By David Brierley and Saad Sarfraz
Perhaps it’s a sign of the times. The Deutsche Bundesbank is abandoning its profound anti-inflation principles. Head of the Bundesbank Jens Weidmann has suggested that a 3% rise in German employees’ income, which is traditionally linked to productivity and inflation, would be appropriate.
A 3% increase would go well beyond the traditional linkage given the very low levels of inflation in the eurozone. The suggestion has unsurprisingly pleased German unions but distressed German employers.
Peter Praet, executive board member and chief economist at the ECB, has welcomed the suggestion because it might address the competitive challenge faced by economies in the periphery. In those countries, low wages are required to regain competitiveness. Germany famously used monetary union to improve its productivity and competitiveness, thereby strengthening its export performance in the eurozone. Now some of those gains could be given to working Germans instead.
However, the newfound radicalism of the Bundesbank could have other targets.
“I assume the Bundesbank wants to raise wages to avoid deflation in the eurozone, which should also undermine the ECB’s arguments for quantitative easing,” said Hans-Werner Sinn of the Ifo-Institute for Economic Research in Munich, as the Frankfurter Allgemeine reported July 27.
Monetary policy remains deeply troubled in the eurozone, as SNL FINANCIAL charts based on ECB data show.
There is a profound dislocation in the real interest rates available to consumers, businesses, including sole traders, and business credit card users between the two core European nations of France and Germany and the two peripheral nations of Spain and Italy. Identical policy rates are producing very differing results, distorting competition across the euro area.
Only mortgage lending and revolving loans and overdrafts show a less stark differentiation between core and periphery, probably reflecting the different levels of credit risk in the individual MARKETS concerned. Italians, for example, have low levels of personal debt and are frequently property owners, making their credit card usage relatively low risk.
The critical difference for monetary policy is the price paid by businesses to lend and thus INVEST .
Nonfinancial companies in Italy and Spain pay perhaps 1 percentage point to 1.5 percentage points more than their peers in France and Germany for new lending. For sole proprietors, the differential rises to around 2 percentage points to 3 percentage points. Given that this lending is vital for fresh growth and rising employment, this is a serious dislocation of policy. Businesses in the periphery can only struggle to compete with the core and grow.
“Monetary policy is not effective for the whole of the euro area,” Ken Wattret, co-head of European and central eastern Europe, Middle East and Africa MARKET economics for BNP Paribas, told SNL.
“Is the stance for the eurozone as a whole accommodative enough? Although policy rates are pretty much as low as they can go, you still have had an exchange rate appreciation of some magnitude since mid-2012.
“From that perspective, you can argue that rates are not accommodative enough given the persistence of low inflation. Although the policy rate is the same everywhere, the effective cost of borrowing for households and FINANCIAL corporates varies considerably.”
He added: “The impairment of monetary policy has been slow to be addressed. The main reason for this is risk-aversion in the financial sector.”
Eurozone banks, in other words, are partly to blame for the distorted transmission of monetary policy through the eurozone.
Commerzbank economist Christoph Balz attributes the high interest rates seen in the periphery to high-risk premiums on loans and believes that this is clearly linked to the banks’ asset quality and cost of lending. “The very high percentages of nonperforming loans explain the higher rates in the periphery,” Balz remarked to SNL.
It amounts to a monetary nightmare. The question is what the ECB can do now. This year’s asset quality review and stress test should give banks and MARKETS more confidence about their balance sheets while the ECB has recently announced negative interest rates and the use of targeted longer-term financing operations to help banks lend.
ECB in wait-and-see mode
Both Balz and Wattret think the ECB would now wait to see what effect these measures might bring. Indeed, as Commerzbank observed in an Aug. 1 note, ECB Vice President Vitor Constâncio has said that the central bank “will not undertake any further [measures] until we have checked the effectiveness of these steps.”
While Wattret believes that lending costs might normalize over time in the eurozone, he still thinks extraordinary measures would be required; that is, the significant purchase of assets as an alternative to the traditional conduit of monetary policy through bank lending. Balz foresees a 40% chance of quantitative easing.
The Bundesbank, as noted, has already made its proposal, indicating that it too fears more action will be needed given the very low level of inflation. This reached 0.4% in July in the eurozone, underlining fears of deflation.
Wattret said the ECB had been relatively pusillanimous compared to the Federal Reserve and the Bank of England in terms of extraordinary monetary measures.
Balz added that quantitative easing would only happen once the core interest rate had been cut by a further 0.25 percentage point and if it is clear that demand for TLTROs only amounts to double-digit euro billions. He further pointed out that it was difficult to effect asset price purchasing equitably — for example, buying bonds issued by PSA Peugeot Citroën or Volkswagen AG could disadvantage Opel AG, which is funded by U.S. parent General Motors Corp. Moreover, unlike in the U.S., there is little or no bond issuance in Europe by the small to medium-sized enterprises that are the key to employment growth.
