BBC BLOGS - Stephanomics

Archives for May 2011

Moving on

Stephanie Flanders | 12:25 UK time, Thursday, 12 May 2011

Stephanomics is dead. Long live Stephanomics. Today's news is that this blog is moving to a new home with a fresh format.

I know, change is hard, but they tell me it's going to better - and if it isn't, I know you'll be the first to tell me. At least all my work will be in one place - including my video, audio, news stories and, soon, my tweets. This is where you'll find me from now on.

Remember, it's not goodbye. Just a change of scene.

Inflation up. Growth down. Uncertainty everywhere

Stephanie Flanders | 14:34 UK time, Wednesday, 11 May 2011

You don't go to Inflation Report press conferences nowadays to get cheered up. The "news", if we can call it that, is that the Bank's Monetary Policy Committee (MPC) now thinks inflation will be significantly higher than they previously thought, not just in 2011 but in 2012. Indeed, if reality - by some freakish accident - follows the path suggested by the new forecast, the target measure of inflation will still be within shouting distance of 3% a year from now.

This won't come as a surprise to many, though the sharp rises in utility prices which underpin the new forecast will come as a shock to consumers who hoped the period of rising energy bills might soon be over.

The chart below (Chart 5.2, Chapter 5, page 39) shows the range of possibilities now for inflation in the second quarter of 2012 (in red) compared to the forecasts the Bank drew up in February (marked by the grey line). This shows clearly how the distribution has shifted, with a mid-point close to 3% instead of 2%.


As usual, every word the MPC or Mervyn King says on this subject comes laden with caveats and reminders of the uncertainty that surrounds them. But other things equal, the implication of this new forecast is that real wages will be further squeezed in 2012. Indeed, the Bank needs "other things to be equal" - needs nominal wages not to respond to this extra bout of inflation - for the rest of its forecast to be realised, and inflation to fall back to target by the middle of 2013.

A similar chart for GDP (page 41, if you're interested) shows the Bank has not made such large adjustments to its growth forecasts, though the picture is somewhat weaker than before.

There was much discussion in the press conference of what the governor was pleased to call the "soft patch" in the recovery: whether it would last, and what the long-term impact might be for the level of national output in a few years' time.

On this, the Bank is still on the more optimistic side of the spectrum; it thinks growth in the first quarter was probably stronger than the ONS figures suggest (yes, it's that construction output puzzle again), and that the recovery will probably get back on track over the next six months.

But, as I keep saying, what counts as an optimistic forecast these days is pretty anaemic by historical standards, and compared to the Bank's own forecast, only a year ago, of growth this year of nearly 3%. Also, though the path of the recovery from here might not be very different before, we will be starting from a lower base.

In that sense, the Bank is saying that the ground lost at the end of last year will not be quickly made up. To quote the report:

"The projection for growth implies a lower level of GDP than was judged probable in February. Given the observed weakness in productivity over recent quarters, the Committee judges that the outlook for productivity, and so for the supply capacity of the economy, is also weaker than in February."

Productivity has been unusually weak since the start of the recession, reflecting the fact that employment has held up even as output has gone down. The Bank thinks that part of the shortfall in productivity will never be regained - in other words, output per worker might be permanently lower as a result of this crisis, with, potentially, long-term consequences for national income as well. But the Bank does think that companies have some room to expand productivity and output at limited extra cost. That is what is known as spare capacity.

However, it's also possible that firms will try to regain their lost productivity another way, by simply laying off workers they have previously tried to keep on. Long-term, that might not be disastrous for national output (if the higher productivity ultimately generates higher demand) but it would have pretty undesirable short-term consequences for the labour market.

So much for the big picture on growth and inflation. The other thing that jumped out at me was the governor's comments on the relatively high cost of bank funding and how this was influencing monetary policy.

As this second chart shows, the marginal cost of money, if you are a bank, is much lower now than it was at the height of the crisis. But the gap between the rate banks pay and the official base rate is still high by historical standards.

It's no secret that this was a key factor behind the MPC's decision to cut the official interest rate so dramatically, and keep it at this low levelfor so long. But it was interesting to hear Mervyn King spell out that the future level of interest rates would be dependent, not just on the state of the economy but also on the state of the wholesale market for bank funding.


As he said, if the gap between the official Bank rate and the actual cost of funds for banks starts to narrow, that would suggest that the official interest rate would need to go up, merely to keep the stance of monetary stance unchanged. (If the Bank rate didn't go up, in those circumstances, that would mean policy had been loosened, assuming that banks pass on the fall in the cost of money to their customers or their shareholders.)

