August 15, 2014

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The price we are paying for serial policy errors

This is our last briefing before our annual break. We will resume Monday, September 1.

Our overriding focusing today is, of course, the eurozone economy, which continues to disappoint. We were just able yesterday to give you the news of the German 0.2% fall in GDP during Q2. Eurostat followed up on this with the flash estimate for eurozone-wide GDP, which came in at zero. It is not hard to imagine the sheer volume of outraged editorials in the media: something, surely, must be done.

Just as the ECB re-iterated for the millionth time that inflation expectations remain firmly anchored, German 10-year yields defiantly dropped below 1% for the first time ever. We are not generally overawed by “records” – but this is the clearest sign yet that the markets are betting against the ECB’s inflation target. The message from the largest and most liquid fixed-interest rate market in Europe is telling us that Inflation expectations have firmly de-anchored despite of what the ECB says. The ECB is still clinging on the 5y-5y inflation swaps in defence of its views that, in the long run, inflation expectations are anchored, but we are not sure that this derivative instrument is all that meaningful. For us the question is no longer whether inflation expectations have come unstuck. They have. The question is: can they be re-anchored?

It is interesting that Frankfurter Allgemeine and other German newspapers hardly mention any of this – they cover the overshooting French deficit obsessively. The paper’s Paris correspondent has an outraged editorial, which fails to mention that the French economy outperformed the German economy in Q2 (and for the period since the beginning of the eurozone as well).

The Italian papers focus on Matteo Renzi’s comment: See, it’s not just us. The whole of the eurozone is in crisis. La Repubblica reports on Renzi’s comment that these data will soften Angela Merkel’s views on the fiscal overshoot. We at Eurointelligence are not sure that they will – also in view of the FAZ’ comment on France. The German consensus view is that one should never allow a recession to get in the way of a good deficit reduction.

Among the interpretations of what happened, we noted Simon Wren-Lewis’ observation on household savings. He found that in the UK the savings rate increased after the crisis, and the recovery started just as the savings rate began to fall. In the eurozone that decrease in the savings rate already occurred earlier in response to the austerity. Wren-Lewis says the eurozone already had its recovery, which came in the form a declining savings ratio helping mitigate the 2012 recession. The key question is now to which extent financial balance sheets of consumers are restored?

From the eccentric Ambrose Evans-Pritchard we learn of Paul de Grauwe’s interpretation of what happened. EU policy makers are treating a demand crisis as if it were a supply crisis by imposing reforms. De Grauwe:

“They are doing everything they can to stop recovery taking off, so they should not be surprised if there is in fact no take-off. It is balanced-budget fundamentalism, and it has become religious. We know from the 1930s that if everybody is trying to pay off debt and the government then deleverages at the same time, the result is a downward spiral. The rigidities in the European economy have been there for ages. They have absolutely nothing to do with the problem we face today.”

Pritchard himself makes the point that policy is even too tight for Germany. This is so “because otherwise Latins might get off too lightly”.

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A message from Wolfgang Münchau

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Since 2006 we have been providing our readers from central banks, European and international institutions and the financial sector with our daily morning newsbriefing, each morning, at 9am CET, Mondays to Fridays. We are independent from governments and institutions, so you get our honest, sharp and frequently humorous take on the news and the debate. The subjects we are currently focusing on are the now clearly visible economic slowdown, the sustainability of the Italian debt, whether the economic recovery in Spain is for real and our assessment of the impact of the geopolitical tensions in Eastern Europe in particular. Naturally we also follow the ECB and the European institutions as they work through the crisis.


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Wolfgang Münchau
Director Eurointelligence