On Italy’s decoupling from the periphery and Merkel’s electoral losses

I have been trying to break up the links posts because I have so many. So I have been writing brief theme posts to go with the links as I used to do when I had more time. I want to make this one short here and I have two topics to highlight.

The first topic is Italy and its leaving the EC’s excessive deficit list. I brought this possibility up in my post on Italy earlier in the week. And I think this is pretty much a done deal now. All of the policy statements line up this way. Of note, Olli Rehn, who will be the chief EC minister presiding over this decision, has already said he is in favor of relaxing deficit targets. It is clear to me then that he favors the “medium-term fiscal consolidation” path that Mario Draghi was talking about at today’s ECB press conference. And it also occurs to me that Draghi may have had Italy uppermost in mind when he made these comments.

Here’s what the FT says about the situation:

“Italy is confident of soon joining a “small group of virtuous countries” that have met Europe’s budget targets and is committed to remaining within the limit, according to Fabrizio Saccomanni, finance minister in the new coalition government.

Exiting the European Commission’s “excessive deficit procedure” next month would contribute to lowering the cost of borrowing for the government and private sector, Mr Saccomanni said on Thursday, while freeing up €12bn in regional investment spending co-financed by Europe.”

Notice that Italy automatically receives stimulus once they get off the excessive deficit list. This is important as Italy is the third largest economy in the eurozone and banks there are getting chewed up by the increase in non-performing loans that is a direct result of austerity. If you listened to Draghi during the ECB presser, you would have noticed that he spoke a lot about the negative impact of recession on the quality of loan books for banks within the euro zone. He was quick to say that he wasn’t speaking about specific banks but he did note that more capital will need to be raised and that this negative impact needed to be mitigated. This, again, leads me to believe he was thinking about Italy and its huge importance within the euro zone.

I believe policy makers in Europe now believe stopping debt deflation in Italy is the most important policy agenda item at present. And they are prepared to give Italy a boost to break the negative cycle. I anticipate this will mean de-coupling from the periphery, a process that I felt was beginning early in the year before the electoral crisis interrupted it.

On Germany the story is also a continuation of a post from earlier in the week, the one on why German EU positions will change after the German General Elections. Another FT article caught my eye here. The FT writes:

“German voter support for Chancellor Angela Merkel’s party has slipped to its lowest level this year in the wake of a tax evasion case involving a prominent ally.

Support for Ms Merkel’s Christian Democrats and their Bavarian sister party has fallen below 40 per cent for the first time since December after an unusually large weekly drop of three percentage points, according to the latest Forsa poll.”

I don’t make a lot of the tax scandal. It will be a non-event by election time. On the other hand, the slipping poll numbers make the scenario I painted of Merkel winning the general election but still losing the Chancellery more likely. The numbers do not work in her favor because the FDP is weak. And the smaller the CDU/CSU margin of victory becomes, the more likely it is that the SPD get pole position. I haven’t hear anyone talking about this, but I believe this is how things are shaping up at this juncture. And note that the German economy is faltering. The latest PMIs came in below 50, meaning that manufacturing in Germany is now contracting. The manufacturing PMI fell from 49.0 in March to 48.1 in April. A softening economy wll work against Merkel come election time.

Below are the European-themed links. US and other economic links will come in a separate post.

History of the interest-only mortgage crisis – Telegraph

“Of the 600,000 households with interest-only mortgages expiring by 2020, half won’t be able to clear the loan. We explain the history of the crisis.”

Slovenia issues US$3.5bn bond, buying time on reforms | Capital City | IFRe

“Slovenia sold US$1bn in five-year, 4.75% coupon bonds to yield 4.95% and US$2.5bn in 10-year, 5.85% coupon bonds to yield 6%, cheaper than initial price guidance of 5.125% and 6.25%.
Slovenia’s 10-year benchmark was bid at 5.918 late on Thursday, while the 6% yield on the bond was above Spain’s 4.041 and Portugal’s 5.734, according to Reuters data.
“If anyone had any doubts about the investors’ thirst for yield, this is proof,” said RBS Analyst Abbas Ameli-Renani. “A country that was being compared to Cyprus only a month ago received demand for its bonds almost equivalent to a third of its GDP.””

Sweden Manufacturing Shrinks as Job Cuts Grow on Krona Surge – Bloomberg

“Swedish manufacturing unexpectedly contracted in April as the euro area recession and a stronger krona weighed on output amid deepening jobs losses in the largest Nordic economy.
The krona fell 0.4 percent against the euro to 8.5553 as of 9:53 a.m. and slid 0.5 percent versus the dollar on increased speculation the central bank will need to cut interest rates again. The currency has gained 3.5 percent versus the euro and the dollar over the past 12 months, raising costs on exports.”

Merkel slips in polls after tax evasion scandal – FT.com

“German voter support for Chancellor Angela Merkel’s party has slipped to its lowest level this year in the wake of a tax evasion case involving a prominent ally.
Support for Ms Merkel’s Christian Democrats and their Bavarian sister party has fallen below 40 per cent for the first time since December after an unusually large weekly drop of three percentage points, according to the latest Forsa poll.”