It's always been technically true that the market price banks pay for their money will affect the interest rate they offer to us - with consequences, in turn, for the way that the MPC thinks about the level of the Bank rate. But it's rare that the gap between these three should be so consequential for policy.

Greek lessons

Stephanie Flanders | 10:57 UK time, Wednesday, 11 May 2011

Here's what I learned from spending almost an entire day in Greece.

First, most Greeks I spoke to don't want the country to default on its obligations, and the average person there probably has a better idea of what a default would mean for the country in the short-term than some of the outsiders who blithely recommend it.

Of course, that's especially true of anyone close to the financial system. But reformers - inside and outside the government - suspect the political cost of default could be equally high. To their mind, the debt crisis has forced a once in a generation opportunity to push through long overdue reforms. As and when the debt burden is lifted, they worry that this great window of reform opportunity will close as well.

That may explain why - as I mentioned on the Today programme this morning - the government is still, amazingly, a little ahead in the opinion polls. Austerity has few fans, but so far the opposition has not persuaded the voters that there is a better alternative.

But all of this is about the short-term. Another observation from my brief time in Greece is that even the most committed optimists question whether the government can get to the end of the IMF programme without some form of debt restructuring. Put simply, no country has ever achieved the fiscal and economic turnaround the government has committed itself to without either a default or a currency devaluation. Usually both (though I wouldn't lay bets on Greece leaving the euro).

The fact that everyone - inside and outside Greece - expects a debt restructuring in the future is precisely why the Germans and some others are keen to see voluntary "re-profiling" of privately held Greek debt this year. They don't want most of the private bondholders - holding debt that matures in the next year or so - to get out, leaving mainly governments and official institutions bearing the brunt of a default after 2012.

But of course, it is that same logic that will make it hard to persuade private investors and institutions to take on longer term debt "voluntarily". They want out as much as the governments want them in.

If Greece does have to go down the re-profiling road, Greek bankers are terrified that the ratings agencies will consider it a "selective default", and they will no longer be able to use Greek debt as collateral for funds from the European Central Bank. A lot of energy - inside and outside Greece - is now being devoted to establishing whether this can be avoided.

Meanwhile, the underlying drumbeat in Athens seems much the same as it is elsewhere - "Lord gives us a Greek default, but not yet."

Update 14:39: I hoped my ironic reference to being in Greece "an entire day" would suggest humility - and act as a health warning for what followed. But it appears that many of you took it literally.

To be clear: I do think there's a limit to what anyone can discover about a country in a single day. I do not think 24 hours is a long time.

Why the Greek bail-out has worked

Stephanie Flanders | 10:46 UK time, Tuesday, 10 May 2011

Everyone says that heightened talk of a Greek default is proof that last year's bail-out has "failed". But you could make a strong case for the opposite.

In reality, all that the Greek support programme last year was ever going to do was buy time. And that is exactly what it has done. It just hasn't bought quite as much as governments hoped.

As I said in my last post, officials are agreed that Greece needs more support. The only issue is what form this takes - and how many hoops the government has to jump through to get it. Germany is also looking for voluntary re-profiling of privately held debt along the lines that I described yesterday as part of the deal. (Though it's far from clear that can happen on the timetable available).

Even the non-eurozone officials who have been most exasperated by Europe's management of the crisis would accept that governments were right a year ago to kick the Greek problem down the road and buy the system some time.

One year on, they are roughly back where they were, facing the same choice.

What's changed, from a Greek standpoint, is that its government is now much less popular than it was, and it now has even more debt to repay.

For the rest of the eurozone, the key differences between now and then are that a much larger share of Greek debt is now owed to official institutions (notably the European Central Bank), and that outside the periphery, Europe is enjoying a decent recovery.

Put it another way: Greece looks less able to repay than it did a year ago - while the system as a whole looks in better shape to withstand a default.

For some, these new dynamics shift the balance in favour of facing up to the reality of an involuntary restructuring or Greek default. Officials should stop fighting it, on this view, and instead focus on limiting the collateral damage, by recapitalising the banks that will be hardest hit (notably the Greek, French and German). They also need to have a credible line on what will happen to the sovereign debts of Portugal and the Irish Republic.

That is the voice you hear in the markets these days. I am in Athens today, and so far that is also what I am hearing from people here.