According to ECB chief Mario Draghi, €1 trillion of TLTRO FUNDING could be made available. This sounds optimistic.
Speaking in late July during their second-quarter results analyst meetings, Spain’sBanco Bilbao Vizcaya Argentaria SA and Banco Santander SA, as well as Italy’sIntesa Sanpaolo SpA, appeared especially keen on TLTRO FUNDING .
While neither BBVA nor Santander looked ready to commit to taking the FUNDS , Intesa Sanpaolo said it would do so, splitting the interest rate advantage of the money with its clients. In other words, Italian corporates could benefit from lower interest rates on lending. However, TLTRO funding will not address the cost of risk premium, which peripheral banks are passing on to their customers.
Both BBVA and Intesa Sanpaolo reported figures indicating some interim improvement in their domestic economies year over year but a still tough current environment in 2014 — whereby Spain looks to have undertaken more than Italy to render possible a recovery.
Spanish banks have, as our charts show, managed to reprice much of their deposits to enhance their margins. Italy has further to go and thus a greater opportunity to raise profits while Germany’s banks truly are being squeezed by generally very low corporate lending rates and deposit rates which, Balz said, could hardly go lower.
Although Intesa celebrated the strength of its own first-half 2014 profitability, the outlook for Italy’s banks as a whole remains unimpressive. As Moody’s stated July 15: “Italian banks’ problem loan levels will remain high over the 12- to 18-month outlook period, likely requiring additional provisions, whilst the influx of new problem loans will continue until the economic recovery translates into more tangible improvements in employment, consumer spending and corporate investments.”
There is some sign that the new inflow is improving in Spain. However, given that unemployment is around 25% in the country, similar balance sheet issues will weigh on economic progress and banks’ cost of risk. This effect will continue to feed through to the banks’ lending costs and to the costs of borrowing for businesses in both Italy and Spain. It will also hurt banks’ profitability. The great hope now is that the TLTRO will address these issues.
Sterling rises above $1.37 for first time since 2018; UK inflation rises
By Elizabeth Howcroft
LONDON (Reuters) – A combination of heightened risk appetite in global markets and UK-specific optimism lifted the pound on Wednesday, as it strengthened to its highest in nearly three years against the dollar and five-month highs against the euro.
The dollar weakened against major currencies for the third straight session, helped by U.S. Treasury Secretary nominee Janet Yellen’s urging lawmakers to “act big” on spending and worry about debt later.
The pound rose above $1.37, hitting $1.3720 — its highest since May 2018 — at 1045 GMT. By 1136 GMT it had eased some gains and changed hands at $1.3687, up 0.4% on the day and up 0.2% so far this year.
Versus the euro, the pound hit a five-month high of 88.38 pence per euro, before easing to 88.51 at 1137 GMT, up around 0.5% on the day.
The pound’s recent strengthening can be attributed in part to relief among investors that the impact of Brexit has not caused the chaos some feared, as well as a lessening of negative rates expectations, said Neil Jones, head of FX sales at Mizuho.
“Going into early 2021, there was a bearish sentiment building into the pound on the Brexit deal, in terms of maybe it had a limited reach, and then secondly an expectation of negative rates and so to some extent the market has been cutting down on sterling shorts because neither of those things have been quite so apparent as they were,” he said.
Bank of England Governor Andrew Bailey said last week that there were “lots of issues” with cutting interest rates below zero – a comment which caused sterling to jump.
The UK’s progress in rolling out vaccines is also seen as a positive for investors, Jones said.
Currently, the United Kingdom has vaccinated 4.27 million people with a first dose of the vaccine, among the best in the world per head of population.
“Further progress in vaccinations (a pick-up in the daily rate) by the time the BoE MPC meeting takes place on 4th February may prove enough to hold off on any additional monetary easing,” wrote Derek Halpenny, head of research for global markets at MUFG.
Inflation data for December showed that prices in the UK picked up by more than expected in December, to a 0.6% annual rate.0.6
Inflation has been below the Bank of England’s 2% target since mid-2019 and the COVID-19 pandemic pushed it close to zero as the economy tanked.
(Graphic: CFTC: https://fingfx.thomsonreuters.com/gfx/mkt/oakpeyayxpr/CFTC.png)
(Reporting by Elizabeth Howcroft, editing by Larry King)
Euro sinks amid broader risk rally against dollar
By Ritvik Carvalho
LONDON (Reuters) – The euro struggled to join a broader risk rally against the dollar on Wednesday as analysts said the risk of extended lockdowns in Europe to combat the spread of COVID-19 and the continent’s lag in a vaccine rollout were weighing on the currency.
