Spain is on the edge
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- Published on Saturday, 28 April 2012 11:11
- Written by Sibalene
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As so often occurs during a crisis, events are so fast-moving and far-reaching that it is often a tremendous challenge to keep up. Yesterday, the Rajoy Government gained parliamentary acceptance for a budget stability law which compels Spain to achieve a balanced budget by 2020. With the economy in rapid reverse and likely to stay that way for some time, achieving this objective will be incredibly difficult. Last year’s fiscal deficit was 8.5% of GDP, or around EUR 90bn.
Recognising that much of the fiscal slippage encountered last year occurred at the regional level, Rajoy continues to press the governments of these 17 autonomous regions to honour the budget commitments Spain has made to Brussels. A number of ministers have recently lambasted some of the regions for their excesses. The budget stability law just passed allows the central government to intervene in the financial affairs of regional fiscal miscreants. This in turn has lit the touch-paper on that perennially sensitive subject in Spain, namely regional autonomy. One of the major criticisms levelled at Spain over the past decade is the explosion in public sector employment and the attendant inefficiencies that often accompanies such a huge presence. As Rajoy and his senior finance officials have made clear, it remains imperative for Spain to convince international investors of its credit-worthiness, or else Spain will suffer the same fate as the likes of Greece, Portugal and Ireland.
Unfortunately, the constant brush-fires evident at the regional level are being replicated in the equally troubled banking sector. Although some Spanish banks took advantage of the ECB’s generous provision of liquidity (via the LTRO), this has merely papered over the cratering being experienced on the asset side of their balance sheets. The Bank of Spain has already proposed that banks in Spain increase their provisions by EUR 50bn. Given the rapidity of the decline in property prices, this will likely need to be raised significantly.
For good reason, the Rajoy government has gained the plaudits of international leaders. However, bond investors are more circumspect, because they suspect that, despite his best endeavours Rajoy will be unable to prevent Spain also falling into the hands of international creditors. The ECB must be desperately hoping that the latter does not occur. Ramping up the SMP will cause huge divisions within the ECB and another helicopter drop of liquidity via a third round of LTRO would look desperate and would probably also fail to mollify investors.
As most money managers around the world now appreciate, Spain is the elephant in the room for the major asset classes.
UK QE loses its biggest sponsor
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- Published on Saturday, 28 April 2012 11:10
- Written by Sibalene
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The minutes of April’s Monetary Policy Committee (MPC) meeting revealed that the biggest supporter of QE in the UK lost its main sponsor, Adam Posen. Since October 2010, Posen has been pushing for further QE at nearly every meeting, only falling into line in after the agreed increase in October 2011. But even before 2010 (he joined the MPC Sept. ‘09) he was more often than not the biggest proponent of further QE. For the only member still voting for more QE, David Miles, there was a recognition that the decision was “finely balanced”, which could be his way of backing down once the May inflation-forecasting round gets underway.
In light of yesterday’s CPI data however, these decisions are perhaps understandable. Once again, next month the BoE will be in the position of needing to explain why inflation has not fallen as much as they it anticipated three months previously. Of course, nobody is expecting the Bank to have perfect foresight, but the BoE is gaining a reputation for underestimating inflation and there are only so many occasions on which one can blame one-off and special factors. The rise in core inflation backs this view. It was in March last year that Posen (Guardian, 27th March 2011) stated that inflation would fall below the 2% target in the second half of this year. This still may prove to be true, but it’s looking far less likely.
Whilst sterling markets were able to hold their nerve yesterday, the signals of the shift in the MPC’s thinking, combined with the slightly better than expected labour market numbers, have caused a re-assessment in interest rate markets (where there is less scope for lower market rates). The impact has been felt on the pound, pushing higher both vs. the dollar and more so vs. the euro. Near-term the move is understandable but there will be questions over the BoE’s credibility in the coming weeks and especially going into the May Inflation Report.
