• Impulses. The global economy is back on a growth path again – but only with the helping hand of government fiscal packages and the inventory cycle. Stimulus programs running into the billions have averted the economic meltdown and returned economies rather rapidly to expansion territory. And for the time being, they remain an indispensable catalyst. 

  • US. In the first half of 2010, stimulus measures will still contribute almost 1½pp to (annualized) US growth. Nevertheless, growth impulses have already peaked. In the second half of 2009, the GDP contribution was as high as more than three percentage points (pages 4-6 & chart below). 

  • Germany. According to our calculations, the German economic stimulus program will contribute close to 1% to GDP growth this year – which is roughly the same impulse as in 2009. Whereas aid for households dominated last year, public infrastructure investment will be the main impulse in 2010 (pages 7-9).

  • Strain. The fiscal programs are, however, unlikely to generate a selfsustaining and pronounced recovery. The expiration of the initiatives will be a drag on growth. It should therefore be no surprise if real US GDP expands by only 1¾% this summer (4Q09: +5.9%). And economic growth will remain below average over the medium term as well. 

  • Debt. The reason for this is the inevitable consolidation requirement following soaring public deficits. The recent attack on sterling and the nosedive by the euro in the aftermath of the budget crisis in EMU periphery reveal the dark side of fiscal spending – even though the causes of the debacle in Greece are more complex. 

  • Further topics: 

    – Weekly Comment: ECB versus IMF (page 2). 

    – Greece: Strong commitment to consolidation (page 10). 

    – Commodity investments: Strong gains in February (page 12). 

    – Data outlook: EMU production gain on technical factors (page 15). 

    – Market outlook: Euro to remain susceptible (page 23).


ECB versus IMF

Mr. Trichet yesterday confirmed that the ECB will keep outstanding liquidity ample for the time being while shortening its duration, to be able to withdraw it in a prompt and flexible way. The steps outlined yesterday were in line with what we advocated, and I still believe that we will see short term market rates remain low through the summer and then rise gradually back in line with the refi rate, opening the way for a first rate hike in 1Q11. The ECB gave a ringing endorsement to Greece’s latest efforts and subscribed unconditionally to the idea of an "expansionary fiscal contraction" – in stark contrast with the IMF’s new philosophy. Mr. Trichet also described the handling of the Greek crisis so far as a demonstration of the successful functioning of the euro zone, which I believe is going quite a bit too far. The jury is still out, and the euro zone is not out of the woods yet; it still needs to demonstrate that it can enforce fiscal discipline while generating stronger and sustainable growth. Mr. Trichet also demolished IMF Chief Economist Blanchard’s suggestion of a higher inflation target, and warned that IMF loans would not be “appropriate” for a euro-zone member.

The much-awaited roadmap for the exit strategy was almost perfectly in line with our recommendations and predictions: (1) the last 6-month Long-Term Refinancing Operation (scheduled for 31 March) will be held at a variable rate equal to the average minimum bid rate at the Main Refinancing Operations over the relevant six months, as was done for the last 12-month LTRO; (2) the regular 3-month LTROs will go back to a variable rate system starting on 28 April; (3) the regular weekly MROs and the special 1-month operations will remain at full allotment, fixed rate at least until 12 October 2010. The driving principle of the exit strategy at this stage therefore remains to shorten the duration of outstanding liquidity, so as to be able to drain it in a more timely and flexible manner when appropriate. The message is extremely clear: the ECB will continue to provide ample liquidity for as long as necessary, and is only accompanying the gradual normalization process in financial markets, not forcing it. At the same time, as the normalization is indeed under way, some of the exceptional support measures are no longer necessary, and the ECB is preparing to withdraw liquidity as needed.

I see yesterday’s decisions as consistent with our call of a first refi rate hike in 1Q11, and the most likely outlook is that short-term market rates will remain low through September to then rise fairly rapidly back in line with the 1.0% refi rate, opening the way for the first hike: the introductory statement specified that allotment at the 3-month operations will be set to ensure smooth conditions in money markets and to avoid “significant spreads” with the prevailing MRO bid rates; moreover, in the Q&A, Mr. Trichet indicated that he does not expect EONIA rates to rise in the short term (they remain currently at about 0.35%), and declined to comment on current market expectations that the first rate hike will only occur in August-September next year –Trichet only stated “the market knows we will take whatever decision is needed to ensure price stability”. He also emphasized, as in previous press conferences, that the decisions taken “with overwhelming consensus” on the liquidity operations should in no way be seen as signals of possible changes in the monetary policy stance, which is still seen as appropriate by the unanimity of the Governing Council. At the same time, however, the new staff forecasts include a material upgrade in the 2011 GDP growth forecasts, by 0.3 percentage points, predicated on a stronger global growth outlook. Inflation forecasts are virtually unchanged, lower by 0.1pp in 2010 and higher by 0.1pp for 2011. Trichet declined to characterize these changes as reflecting greater confidence in the recovery, observing simply that the ECB had been more cautious than most observers, and that recent data supported its prudent view.