But most of the eurozone officials who would actually have to deal with the fallout from a Greek default - and the blame, potentially, for another Lehmans - see things differently.

From their perspective, buying time has worked for the eurozone. It just hasn't been working out so well for Greece.

When is a default not a default?

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Stephanie Flanders | 17:29 UK time, Monday, 9 May 2011

Outside of wartime, serious governments don't default. And if they do, it's a seismic market event. That's why the European authorities will do everything to prevent Greece from going down that path.

But there are plenty of ways to lower a country's debt burden which stop short of a formal default. The question is whether the more benign, voluntary approaches to restructuring can be done quickly enough, or deliver enough relief to the hard-pressed Greeks.

Officials have been looking into this privately since at least the G20 Summit in Seoul; some would say, since the Greek bailout was announced just over a year ago. In fact, there has already been a restructuring of Greek debt, in the decision to lower the interest rate and lengthen the maturity on the bailout funds that Greece signed up for just over a year ago.

A coalition of 17

Now further market pressure and some enthusiastic German reporting has brought the discussions into the open, and made them a good deal more urgent.

David Cameron and Nick Clegg think they have trouble; they should consider what it would be like to be in a coalition of 17. You can see why the big players would try to get together privately on Friday to see if it was possible to agree the outlines of a solution for Greece - even at the cost of irritating the excluded countries and further riling the markets on the subject of Greece.

Did they come to a magic solution? No. But they reconcile themselves to two basic realities - which many in the markets would consider the blindingly obvious.

First, Greece will not be able to go back to the traditional sovereign debt market in the second quarter of 2012, as previously hoped. Second, and most difficult for the Germans, the Greeks are going to need more official support, with or without any voluntary restructuring - or "re-profiling" - of shorter term Greek government bonds which are held by the private sector.

Re-profiling would mean the principal (the initial amount that was borrowed) would remain the same, but the maturity is extended by, say, 5 years. In theory, investors agree to the exchange because the net present value stays the same.

Financial carrots

These solutions can work - for example, Uruguay pulled it off, with not much trouble, in 2003. But most of the holders of this debt are not indifferent to the maturity of the debt they hold, or the risk of further restructuring down the road if they continue to hold Greek bonds.

You'd probably have to offer various carrots for them to sign up, for example exchanging the debt at a market premium. You'd also have to be fairly confident that this would not constitute a "credit event" for the purposes of credit default swaps and other contracts which are entered into to insure against - or more likely speculate on - a Greek default.

In other words, such voluntary approaches could work for Greece - but they would take time, and - crucially, from the bondholder's perspective - they wouldn't necessarily deliver enough relief to prevent the government from coming back for more.

Three options for Greece

Realistically, that leaves three options for lowering the Greek government's short-term debt problem:

  • further successful privatisation of assets by the Greek government (over and above the very large asset sales already included in the IMF programme, on which the government has made limited progress);

  • further official support from European partners, including further "re-profiling" of official loans;

  • and/or involuntary restructuring of private debt, including, possibly, an outright default.

On recent performance, the first of these, which involves more heroic effort by the Greek government, in an economy in which it's far from clear what public assets are worth - seems the least likely, at least in the short term. The question is whether fear of the third possibility - a disorderly repudiation of the Greek government's obligations - can induce the German coalition to support the second option, which is yet more official support.

On the basis of the past year, you have to assume that the Germans will sign up to giving Greece more help. After all, that's what they've done every other time so far such a choice has presented itself.

But it would help them if the European Financial Stability Facility (EFSF) could provide the help - for example, by buying Greek debt directly when it is issued next year. That would be deeply preferable to the Germans, since it would avoid the need to go once again to the parliament, and the German taxpayer.

Delaying tactics

Will that be agreed by next week's Ecofin meeting? Perhaps. But the odds are against it.

Here are too many details to be sorted out - and face-saving conditions and caveats to be devised by all involved. However, the consensus coming out of Friday's meeting seems to have been that something would have to be sorted out before the IMF completes its next review of the Greek programme, in the middle of June.

No-one thinks that will be the end of the Greek saga. But it would have the great advantage - common to all past "solutions" to the Eurozone crisis - of delaying the day of market reckoning a little longer.

Commodities: 'epic rout' or the new normal?

Stephanie Flanders | 14:25 UK time, Friday, 6 May 2011

The "epic rout" in commodity markets in recent days has left some traders and investors in a state of shock. But, if the damage turns out to be localised, Ben Bernanke will consider it useful - and we probably should as well.

