If the Euro area outlook is so good how do you explain Deutsche Bank?

by Shaun Richards

This morning we have the opportunity to take a look at the latest forecasts of the European Central Bank. After a frankly rather turgid opening it tells us this.

The euro area economic expansion remains solid and broad-based across countries and sectors, despite recent weaker than expected data and indicators.

The broad-based part rather echoed the words of its President Mario Draghi in April except the direction of travel was somewhat different.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

Actually very quickly today’s ECB version seems not quite so sure as it covers nearly all the possible bases.

 The latest economic indicators and survey results are weaker, but remain consistent with ongoing solid and broad-based economic growth.

Having discussed how much central banks love wealth effects this week several times already it would be remiss of me not to point out these bits.

 Private consumption is supported by ongoing employment gains, which, in turn, partly reflect past labour market reforms, and by growing household wealth. ………Housing investment remains robust.

Moving onto the numbers here are the specific forecasts.

The June 2018 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP increasing by 2.1% in 2018, 1.9% in 2019 and 1.7% in 2020.

So a bit lower for this year. So  in essence the first quarter of 2018 was the template for the rest of the year. The ECB will have its fingers crossed about this on two counts. The first comes from the reality of this.

the Governing Council will continue to make net purchases under the APP at the current monthly pace of €30 billion until the end of September 2018. The Governing Council anticipates that, after September 2018, subject to incoming data confirming its medium-term inflation outlook, it will reduce the monthly pace of the net asset purchases to €15 billion until the end of December 2018 and then end net purchases.

It will fear criticism of this should the economy slow. My critique is deeper as we mull how much of the recent better economic times for the Euro area has been driven by the extraordinary monetary policy of nearly 2 trillion Euros of government bond purchases and negative interest-rates? The irony is that the more successful the ECB has been the deeper the hole it is in. The situation is even worse if you think that the side-effects of this may reduce longer-term growth prospects for example by continuing to prop up what are zombie banks.

Deutsche Bank

Did I mention zombie banks?

Some of the new fears may have been driven by the mention of £29 trillion of derivatives being dependent on Brexit by Bank of England Governor Carney yesterday. After all the fact your own derivative book has been rumoured to be twice that size will hardly calm worries about this area.

Then there are the issues highlighted by Fitch Ratings a week ago.

Deutsche Bank’s ratings and the Negative Outlook reflect Fitch’s view that the bank faces substantial execution risk in its restructuring, which aims to strengthen its business model, stabilise earnings and further strengthen risk controls.

There have to be questions based around the fact that the domestic market situation as in the German economy has been strong so why is Deutsche Bank suffering? With house prices growing at an annual rate of around 4% you would think if you look at the story for the German and indeed Euro area economy that DB should be blooming. But instead it is struggling yet again.

If we move to its bonds which are used as capital or CoCo’s there has been a clear change this year. The 6% coupon one was yielding 4.4% in early February as opposed to the 9.7% today. Still less that early 2016 but of course then the economic outlook was different.

Inflation

The story here has been changing as highlighted by this earlier from @LiveSquawk .

German Baden-Wuerttemberg June CPI M./M: 0.2% (prev 0.5%) German Baden-Wurttemberg June CPI Y/Y: 2.4% (prev 2.3%)

This is one of the higher numbers but there have been other rises around such as the one in Italy rising to 1.5%. Whilst the detail is for Italy’s own inflation measure it does highlight the main player here.

The acceleration of the growth on annual basis of All items index was mainly due to prices of Non-regulated energy products (from +5.3% to +9.4%).

So the ECB has what it wants with inflation until you look at the detail. That tells us that as we have discussed many times QE has had a surprisingly low impact on inflation over time ( partly because asset prices are omitted) but the oil price is invariably a major player. Right now with the oil price above US $77 for a barrel of Brent Crude and the Euro below 1.16 versus the US Dollar the heat is on in this respect. This hurts the Euro area economy via real wages and also because it is an energy importer. If this has you confused then simply forecast that inflation will be the same.

This assessment is also broadly reflected in the June 2018 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.7% in 2018, 2019 and 2020.

Also German inflation prospects will be helped by this.

You can now cop the adidas Germany jersey for 30 percent off: ( @highsnobiety )

Money Supply

Here there is a little cheer as the ECB went to press with the state of play being this.

The monetary analysis showed broad money growth gradually declining in the context of reduced monthly net asset purchases, with an annual rate of growth of M3 at 3.9% in April 2018, after 3.7% in March and 4.3% in February.

Whereas yesterday at least in nominal terms things were a little better.

Annual growth rate of broad monetary aggregate M3 increased to 4.0% in May 2018 from 3.8%
in April (revised from 3.9%) …… Annual growth rate of narrower aggregate M1, comprising currency in circulation and overnight deposits, increased to 7.5% in May from 7.0% in April

The rub comes when you start to allow for inflation.

Comment

The recent period has been one where the ECB and in particular its President Mario Draghi has been able to portray it/himself as a “master of the universe”. The fall in oil prices lead to lower inflation meaning it had an opportunity to push the monetary pedal to the metal whilst claiming it was simply trying to hit its target. Of course this made it extremely popular with politicians as their borrowing costs fell and the economic outlook changed. Sticking with the politicians theme though the clouds gather. As the appointment of the Spanish politician and former minister Luis de Guindos begs various questions. For a start the claim of “political independence” and I do not mean parties here I mean the political class resuming control of monetary policy. Next is the issue of skills and competence which was highlighted when at the most recent press conference President Draghi pointed out they have not found any specific roles for him yet.

Now we enter a more difficult phase as for example being a banking regulator made not be fun if DB continues to weaken or the Italians continue to interpret the rules for their own banks. Next comes the issue of the economic situation which is summed up below I think.

ABN Amro now expect the ECB to raise its deposit rate in December 2019 (Prev. September 2019) by 10bps to -0.3% ( @RANSquawk )

So the outlook is so bright they can only raise interest-rates by 0.1% in 18 months or so? Also there is the implied insanity that changing interest-rates by 0.1% achieves anything apart from employment for a few sign writers.

 

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