Is The ECB Measured-Pace Cycle Over?

Well, not unexpectedly, the ECB decided to leave its main refinancing rate unchanged at 2.25% yesterday. Rather more surprisingly (for some at least) the German Federal Statistical agency reported that German economic growth ground to a halt at the end of 2005.

According to the Financial Times:

Johann Hahlen, president of the federal statistics office, said that growth last year had been based largely on exports, with domestic demand remaining weak. “Broad and self-supporting growth is still not being observed”.

Again according to the FT, Herr Hahlen’s comments “surprised economists, who had expected growth to continue and have become increasingly upbeat about the outlook in 2006”. I’m surpised the FT can be so blazé in saying ‘economists’: they certainly didn’t surprise me. I think it was reasonably clear that this was coming. If I am surprised by anything it is that it has come so quickly.

So where do we go from here? Well Jean-Claude Trichet, the ECB president, has been trotting out the party line to the effect “we have to be vigilant as regards inflation”, but with inflation now falling back (in December the harmonised rate slipped back a fraction to 2.2% from the 2.3% in the year to November) and with virtually no ‘second round oil rise’ effects in evidence this argument is going to sound increasingly hollow. Couple this with the ongoing ‘low- growth’ environment in the Eurozone (we’re still awaiting the sort of news from Italy which will again I imagine surprise ‘economists’) and you can see that there will be few reasons to justify any serious interest rate rises. At the limit we may just see one more quarter point rise squeezed-in before year’s end. Aside from that the ECB tightening cycle is, as I suggest, just about done.

Since it has recently become fashionableto try to predict the future, below the fold are my 2006 forecasts.

In first, and most prominent, place: the dollar will not decline sharply in 2006. Change on the margin is a much harder call, but, on balance, I expect the euro to nudge down during 2006. The principal factors here will be the interest-rate and growth differential with the US.

Global growth will be a touch slower than in 2005.

Germany and Japan will not have sustained, internal-demand driven, recoveries.

Japan will not ‘break-lose-decsively from the chains of deflation.

China and India will continue to grow pretty much as they are currently doing.

Turkey will continue to be the principal growth tiger in the EU orbit.

Ireland and Spain will continue to have property bubbles.

The US will grow a tad more slowly in 2006. It will not enter recession. The CA deficit problem may well grow.

There will be time enough to forecast 2007 when we have had time to see just how near the mark our 2006 forecasts are

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

13 thoughts on “Is The ECB Measured-Pace Cycle Over?

  1. Edward,

    Just a couple of comments:

    1. I assume you meant tightening instead of easing.

    2. You noted: “Well Jean-Claude Trichet, the ECB president, has been trotting out the party line to the effect “we have to be vigilant as regards inflation”,”

    The FT, however, pointed out that: “The ECB risked confusing its message by not using the term “vigilant” to describe its stance in respect of future inflation risks. But Mr Trichet said the ECB would “continue to monitor very closely all developments”.

    3. I like the summation by Barclay’s Callow as quoted by FT: “we have a case of the hawkishness that dare not speak its name.”

    Cheers,

    Pepe

  2. You’re using the weather forecaster’s principle that there is a greater than 50 per cent chance that the weather will be the same tomorrow?

  3. “I assume you meant tightening instead of easing”.

    God Pepe, thanks for that. I have changed it. I must have had a “cruce de cables”. I think I was so focused on what has just emerged from Germany that I forgot some important details :).

    “I like the summation by Barclay’s Callow”

    Yes, I was going to quote that, I was even in two minds about using it as a headline :).

    “The ECB risked confusing its message by not using the term “vigilant” to describe its stance in respect of future inflation risks. But Mr Trichet said the ECB would “continue to monitor very closely all developments”.

    Obviously they are hedging. They don’t really know what to do. They are hoping that the data will look a bit better in the next quarter (and of course it might do), and then they could have a final face-saving raise in March, otherwise they risk being punished by the markets for promising and not delivering. This is a very dangerous game, which is why I feel the whole Trichet thing was so ill-advised in december: if you poke your head over the parapit, there’s always a danger of getting it shot off :).

    Meantime I think we can almost feel the disappointment here in Spain, since this means the housing bubble is definitely set to continue, with no remedy in sight.

    On a side issue, the 50 year mortgages they are now offering in Euskera, I don’t know if you read this post:

    http://fistfulofeuros.net/archives/002230.php

    but from an actuarial point of view they make perfect sense. Life expectancy is rising by one year every four years. If this continues (and there is no reason why it shouldn’t) then 50 years from now average male life expectancy in Spain should be 12.5 years more (ie instead of 78, it should be a little over 90). This is an average remember. So it is not unrealistic to imagine that by 2050 a not insignificant number of people could be working to 80. Which means they can pay off the mortgages.