Italian coalition aims to join eurozone’s ‘virtuous’ deficit club – FT.com

“Italy is confident of soon joining a “small group of virtuous countries” that have met Europe’s budget targets and is committed to remaining within the limit, according to Fabrizio Saccomanni, finance minister in the new coalition government.
Exiting the European Commission’s “excessive deficit procedure” next month would contribute to lowering the cost of borrowing for the government and private sector, Mr Saccomanni said on Thursday, while freeing up €12bn in regional investment spending co-financed by Europe.”

Angela Merkel, Francois Hollande rift deepens after leaked memo | Economy | News | Financial Post

“A scathing German assessment of France’s economic weakness — titled “Europe’s biggest problem child” — has reopened divisions between the continent’s major powers.
A leaked internal briefing from Angela Merkel’s coalition partners, the Free Democrats, refers to President Francois Hollande as “meandering” and draws attention to France’s “highly regulated labour market and highly developed social security system”.”

99 Draghi trial balloons [updated] | FT Alphaville

“The tl;dr version of May’s Draghi presser involved the ECB chief mentioning a heap of possible actions — from getting the “dead” ABS market going to help SMEs, through to negative interest rates, while giving a little bit of forward guidance on policy — but without committing to anything concrete.”

Debt-crippled Holland falls victim to EMU blunders as property slump deepens – Telegraph

“The eurozone’s slow suffocation is going Dutch. Each extra month of slump caused by Europe’s negligent authorities is pushing Holland closer to a debt-deflation trap.”

ekathimerini.com | Latvia bank deposits to grow as cash leaves Cyprus, Moody’s says

“Non-resident deposits in Latvia, which plans to adopt the euro in 2014, will swell as cash leaves Cyprus after the island’s bailout, according to Moody’s Investors Service.
Non-resident deposits, which make up almost half the Baltic nation’s total, rose 32 percent in the last two years, while domestic savings fell 2 percent, Moody’s said today in an e- mailed report. Instability in countries such as Russia and Cyprus may spur that trend as depositors turn to the European Union as a home for their cash, it said.”

German bond yields hit record low after ECB rate cut falls short – Telegraph

“Yields on 10-year German Bunds fell to an all-time low of 1.16pc, signalling the risk of a deflationary crisis and a slide towards outright depression.
Mario Draghi, the ECB’s chief, said the bank “stands ready to act” with further stimulus if needed but insisted that the economy would recover “later this year”.”

City regulator warns homeowners over interest-only mortgages | Money | The Guardian

“Research finding that 1.3m homeowners may not be able to pay off their interest-only mortgage raises fears of repossession”

What the ECB can and cannot do to heal the eurozone | Gavyn Davies

“But a more radical easing in monetary conditions may prove necessary to drag the economy out of recession, and prevent inflation from falling further below the target, which is defined as “below but close to 2 per cent”. In March, the ECB staff forecast for inflation in 2014 was 0.6-2.0 per cent, which seems barely consistent with the mandate, especially as the recession shows no sign of ending and fiscal policy is still being tightened. Any other major central bank would be urgently reviewing its options for aggressive easing, and the markets could become very disillusioned if they sense that the ECB is unwilling to do the same.
So what, realistically, can the ECB do? “

Italy should use its gold reserves to force a change in EMU policy – Telegraph Blogs

“By using the reserves – the world’s fourth largest – to collateralise the first chunk of any losses for bondholders, Italy could raise €400bn or so on the capital markets and determine its own future for a while.
Italy did this in 1974 when it borrowed $2bn from the Bundesbank, using gold as collateral.
Portugal did the same thing to borrow $1bn from the BIS in the 1975-1977, and India used its gold to borrow from Japan in 1991.”

‘Who, me the next Cyprus?’, Latvia edition | FT Alphaville

“The attractions of having a rep as a Russian-friendly offshore banking haven seem a little different these days, don’t they?”

Euro zone factory downturn deepens as Germany struggles: PMI | Reuters

“Markit’s Eurozone Manufacturing Purchasing Managers’ Index (PMI) fell to 46.7 last month from March’s 46.8, a four-month low but coming in ahead of an earlier flash reading of 46.5.
“The fact that the Eurozone Manufacturing PMI came in slightly higher than its flash reading offers little consolation to the fact that the index fell further in April,” Williamson said.”

Austerity is not the only answer to a debt problem – FT.com

“no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched – if there remains a choice, that is. Faced with, at best, haphazard access to international capital markets and high borrowing costs, periphery countries in Europe face more limited alternatives.
Nevertheless, given current debt levels, enhanced stimulus should only be taken selectively and with due caution. A higher borrowing trajectory is warranted, given weak demand and low interest rates, where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower. We have argued this consistently since the outset of the crisis.
Ultra-Keynesians would go further and abandon any pretence of concern about longer-term debt reduction. This position has been in the rhetorical ascendancy in recent months, with new signs of weaker growth. It throws caution to the wind on debt and, to quote Star Trek, pushes governments to “go where no man has gone before”. The basic rationale is that low interest rates make borrowing a free lunch.
Unfortunately, ultra-Keynesians are too dismissive of the risk of a rise in real interest rates. “