Trichet gave an extremely strong endorsement to Greece’s latest efforts, which he described as proof of the successful functioning of the euro zone in its current setup. He repeated the Governing Council’s statement of praise for Greece’s fiscal adjustment plan, with decisive and durable measures which would be swiftly implemented to guarantee the necessary adjustment in 2010, while helping the country regain competitiveness and lay the basis for sustainable growth and debt dynamics. On Greece, the ECB yesterday found itself subscribing unconditionally to the theory of “expansionary fiscal contractions”, with Vice President Papademos explaining how a credible fiscal consolidation would lower borrowing costs and bolster credibility, confidence and competitiveness. This might be going a step too far at this stage, in my view: Greece will need to do much more in terms of structural reforms to be able to combine a sharp fiscal adjustment with an increase in potential growth. This is not to criticize the fiscal adjustment: I fully agree with the ECB that Greece was in a much more difficult spot before launching these new measures, but I still believe more is needed to bolster growth, and hope the necessary steps will be taken. The ECB’s unmitigated praise for Greece’s draconian fiscal plan makes a striking contrast to the IMF’s stance during the crisis: the IMF has emphasized the fact that its new generation of adjustment programs, mostly implemented in the euro zone’s backyard of Central and Eastern Europe, has been much lighter on fiscal adjustment and conditionality, reflecting the lessons of past mistakes (read Asia in the late 1990s). The euro zone meanwhile seems instead to have rediscovered the wisdom of the “old” IMF. The nearly triumphant assessment of the euro zone’s functioning through the Greek crisis seemed exaggerated to me, and sounded a bit like the instinctive powerful selfaffirmation of someone who just narrowly escaped a mortal danger. Indeed the ECB seems very much aware that the euro zone has faced, and perhaps still faces, an existential threat, but it also seems to reiterate that no institutional changes are necessary, and this I think would be a dangerous self-delusion. Mr. Trichet argued that the surveillance process under the Stability and Growth Pact functioned exactly as it was supposed to: the European Commission did its job, so did Greece’s peers, and so in the end did Greece. Never mind the fact that the SGP has been repeatedly violated by several countries with impunity, and that we have reached the stage where the idea of a European debt crisis has been making headlines for months-the ECB’s conclusion seems to be that the euro zone’s institutional setup has been working exactly as it should be. I find this extraordinary; I can understand that the ECB’s official rhetoric must pay homage to the existing institutional set-up, but this kind of ringing endorsement triggers the worrying concern that euro zone policymakers genuinely hope that the crisis is now over and no reform is needed, and that would be a serious mistake. Along the same lines, I still strongly disagree with the ECB’s theory that current account deficits of individual euro zone members do not matter, because the euro zone guarantees ex-ante that there will be full financing by other member countries. I would insist that the current crisis has disproved this idea in the clearest and starkest way: financing pressure can materialize anyway, it just shows up on bond yields rather than the exchange rate.

Mr. Trichet launched a coded warning against Greece’s temptation to possibly call in the IMF, which was prominently reported in the financial press. Unprompted, he stated that it would be inappropriate to have the IMF step in with a loan facility: while the IMF’s technical assistance had been highly appreciated, the conditionality should be imposed strictly within the euro zone and in the framework of the SGP. Asked later whether Greece could unilaterally turn to the IMF and what could be the consequences, he said he did not want to consider “fancy scenarios”. A question from the press offered Mr. Trichet a golden opportunity to rip apart the recent suggestion of IMF Chief Economist Blanchard that central banks could adopt a slightly higher inflation target of 4% rather than 2%, and he did a magnificent job. Trichet rightly pointed out that changing targets in the current situation would undermine credibility, risk un-anchoring inflation expectations, and push up the entire structure of interest rates. It was a passionate, lucid and cogent response, which he closed with a light touch stating, "I could go on and on if we had more time". Trichet is completely right on this.

Trichet was also asked to comment on reports that the US Department of Justice is investigating short-euro trades by a number of hedge funds. He said he had not heard about it, but went on to say that the potential impact on financial stability of a highly-leveraged speculative industry is a very serious question. In the context of the current debate, I find the statement somewhat disturbing. Current legislation on market discipline should obviously be enforced. But if we have to believe press reports according to which a dinner where investors discuss the underlying weaknesses of the euro zone and the likely impact on the currency can raise suspicions of attempts to manipulate one of the most liquid markets in the world, the EUR-USD, then we might be moving dangerously close to a form of financial McCarthyism that would be detrimental to the necessary overhaul of financial regulation.