The fall in prices - which has pushed the main US benchmark price of oil below $100 a barrel and saw the biggest ever one day fall in the price of Brent crude - has been linked to fears about the pace of the global recovery. That isn't good news. But nor is it strictly news.

The economic statistics have been showing signs of weakening in the real economy in the US and Europe for several weeks. The question is whether falling commodity prices make the situation better, or worse. Again, assuming there's limited collateral damage to the broader financial system, the answer ought to be better, for two reasons.

First, remember that one of the reasons we've been worried about the pace of recovery in the big advanced economies has been the rising price of oil and the rest, and the knock-on effect for inflation at a time when central bankers would rather not be raising rates.

It's early days yet - I wouldn't assume that the oil price will stay at this level. But if the global price of oil averages, say $110 a barrel over the next year or two, and not the $120 forecasters had been pencilling in, that could take about 0.2 percentage points off the rate of inflation in 2011 and 2012, relative to what was previously thought. If you're the ECB or the Bank of England, or the Federal Reserve, every little helps.

The other reason why Ben Bernanke and other central bankers will not be unhappy to see this week's price falls is that it suggests the first stage of unwinding the US central bank's emergency support for the US financial system is already quietly under way - and having the desired effect.

Though the ECB is the only major Western central bank to have formally raised interest rates, central banks around the world have been quietly mopping up some of the short-term liquidity that's been injected into the market since 2008. By signalling firmly that there were no plans for QE3, Ben Bernanke has made clear that the US is on that path as well, assuming there's no big market shock between now and June to make him re-think.

If the fall in commodity markets is part of the markets taking this information on board, Mr Bernanke and his central bank colleagues would probably think that was all to the good. In the current circumstances, the past few days of commodity market mayhem may actually be what "normalisation" looks like.

However, a lot depends on how long this price tumble continues - and the impact on other parts of the system.

Some have drawn comparisons with the spectacular fall in commodity prices in the early summer of 2008 after an equally dramatic run-up. This played an important role in the Lehmans meltdown a few months later: depending on whom you talk to, perhaps a decisive one.

The hope is that the past few days show the global economy moving further away from crisis and the emergency policies that it produced - NOT a premonition of another downward lurch. But we're all learning that nothing about this global recovery can be taken for granted.

ECB: Clearing the way for an Italian hawk?

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Stephanie Flanders | 16:58 UK time, Thursday, 5 May 2011

Jean-Claude Trichet was more dove-ish than expected in his press conference today after the European Central Bank's (ECB) latest meeting. The city was surprised, but Mario Draghi may come to be grateful.

You might not have taken Trichet for a dove, listening to his stern words about the "upside" risks to inflation. But in the strange world of ECB-watching these days, it's not what is said, but the precise words that are used to say it.

To give a sense where this has got to, let me quote part of a note from Barclays Wealth, explaining why the ECB president's opening statement suggested that a June rate rise was not on the cards after all. (This is no dig to the author - I've received plenty of similar emails since Mr Trichet sat down.)

"The ECB's introductory statement did not include the phrase "strong vigilance". It did refer to conditions being "still accommodative". We had expected "very" accommodative to be used (as opposed to plain "accommodative" last time), and were not (on balance) expecting use of the phrase "strong vigilance".

In our view, the use of "still" here is much the same as re-insertion of "very" would have been: it implies that the expression can be revised to "vigilance" at the next meeting on 10 June. We continue therefore to look for a 25bp rate increase at the 7 July policy meeting, with this signalled at the 9 June meeting by using the word "vigilance"."

So, I hope that's clear.

Before the meeting, people expected the ECB to raise interest rates at least twice more in 2011, with one rate rise in June and the other perhaps in September. After today, the city doesn't expect another rise before July, with the next one perhaps not arriving until the winter.

If that's the correct reading - and it probably is, given that the ECB has previously been eager to participate in this game of "spot the missing adjective" - then two conclusions follow.

The first is that the ECB is taking seriously recent signs that the Eurozone recovery is losing momentum, particularly outside Germany. And it's not been unduly spooked by the jump in eurozone inflation to 2.8% in April, the highest in two and a half years. Trichet's pointed comments about the dollar suggests a concern for the rising Euro as well. Lest we forget, the eurozone - particularly the periphery - is relying on an export-led recovery as well.

The second point - more speculative - is that the delay in the second rate rise might prove helpful to his likely successor.

