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Research Euroland
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In Asia we trust
Wed, Sep 2 2009, 08:52 GMT
by Frank Øland Hansen
- In many respects we should no longer expect the US to be the sole locomotive to pull Euroland out of crisis. We should also look to Asia. Exports to Asia are one of the drivers that we believe will help to get Euroland back on track.
- We expect the strong recovery in Asia to continue. A return of Euroland exports to Asia to previous peak levels will lift Euroland GDP by about 0.35%. We project this to happen quickly and expect Asia to continue as a growth engine thereafter.
- The Asian recovery should in particular benefit Germany, which is the most open of the large Euroland economies. A return of German exports to Asia to peak levels would add 0.6% to GDP. For France this would only add 0.2% of GDP.
- Looking further into the composition of exports we see that Germany benefits from a favourable export mix with a high share of capital goods exported to Asia. This is likely to benefit Germany in the recovery phase.
- Euroland competitiveness briefly benefitted from the depreciation of the euro relative to the US dollar, the yuan renminbi and in particular the yen, which took place in the second half of 2008, but has partly been reversed since then.
Asia has risen to become a vital trading partner
A decade ago Euroland exported almost as much to the US as it did to the whole of Asia. This has changed dramatically and today Asia has become almost twice as important as the US as a destination for Euroland exports of goods and services.
China, Japan and the ASEAN (Association of SouthEast Asian Nations) countries are centre stage in the Asian recovery story. Together this group accounts for about 12% of Euroland exports – equivalent to the share of exports that is destined for the US. In addition the Asian country group has a much higher growth potential than the US, so from a trade growth perspective we should focus much more on what is going on in Asia than in the US.
The rise of Asia has been led by China. The share of exports heading for China (including Hong Kong) has doubled within a decade and today more than 6% of Euroland exports are destined for China. India is a rising star too and may soon account for as much Euroland export as Japan, which has seen its share of Euroland exports dwindle for a decade. The prospects for growth in both China and India are very positive and we should expect to see their export share continue to grow for another decade.
Published on Wed, Sep 2 2009, 08:52 GMT
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Arguments for ECB to hike in 2010
Wed, Aug 26 2009, 09:08 GMT
by Frank Øland Hansen
- The focus of the ECB now appears to be shifting from whether to implement more stimulus measures to when to begin withdrawing them.
- We believe that the euro area next summer will have recovered so much that the ECB will consider interest rates at historical lows as being inappropriate and will start hiking.
- When the ECB starts hiking it will probably deliver about 0.5 percentage points each quarter, which was the average hiking speed seen in the 2000-01 hiking cycle.
- The exit strategy is likely to begin with alterations of the conditions for the long-term refinancing operations.
The focus of the ECB is shifting toward an exit strategy
On August 19, Governing Council member Axel Weber said to the German newspaper Die Zeit that it is too early to withdraw stimulus measures. We fully agree with that, but while some misinterpreted this as meaning that more stimulation was needed we take note that the focus of the ECB now appears to be shifting from whether to implement more stimulus measures to when to begin withdrawing them.
Below we discuss in detail why we believe the ECB will find that the conditions are in place to start hiking next summer and outline what an exit strategy might look like.
Growth
Unless inflation is very high (as in July 2008) ECB policy tends to be driven by growth developments. In 1999 the ECB started hiking when PMI new orders were 59 and in 2005 it hiked when they reached 54. PMI new orders are currently at 49.5 and increasing strongly. We anticipate that they could reach 59, or more, in early 2010 and would thus send a strong signal for the ECB to embark on a hiking cycle.
The ECB will have to revise its downbeat staff macroeconomic projections significantly up at the next Governing Council meeting. The ECB currently (June 2009) projects growth to remain negative until mid-2010, but with France and Germany out of recession in Q2 this year and the euro area in positive growth territory in Q3 – a year before the ECB officially expects – it will clearly have to change its view radically. We anticipate strong growth of about 3% q/q annualised in Q3 and Q4 09, driven primarily by the inventory cycle and exports. Thereafter we expect that growth will slow down to around 2% q/q in 2010 and become more broad based.
Published on Wed, Aug 26 2009, 09:08 GMT
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The Spanish public budget
Wed, Jul 29 2009, 07:18 GMT
by Frank Øland Hansen
- This is the third paper in a series on the Spanish economy. The first paper is The Spanish recession and the second is The Spanish banks.
- Spain is in recession. Unemployment has surged and as a result the economy’s automatic stabilisers have negatively affected the public deficit, with tax receipts down and benefit payments up.
- In addition Spain has launched a hefty discretionary fiscal easing of 3.0% of GDP in 2008 and 2.0% in 2009. We expect the fiscal easing together with the automatic stabilisers to push the public deficit to -9.5% of GDP in 2009. Given the high forecast unemployment rate next year, we expect the fiscal deficit to amount to -9.0% of GDP in 2010, despite a likely reversal of the fiscal easing.