Down 0.1% against the dollar at $1.2117 by 1130 GMT, Europe’s shared currency had only the safe-haven Swiss franc and Sweden’s crown for company in resisting a broad rally against the greenback by the G-10 group of currencies.
“We’re getting more headlines that the current lockdowns will be extended further, which could mean that the euro zone would be flirting with a double-dip recession before long,” said Valentin Marinov, head of G10 FX research at Credit Agricole, noting Europe’s lag in rolling out a coronavirus vaccine compared to the United States and Britain.
“So all of that plays into the story that tomorrow’s ECB meeting, while uneventful in terms of policy announcements, could convey a relatively dovish message to the market. On top of that, President Lagarde could once again jawbone the euro, so the euro is kind of lagging behind.”
Marinov also noted price action in the pound, which hit $1.3720 – a 2-1/2-year high – and 88.38 pence – its highest since May 2020 against the euro – as a contributing factor to euro weakness. [GBP/]
There was also focus on a story by Bloomberg News, which reported the European Central Bank was conducting its bond purchases with specific yield spreads in mind, a strategy that would be reminiscent of yield curve control.
Elsewhere, the risk-sensitive Australian dollar gained 0.4% to $0.7727. The New Zealand dollar, also a commodity currency like the Aussie, gained 0.25% to $0.7133.
While the world will be watching Joe Biden’s inauguration as U.S. president at noon in Washington (1700 GMT), traders were more focused on his policies than the ceremony.
U.S. Treasury Secretary nominee Janet Yellen urged lawmakers at her confirmation hearing to “act big” on stimulus spending and said she believes in market-determined exchange rates, without expressing a view on the dollar’s direction.
The index that measures the dollar’s strength against a basket of peers was up almost 0.1% at 90.510. The euro forms nearly 60% of the dollar index by weight.
It also fell 0.1% against the Japanese yen to 103.81 yen per dollar.
While the dollar has perked up in recent weeks on the back of a rise in U.S. Treasury yields, investors still expect the currency to weaken.
“We remain bearish U.S. dollar, and expect the downtrend to resume as U.S. real yields top out,” said Ebrahim Rahbari, FX strategist at CitiFX.
“Continued Fed dovishness remains important for our view, in addition to global recovery, so we’ll watch upcoming Fed-speak closely.”
Positioning data shows investors are overwhelmingly short dollars as they figure that budget and current account deficits will weigh on the greenback.
(Graphic: Dollar positioning: https://fingfx.thomsonreuters.com/gfx/mkt/oakveyombvr/Pasted%20image%201611132945366.png)
UBS Global Wealth Management’s chief investment officer Mark Haefele reiterated a bearish view on the dollar, saying that pro-cyclical currencies such as the euro, commodity-producer currencies, and the pound would benefit “from a broadening economic recovery supported by vaccine rollouts”.
The cryptocurrency Bitcoin fell 4%, trading at $34,468.
(Reporting by Ritvik Carvalho; Editing by Angus MacSwan)
England soccer star Rashford nets younger buyers for Burberry
By Sarah Young
LONDON (Reuters) – Burberry stuck to its full-year goals on Wednesday after a media campaign fronted by high-profile English soccer star and social justice advocate Marcus Rashford drew a younger clientele to the British luxury brand.
Higher full-price sales would boost annual margins and Asian demand remained strong, Burberry said, while warning that it could suffer more sales disruption from COVID-19 lockdowns.
Manchester United striker Rashford, 23, has won plaudits for his campaign to help ensure that poorer children do not go hungry with schools closed during the pandemic.
A first coronavirus wave last year cut Burberry’s sales by as much as 45% before a bounce back on strong demand in mainland China and South Korea, which continued in the last few months.
Shares in Burberry were up 5% to 1,825 pence at 0905 GMT, with Citi analysts saying that improved sales quality from fewer markdowns would drive full-year consensus upgrades.
Burberry’s 9% sales decline in its third quarter was worse than the 6% fall in the second, and the company said that 15% of stores were currently closed and 36% operating with restrictions as a result of measures to curb COVID-19’s spread.
“We expect trading will remain susceptible to regional disruptions as we close the financial year,” Burberry said, adding that it was confident of rebounding when the pandemic eases given the brand’s resonance with customers.
In the third quarter, comparable store sales in Europe, the Middle East, India and Africa declined 37%, hit by shops shut in lockdowns and a lack of tourists visiting Europe, but in the same period, it posted sales growth of 11% in Asia Pacific.
Burberry said that Britain’s new relationship with the European Union would cause headwinds, warning of a modest increase in costs to comply with new rules and also the impact of an end to a scheme for VAT refunds for non-EU tourists.
This would make Britain a less attractive destination for luxury shopping when tourism returns after the pandemic, Burberry said, adding that it would try to mitigate the effect.
(Reporting by Sarah Young; Editing by Kate Holton, James Davey and Alexander Smith)
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