The euro at 80 pence – and heading towards parity

 

 

The pound hit a new record low against the euro, when it traded at 80 pence to the euro. Frankfurter Allgemeine reports that the latest bout of speculation was due to speculation that the Bank of England, which has just cut interest rates by a quarter point to 5%, may cut again next week, perhaps by 0.5%. The FT says the fall in the pound was also due to the downward revision of UK growth by the IMF. As the UK housing recession is now evident, with house price down 2.5% in March, compared to February, there is a significant likelihood of further economic weakness and monetary easing ahead. So we may be heading for further declines in the sterling/euro exchange – a major exchange rate tremor inside the EU.

                                       

 

The Economist on UK house prices

The Economist has a refreshingly frank article on the coming UK housing bust, following this week’s announcement by the Halifax building society that property prices dropped 2.5% in a month, the biggest such fall since 1992. The article quoted the recent IMF chapter on housing, according to which the UK has the third most overvalued property market – 30% overvalued in fact. There is likely to be a significant correction, which will have negative effects on economic growth, and on Gordon Brown’s government, the Economist concludes.

 

 

IMF pessimistic on world economy

The IMF’s spring forecast are probably the most pessimistic forecasts currently around. The FT has a great graphic which shows the main forecasts at a glance. The euro area is to grow by 1.4% this year (1.2% next). The IMF says the euro area will suffer a credit squeeze, and points out that there is scope for interest rate cuts. UK growth is projected to be higher at 1.6%, while US growth will be only 0.5%. FT Deutschland reports that IMF staff economists say there is a 25% chance of global growth falling below 3% - which some economists would consider consistent with a global recession. European newspapers all lead with the domestic end of the forecasts. Italy has the lowest growth of all major industrial nations, with 0.3% for both 2008 and 2009, and Spain will see the largest fall – from 3.8% last year to a projected level of 1.8%. See the coverage of El Pais, and Il sole 24 ore.

 

 

CDS rally ends

FT Alphaville has a note that the CDS rally, which saw the iTraxx Crossover index – a European benchmark for high-risk bonds – fall from 650 to 450bp. (a lower number means that it costs less to insure against default, in other words: a low number signals an increase in risk appetite). Yesterday the iTraxx Crossover went back up over 500bp as investors wondered how those companies would fare during a recession. (we have been wondering about this for almost a year!). Even a return of defaults to normal (which is more than three times current levels) could wreck havoc on this market.

 

 

Sarkozy's reforms are costly, but not efficient

Sarkozy’s employment and purchasing power bill (TEPA), adopted last autumn, is expensive - €14bn in total - and not very effective, this is the conclusion of a report to the Parliament’s finance committee, reports Le Monde. The verdict is especially sober for the de-taxation of the extra working hours, which is estimated to cost more to the state (€4.1bn) than it benefits employees (€3.78bn). Moreover, the volume of extra hours hardly increased, 600m hours instead of 900m promised by the government when the law was presented to the parliament.  Socialist Didier Migaud, president of the finance committee, said in an interview with Le Monde that the money could have been spent more wisely.

 
Nicolas Sarkozy apparently changed the emphasis of his discourse when blamed social policy expenditures for the budget deficit and debt, concludes Le Monde. Passing over to our children the expenses for health and pension via debt at the same time as the population is getting older is profoundly immoral, Sarkozy said in his speech in Cahors.

 

 

The Fed’s plan B

Apologies this is a longer post than usual. But it needs to be. It is a technical and informed article by Greg Ip, the Fed watcher at the Wall Street Journal. He makes four suggestions – which are almost certainly not his own but come straight from the Fed. We think this is therefore news, not comment.

 

Here they are:

The first, and apparently most favoured option by the Fed, is this. We quote in full: “The easiest would be to ask Treasury to issue more debt than it needs to fund government operations. As investors pay for the bonds, their cash moves from bank reserve accounts at the Fed to Treasury accounts at the Fed. The Treasury would allow the money to remain there, rather than disbursing it or shifting it to commercial banks who, unlike the Fed, pay interest. Because the shift of cash out of reserve accounts leads to a shortage of reserves, it puts upward pressure on the federal funds rate. To offset that, the Fed would enter the open market and purchase Treasurys (or some other asset), replenishing banks’ reserve accounts. The net result is that the Fed’s assets and liabilities have both grown but reserves and the federal funds rate are unaffected. This wouldn’t cost Treasury anything so long as it doesn’t bump up against the statutory debt limit. The loss of interest on its cash deposits at the Fed would be roughly offset by the additional income the Fed pays Treasury each year from the interest on its bond holdings.”

 

Yves Smith at Naked Capitalism, says Ip’s article had the “the aura of being a sanctioned piece. It seeks to dismiss the idea which has been widely discussed on the Internet and is getting some attention in the media, that the Fed is at risk of exhausting its abiiity to take on more collateral for loans, or as it has been put more colloquially, that the Fed might run out of firepower.”

 

The second, though less favoured option, would be for the Fed to issue its own short-term paper. The third would be to pay interest on reserves, which would effectively put a floor under the federal funds rate. The forth would be for the Fed to act as a transaction middlemen between the MBS and Treasuries market – which might work as nobody would expect the Fed to fail.

To us the fact that this article has been written at this level of detail suggests that these options are actively considered by the Fed right this minute.

 

 

Three reasons to vote in Italy

Lavoce’s editorial team wrote an editorial saying that there are three good reasons to go voting in the national election on Sunday and Monday. While the voting system lack civility, the closed lists – proposed by parties, which voters cannot change according to their preferences – does show party political preference, and thus contain important information to the voter. Secondly, while the attempt to have quotas for women and younger people is not entirely genuine, it will some effect that should not be underestimated; and thirdly, there is always a tomorrow. This election not only decides on the next government, but also indirectly on the electoral law, which has to be approved by referendum. Not all parties, Lavoce concludes, are keen on changing the law. All in all, there are differences between the parties – especially the two main parties – that are significant.

 

 

 

 

Why the rejection of the Air France bid for Alitalia is a disaster for Italy

Andrea Boitani has a well argued article in Lavoce (in Italian) and Telos (in French) in which he debunks the myth of a “cordata del nord”, a group of mystery businessmen Berlusconi promise produce out of his sleeve as saviours of the Italian airline. For a start, any commercial rescue attempt will have far more serious consequences for Alitalia staff than what is offered by Air France. Remember what happened to Sabene and Swiss Air, both of which were seriously shrunk after their collapse when they became Brussels Airlines and Swiss. The cordata, about which the unions that blocked the deal are still dreaming, will turn out to be a phantom.

 

 

More on Iceland

Iceland continues to attract comments. One is from Gylfi Zoega, who writes in Vox that Iceland’s economic turbulence sounds like a familiar macroeconomic story – a credit expansion fuelled excessive borrowing and spending. But there are unfamiliar details – an unusually large banking sector and a central bank unable to serve as a credible lender of last resort – that raise concerns. Nevertheless, Iceland should be able to weather the current turmoil.

 

 

In defence of Basel II

The FT carries a comment by Nout Wellink, head of the Dutch central bank, in defence of Basel II, the regulatory framework which has come under much criticism for being procyclical, and that it relies on the same rating models that failed during the present crisis. Wellink says that Basel II will put capital regulation on a sounder footing. It will enhance capital regulation, supervision, risk management and market transparency. All exposure, including off-balance sheet, will now be subject to regulation. There will be greater differentiation in capital requirements for high and low risk exposures. And it will introduce more robust capital adequacy requirements for rapidly growing banks.  He argues that the new regime will be a big advance on the much less flexible Basel I regime.

 

 

 

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