Government
Fiscal stimulus in response to the crisis
As the global recession picked up shortly after the Spanish housing market started correcting (see The Spanish Recession), the Spanish government acted immediately. In 2008 government expenditure rose by 5% of GDP on the back of a massive stimulus. This was partly due to automatic stabilisers kicking in but also due to the government implementing further fiscal stimulus.
The discretionary fiscal stimulus amounted to 3% of GDP being allocated in 2008 and 2% in 2009. The stimulus consisted of measures to offset falling domestic demand through tax breaks for firms, subsidies for employment and further assistance for the unemployed. The government has also secured the banks by raising deposit insurance, improving liquidity and guaranteeing debt issuance. Though all the above-mentioned measures are well timed and have helped Spain to weather the storm, the government has failed to implement overdue reforms to secure the country’s long term potential, such as much needed labour market reform.
Published on Wed, Jul 29 2009, 07:18 GMT
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The Spanish banks
Tue, Jul 28 2009, 08:53 GMT
by Frank Øland Hansen
- This is the second paper in a series on the Spanish economy. The first paper is The Spanish recession.
- Spanish banks have suffered relatively small losses during the financial crisis because they invested very little in American sub-prime assets. But their exposures to the domestic housing market and Latin America pose a risk.
- Spanish banks generally hold a better quality of assets than their European counterparts. Thus their expected losses are smaller, and with their larger reserves they are in a better position to sustain any further losses.
We don’t expect their balance sheets to deteriorate to an extent that would need much recapitalisation. We therefore anticipate the total amount of recapitalisation for the sector to be small.
Banking sector asset risks
Spanish leverage in the private sector has ballooned in recent years. Spanish banks have acquired more assets and increased their liabilities in the process. There is a potential risk of rising non-payments of loans, which could amount to significant losses for the banks. In this section we briefly explain the major risks that the Spanish financial sector is facing domestically and abroad.
Published on Tue, Jul 28 2009, 08:53 GMT
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The Spanish recession
Mon, Jul 27 2009, 10:34 GMT
by Danske Research Team
- The Spanish fiesta is over – Was it too much Sangria? What are the consequences? Following a huge economic boom, the financial crisis is now taking its toll on Spain.
- Investment, especially housing investment, has been a driver of the Spanish economy. The housing market is now in the midst of a severe correction, which is expected to drag the economy down through the construction sector and lower household spending.
- Private domestic demand will be severely constrained as both investment and consumption are at very low levels. Increased public consumption will help to mitigate some of the negative impact of the crisis.
- We expect a global recovery in 2010 will lead to net exports being a key driver in ending the recession in Spain. Spain has a huge trade imbalance of near -10% of GDP; an improvement in this balance is necessary for Spain to recover.
- We expect the Spanish economy to contract 3.8% in 2009, and grow just 0.4% in 2010, compared to an average of 4% over the last 15 years.
The Spanish story
The Spanish downturn began in the middle of 2007, simultaneously with the financial crisis. Since then unemployment has exploded and economic activity has deteriorated rapidly. We note, though, that the Spanish economic downturn was not caused by the financial crisis, but was magnified and probably emerged faster because of it. The fundamental cause was rather due to years of too high growth and the inevitable slowdown of an overheated Spanish economy, and in particular an overheated Spanish housing market. The domestic housing market actually began cooling before the global crisis emerged.
Published on Mon, Jul 27 2009, 10:34 GMT
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Irish Economic Outlook: Dire recession nears the end: difficult recovery to begin
Mon, Jul 6 2009, 09:11 GMT
by Allan von Mehren
The dramatic decline in the Irish economy continued into the second quarter of this year, the fifth consecutive quarter of decline. The damage wreaked by this recession has been immense, whether seen through the collapse in house building, the surge in unemployment, the decimation of Government tax revenue, or the sharp decline in consumer demand.
The more positive news is that the pace of decline has eased in the second quarter. A number of indicators of activity, whether soft (consumer confidence, PMI surveys, global economic prospects) or hard (unemployment, tax revenue, retail sales), show continued weakness, although the pace of decline has eased considerably.
The cause of Ireland’s economic decline is evidenced by the sheer scale of the collapse of private sector demand. In 2006, at the height of the boom, the Irish private sector was a net borrower to the tune of EUR10bn. In 2009 the private sector will be a net saver of EUR20bn a year. This represents a withdrawal of EUR30bn from the economy annually because of less spending on housing and consumer goods, and less capital investment by businesses. High Government borrowing is a direct mirror of this saving. While the spreads on Irish Government debt have risen sharply over the past year, the massive level of domestic savings will make the funding of this deficit easier.