    Whether or not it is a good idea for young people to embargo their lives in this way is another question. My guess is that, as I have already suggested, when this is all over there will have to be a politically negotiated settlement, that everyone will have to accept some sort of haircut or another, and that as part of this the banks will have to accept a renogotiation downwards of the outstanding capital values of the debts.

  4. “You’re using the weather forecaster’s principle that there is a greater than 50 per cent chance that the weather will be the same tomorrow?”

    Gotcha. You’ve caught me at it :). German trend growth has been around 1% per annum for a decade now, and falling slowly (ditto Italy). I see no reason why this should change. So we get around the 0.5% trend about 2010, and we may start seeing negative growth around 2015. But being a good weatherman, I realise that as soon as you start talking about what might happen the day after tomorrow the margins of error get to big, especially due to the presence of subtle non-linearities, so perhaps I had better stick to 2006.

    “the weather forecaster’s principle”

    Actually we could call it the Ormerod principle, after Paul Ormerod, former Head of the Economic Assessment Unit at the Economist and founding director of the Henley Centre for Forecasting.

  5. Edward,

    Re: 50-year *variable-rate* mortgages.

    This “product” (being offered by the BBK, a “caja”) is obviously aimed at maintaining the influx of new entrants at the base of the housing pyramid.

    I don’t know how the banks are pricing these things, but default risk obviously rises (even if probability of death is offset by higher life expectancy, which is BTW already covered by mandatory life insurance policies) due to events such as unemployment, illness, interest-rate risk…

    Also leverage increases as the term of the loan becomes longer. If say, with a 25-year mortgage, every x-percentage-point hike in the euribor means a monthly-payment increase of y%, for a 50-year, the same euribor hike means a 2y% increase in monthly debt service.

  6. “but default risk obviously rises..”

    Thanks for this. Yes, obviously. And really, following my conversation with Alex, the uncertainty rises with every year you move out from 2006.

    The key issues are going to be relative growth rates, and relative GDP per capita between Spain and the rest of the world when it comes to deciding whether these things are payable or not.

    As I am suggesting I think push is going to come to shove long before the 50 year term expires in Spain, all I am indicating here is that the idea of a fifty year mortgage today makes as much sense as a thiry year one did in 1970 (or something like that). It isn’t the loan that’s the problem, but the capital value notionally associated with the property on which it is lent.

  7. “This “product” (being offered by the BBK, a “caja”) is obviously aimed at maintaining the influx of new entrants at the base of the housing pyramid.”

    Yes, I agree.

    You obviously have thought about all this, and have most of the picture. You also recognise the immigrant connection. This is an increasing returns chain mechanism, till it isn’t, if you understand me.

    Anyway, glad you found us. I was tired of talking to myself on this (in Spain I mean).

    If you look at Kindelbergers classic work on Bubbles, you will see that a key indicator is when people ‘go oustide reason’ and refuse to listen. This is what we have here in Spain now, although the veneer is starting to wear thin.

    This paper – Population Age Structure and Housing Investment in Spain – by two Basque economists – Cruz Angel Echevarría and Begoña Eguía is interesting:

    I also just found this relevant piece on Ecuador migration.

    Also this paper Immigrant mothers, Spanish babies: longing for a baby-boom in a lowest-low fertility society by Marta Roig and Teresa Castro.

  8. Edward — shouldn’t it be “Turkey remains the financial crisis waiting to happen in the EU’s orbit, should global liqudity every dry up …”

    Ok, financial crisis is maybe strong. Turkey has made huge, huge strides — its public finances are in surprisingly good shape. But a currency correction seems likely, and a deceleration of growth, should global conditions change.

    What do i see in Turkey. 6% and growing current account deficit, over financed by 10% of GDP capital inflows. A very strong real exchange rate. slowing export growth. A construction driven economy, spurred by an explosion of mortgage lending (Turks like 13% nominal is a very low rate — even if it is 8% real if the central bank hits its 06 inflation target; foreigners dump money in to a country offering 8% real). Its spain, with a less developed mortgage market, but one on the verge of taking off. on the plus side, it is still has its own currency and the exchange rate can adjust.

    you say demographics, i say global liquidity …

  9. “shouldn’t it be “Turkey remains the financial crisis waiting to happen in the EU’s orbit, should global liqudity every dry up …””

    Ok Brad, well thanks for throwing down the gauntlet. This could get interesting.

    Basically I see Turkey (like Bolivia in a different sense) as one of the test cases for all this theory I am quietly marshalling.