Yen softens amidst talk of more BoJ easing
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- Published on Saturday, 28 April 2012 11:09
- Written by Sibalene
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Right on cue, BoJ Deputy Governor Nishimura has sent yen bulls scurrying for cover by suggesting that the Japanese central bank will be prepared to implement additional easing should it become necessary. With the next BoJ meeting just over a week away, many have understandably interpreted his remarks as a warning that the central bank is still disposed towards further measures, notwithstanding the bold announcements already made this year including the huge expansion of its asset-purchase program and the establishment of a 1% inflation target.
In response, the Japanese yen has given back some of its recent gains, with USD/JPY now at 81.30, up one big figure from yesterday. Partial relief then for the MoF which no doubt would have been alarmed by the progressive strengthening of the currency so far this month. Complicating attempts to weaken the currency has been the narrowing in yield spreads over recent weeks between Japan on the one hand, and the US and Germany on the other. In addition, the Japanese economy has just started to look a little healthier.
More than ever, the BoJ is under incredible political pressure both to support the economy and to weaken the currency. There is almost certainly considerable discomfort within the central bank with respect to the direction of BoJ policy, but right now the politicians are carrying the debate and the independence of the BoJ is being compromised.
Uncomfortable UK inflation
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- Published on Saturday, 28 April 2012 11:08
- Written by Sibalene
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For the second consecutive month, the UK inflation numbers have come in above expectations, the March release showing headline inflation rising to 3.5% (from 3.4%) and core inflation up to 2.5% (from 2.4%). Furthermore, if we compare today’s numbers to the expectation of the Bank back in November, it’s clear that the pace of decline in headline prices has not been as quick as it had been expecting back then (on average by 0.1%).
The reason this time around appears to be stronger inflationary forces on the High Street, with food prices adding 0.1% to the increase in headline prices and clothing and footwear 0.08%. The increase in clothing and footwear was the largest monthly increase ever seen. Offsetting the increases were household fuel prices (falling this year, rising last year), whilst transport costs were also pulling the headline rate lower thanks to weaker prices for second-hand cars.
So after peaking at 5.2%, the good news is that inflation has fallen substantially (but that was easy, given the base effect from the Jan. ‘11 VAT increase) but, once again, not as fast as anticipated. From a wider perspective this is worrying because, if we take the start of 2008 as the base, UK prices have increased by nearly16%, vs. 8% in the EU and US. At the same time UK incomes have been held back, so the household sector continues to suffer. Indeed, yesterday’s data showed income per head having risen in only two of the past eight quarters in the UK. In sum, we are now once again questioning the BoE’s inflation-forecasting record, which was already under close scrutiny for consistently underestimating the inflationary spurt of recent years. For the UK, easing policy when inflation has consistently over-shot the target has not been a comfortable or easy task for the BoE. Today’s data suggests that it may not be getting any easier, despite what the headline numbers suggest.
Euro balks at 1.30
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- Published on Saturday, 28 April 2012 11:08
- Written by Sibalene
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After threatening to really crack the 1.30 level yesterday, the single currency is back up at 1.3150 late in the morning session. Those hoping for a cogent explanation for the turnaround can look away now – apart from some good old short-covering, stop-hunting and sovereign wealth fund-buying, there is little in the way of fundamental developments to account for the mood change. Since early London, the euro has been well-bid.
News that the Rajoy government will be really tough on those fiscal miscreants at the regional level has helped the tone in part. Also, better-reasoned analysis of the funding situation in Spain suggests that the country might muddle through. As a sovereign, Spain is roughly 50% pre-funded. Also, most Spanish banks have still not used their LTRO money, the ECB is considering the purchase of Spanish bonds as part of its SMP, European leaders have bolstered the size of their firewall to around EUR 800bn and the IMF may yet be prevailed upon to supply additional funds.
Should Spanish concerns flare up again then we can expect the single currency to be under downward pressure once more.