today, the European Commission will present its plan on how to achieve the targeted amount.
Based on the available information circulating in the media, Juncker's plan should consist of a new investment fund that will give guarantees for private sector investors. The funds own financial means could be around €21bn, according to latest reports, €5bn from the EIB and €16bn from the EU. These guarantees should – in theory – attract almost €300bn of venture capital and private funds for projects identified by the European Commission. The focus of these project will be on infrastructure, energy and high-speed internet.
In our view, this means that hardly any new public money will be invested. The EU funds will very probably come from existing budgets and projects and whether the EIB’s €5bn will be new guarantees or only specially devoted funds remains unclear. Public funds will only be used as “first loss” guarantees. This means that without private sector money, not a single euro will be spent.
As regards the now known technical details, the biggest problem is of course the wished for multiplier. Making €315bn out of €21bn would make any magician jealous. The current construction would indeed cap the risk and therefore increase interest from private investors. However, the problem in our view is the expected return (or yield) on these investments. The identified projects are typical "public goods" projects, where it is hard to calculate an expected yield on the investment. However, this yield is what private investors will be looking for.
With the current low levels of interest rates, it might have been easier for governments to borrow money in the market rather than fixing and promising expected returns on investment for private investors. But to allow for that, one would need another change in the stability programme, effectively keeping investment expenditure outside the current expenditure budget, something Germany is most likely to resist.
All in all, it looks as if Juncker’s plan will not be the big game changer but rather a non-starter. Unless magic is joined by a miracle. As so often in the past, this would transform an excellent idea ultimately into a missed opportunity. To be clear, it should not be the Commission that has to be blamed, but the willingness of member states to chip in fresh money. As long as the Commission – or, for the sake of simplicity, Europe – does not have own funds, any financial attempts to revive growth are deemed to fail. This would be a pity as the underlying idea is good: find European projects and start investing to stimulate short-term growth but also, and more importantly, potential growth. This could have been the kick-start for the new Commission and the boost for new European growth visions, but instead Europe seems to have a new fund of hope rather than one of hard commitment.