    What I would say straight off is that of cousre none of this is deterministic. Just like you say that the US only ‘can’ have problems with the deficit, I say only that it is ‘unlikely’ that Turkey is going to have a major financial crisis. I have to say unlikely since there are wild cards like the disintegration of Iraq or the arrival of a major avian flu epidemic (the one we have now, like the hurricane Katrina in the US, will only accelerate modernisation, and should raise productivity).

    It was Rod Stewart who said, I think, that the “first cut is the deepest” and while he was talking about love, I think we could apply his idea to the globalisation process: the Asian crisis of 98 was very deep, since it was a new phenomenon, and the adaptive mechanisms of the global system hadn’t been adequately tested. The ‘sweet moment’ economies, and in particular of course China (but also eg Thailand) were obviously much weaker (just like young juveniles really, or 18 year old football stars up against first division hard knocks) but they are now considerably more mature. This would apply to to Argentina and Turkey.

    If you want an unstable place, try Venezuela or Bolivia, or maybe Philipines.

    Looking at my chart I can see that Turkey is still relatively young to be making this transition smoothly (median age 27.7), I’d be looking for them to get a bit older (median age 29/30) for real solidity to come. But then the EU *is* a huge and powerful anchor, so I guess this counts for something.

    Basically I am in the process of putting up a Turkey page, since it fits in with a much broader piece of work I am doing. One economist who I think is reading the tealeaves just fine on Turkey is Morgan Stanley’s Serhan Cevic, and you will find a link to many of his posts there. For now I will just pick out one: The Big Picture:

    Turkey’s current account deficit reached a record $16.4 billion in the first nine months of this year, implying an annual deficit of 6.5% of GDP. With such a significant deviation from the average deficit of 1.4% in the 1990-2004 period, some observers make predictions with dreadful consequences for the Turkish economy. Even though there is nothing fundamentally wrong with running a current account deficit, especially when a country becomes more closely integrated with the global economy, we want to look beyond the headlines in search of the real roots of Turkey’s current account deficit. Along with external factors, such as the slowdown in foreign demand and the rise in commodity prices, fundamental shifts in the domestic economy, such as the behaviour of savings, the surge in business investment spending and the acceleration of productivity growth, have played significant roles in reshaping Turkey’s external accounts.

    As the data clearly show, Turkey’s current account deficit is result of a sharp increase in investment, not a fall in national savings rate. Domestic investment spending surged from the post-crisis low of 18.9% of GDP in 2002 to 24.3% in 2004 and 25.6% this year. Just like the trend in national savings, we have also witnessed a structural shift in investment behaviour, moving well above the average of 21.3% in the 1950-2003 period.

    More to come ‘as time goes by’, as they say.

  10. “Obviously they are hedging. They don’t really know what to do. They are hoping that the data will look a bit better in the next quarter”

    I agree, but ultimately I fear that the ECB’s inflation fighting credentials will weigh heavier than how to stimulate growth in the future … bottomline is: Yes, they are hedging but the rhetorics remain the same!

  11. “I fear that the ECB’s inflation fighting credentials”

    The curious thing is Claus, just who exactly is questioning these credentials (it is the US Fed and Greenspan and Bernanke who are normally taking the flack on this, since, if anything, they have an anti-deflation, and not an anti-inflation bias).

    No-one in their right mind seems to be questioning the EU on this score. As far as I can see they are simply having a debate with their own alter-egos.

    “how to stimulate growth in the future …”

    Well the issue is that some countries have growth and inflation (Ireland and Spain) and others have neither (Italy and Germany). Now how do you square that in monetary policy terms. It is beyond me.

    Oh, I know, we target Mr Average, that must be the way it will work!

  12. “What do i see in Turkey. 6% and growing current account deficit,”

    As usual Brad, post hoc I realise that I have, in your eyes, committed my normal cardinal sin, of consuming a lot of words without answering your key point: on my version, why is Turkey running a Trade deficit while China isn’t? I think what I am trying to say is that Turkey isn’t there yet.

    As Serhan Cevic indicates, a lot of the trade imbalance is due to the pace of investment at a time when the dependency needs of the young population still mean that internal saving is not sufficient to finance it all. That, and of course the fact that Turkey is a machine-heavy economy, and this guzzles oil which has to be paid for.

    Over the next decade Turkey will come to get much nearer the prime age time, saving will increase to fund internally the ongoing investment, export trade with the EU will increase as all that investment comes online, and GDP will be more equilibrated away from heavy industry. Thus I expect Turkey could well be a surplus country come EU accession in 2014.

    Of course, theory is grey, while life is green, so we will only really know whether this view is valid as we move forward. Still, this is what I am expecting to happen, although without the same degree of security as my 2006 forecast :).

  13. How much is that due to the fact that remittance and leisure are a much bigger part of the Turkey’s economy than the Chinese

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