It now seems all but certain that the distinguished Italian technocrat, Mario Draghi, will take over from Mr Trichet in November. What could be better, if you are the first Italian to stand as the guardian of European price stability, than to begin your time in office by raising interest rates?

It's a frivolous point, perhaps. Not to mention highly speculative. But there's a serious-ish point underneath.

At a time when every rate rise makes the countries on the periphery wince (and every rise in inflation makes German housewives curse the loss of their beloved D-mark), there was plenty of nervousness about the possibility of a German taking the helm at the ECB. Especially a well known hawk such as Axel Weber, who was the front-runner until he surprised everyone earlier in the year by announcing he would stand down.

But think about it. Precisely because of his background and reputation, Axel Weber would have come in needing to prove he would put Europe first and Germany second. The pressure on Draghi will be exactly the opposiite.

If you're sitting in Spain and Portugal, you might well wonder whether you would have been better off with a German in charge, trying to show off his inner Italian - than an Italian desperate to prove he's German underneath.

Third time lucky for Portugal - and the eurozone?

Stephanie Flanders | 13:20 UK time, Wednesday, 4 May 2011

What's the difference between a developing country financial crisis and a European one? The answer is that emerging market crises are usually done and dusted in a matter of weeks - whereas in Europe they really like to drag things out.

Watching the eurozone these past two years has been like watching a car crash in really, really slow motion.

It was more than two years ago that senior policy makers - on both sides of the Atlantic - started worrying about a European "leg" of the financial crisis that peaked in the autumn of 2008. European policymakers were urged to think long and hard about the state of their banks, and the deep financial and economic imbalances that had built up in the first 10 years of the single currency - and how they would respond, if and when, these vulnerabilities came to a head.

By and large, these pleas were ignored. European officials preferred to offer short-term support for their banks and their economies - and hope that their long-term weaknesses would quietly go away. Surprise, surprise, that didn't happen. Now Portugal is the third eurozone country to be asked to resolve the single currency's contradictions the hard way.

Unlike the other countries in the mix, Portugal does at least have recent experience of negotiating with the IMF. This will be its third emergency loan from the Fund in the past 34 years. It also had help in 1977 and 1983.

In announcing this deal, the caretaker Prime Minister, Jose Socrates, suggested that the terms of the bail-out were less severe than they had been for the Republic of Ireland and Greece. He is in the middle of an election campaign - we can't know whether that's true until we see more details, notably the interest rate being charged and the structural conditions.

But there's a reason why Portugal was the third in line for a bail-out, not the first: its fiscal situation is not nearly as bad as the Greeks', and its financial system is not nearly as weak as the Republic's - and has not infected the sovereign balance sheet to anything like the same extent. (Though we expect that up to 20bn euros of the 78bn euros will earmarked for the banks.)

It would be surprising, in these circumstances, if Portugal's programme was as tough as the others. But the word is that there will be plenty of structural reforms included in the agreement, including pensions and the labour market, even if the specific areas listed by Mr Socrates have been saved (for example, he suggested there would be no change to the minimum retirement age - which would be surprising, if true).

The few details we do have, showing the budget deficit falling from 9.1% of GDP in 2010 to 3% in 2013, suggest it is tough enough to be getting along with, at least by the purely macroeconomic yardstick of how far the government is being squeezed.

If that timetable appears more generous than it might have been, that is largely because the starting deficit is larger than previously thought. Remember, until recently, we thought the budget deficit in 2010 would 'only' be 7% of GDP.

When you take the higher starting point into account, the pace of deficit reduction is not much slower than the government originally planned. And pretty ambitious, too, when you consider that the EU and the IMF expect the Portuguese economy to shrink by 2% in 2011 and in 2012.

As I noted a while ago, the countries in trouble in the eurozone have a debt problem and a competitiveness problem, and you can't solve one without trying to address the other. As I said then, if one were starting afresh with the single currency, you would want an effective way to manage sovereign debt restructuring. You might also want to think about economic policies which would make it easier for the less developed members of the eurozone to improve their competitiveness without having to suffer years of economic stagnation.

Of course, the eurozone was not starting from scratch in the spring of 2009. But in the past year the debt problem has at least been extensively discussed, even if it is far from being resolved. By contrast, the serious consideration of how countries like Portugal are going to achieve economic growth in the current environment has barely begun. As Greece, Portugal and others have been finding out, a lack of growth can undermine the credibility of a bail-out programme just as quickly as a lack of political resolve.

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