The economic recovery will come from two sources. First, foreign demand for Irish produce will pick up as the global economy recovers. The initial signs here are encouraging. While global exports have been in freefall since Christmas, Irish exports have defied gravity. Second, as domestic confidence returns, the enormous rate of private saving will begin to fall. Consumer spending will bottom out this year and begin to grow slowly around the turn of the year. A pick-up in housing activity will take longer, with the residential sector to remain subdued for an extended period.
However, as long as Irish consumers and businesses remain in retrenchment mode, then overly aggressive measures to reduce government borrowing could be counter-productive. The budgetary measures taken in October and April were necessary, as the deficit was heading for 15% and financial market turmoil meant that there was a genuine (if remote) fear that funding could dry up. However, the Government should refrain from further significant taxation increases, although continue to reform the public and local private service sectors.
Published on Mon, Jul 6 2009, 09:11 GMT
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Denmark: Pro−euro majority is falling
Thu, Jun 25 2009, 07:09 GMT
by Steen Bocian
Danske Bank regularly surveys the opinion of Danes on adopting the euro. Our June poll showed that the Yes camp maintained a narrow lead over the No side. However, the Yes lead continued to shrink, as it has done in recent months – so our June poll does not give grounds for concluding that a majority of Danes would be certain to vote in favour of joining the euro at any future referendum. The modest Yes lead represents a return to a more normal situation following the brief Yes rally in November and December last year.
Our June poll showed that 39.9% of Danes polled would definitely vote Yes to Danish EMU participation, while 38.8% were certain No voters. Add to this the 10% of voters who are in doubt, but lean towards voting Yes and the 7.8% who would perhaps vote No – and the Yes camp has a lead of 3.3 percentage points. This is a rather modest lead, and a comparison with the polls we conducted earlier this year shows – as already mentioned – that the lead has shrunk. In any event, many Danes are still in doubt about how to vote.
The temporary momentum of the Yes side in the final months of 2008 reflected the autumn economic agenda being heavily affected by the escalating financial crisis. Due to the turmoil in financial markets, the Danish central bank, Danmarks Nationalbank (DN), had to widen the rate spread to the eurozone a couple of times during October. Meanwhile, the Danish economy slowed sharply, and many Danes began to feel the impact of rising interest payments on their budgets. This stimulated support among Danish voters for joining the euro. However, since then the foreign exchange turmoil has subsided, so opinion polls have more or less returned to normal, with a modest Yes lead that will likely make a future referendum on euro membership a very close run race.
Published on Thu, Jun 25 2009, 07:09 GMT
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Denmark: Narrow majority in favour of joining euro
Wed, May 20 2009, 12:49 GMT
by Steen Bocian
Prime Minister Lars Løkke Rasmussen once again threw the spotlight on the prospects for a Danish referendum on EMU participation early last week, when he said that he aimed to call an EMU vote within the term of the current parliament – i.e. by autumn 2011 – even though he had indicated soon after his inauguration that he might not call a referendum before the next general election.
Danske Bank regularly surveys the opinion of Danes on adopting the euro. Our May poll showed that the Yes camp maintained a narrow lead over the No side. However, the Yes lead has shrunk in recent months, so our May poll does not give grounds for concluding that a majority of the Danes would be sure to vote in favour of joining the euro at any future referendum. The modest Yes lead represents a return to a more normal situation following the brief Yes rally in November and December last year.
Our May poll showed that 40.3% of Danes polled would definitely vote Yes to Danish EMU participation, while 39% were certain No voters. Add to this the 10.4% of voters who are in doubt, but lean toward voting Yes and the 6.2% who would perhaps vote No – and the Yes camp has a lead of 5.4 percentage points. While this is a decent lead, a comparison with the poll we conducted in April shows – as already mentioned – that the lead has shrunk. At any event, many Danes are still in doubt about how to vote.
The temporary momentum of the Yes side in the final months of 2008 reflected the autumn economic agenda being heavily affected by the escalating financial crisis. Due to the turmoil in financial markets, the Danish central bank, Danmarks Nationalbank (DN), had to widen the rate spread to the eurozone several times during October. Meanwhile, the Danish economy slowed sharply, and many Danes began to feel the impact of rising interest payments on their budgets. This stimulated support among Danish voters for joining the euro. However, since then the foreign exchange turmoil has subsided, so opinion polls have more or less returned to normal, with a modest Yes lead that will likely make a future referendum on euro membership a very close run race.
Published on Wed, May 20 2009, 12:49 GMT
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Credit easing vs quantitative easing
Tue, May 12 2009, 15:53 GMT
by Frank Øland Hansen
- The ECB is about to embark on credit easing. Jean-Claude Trichet emphasised that the ECB will not be embarking on quantitative easing. We look at differences/similarities and the implications of this.
- Credit easing aims at affecting the risk spread across assets, whereas quantitative easing aims at affecting the general level of the longer-term interest rate.
- The ECB move should be enough to positively affect the market for eurodenominated covered bonds while the effect on the overall bond market is likely to be muted.
- In the current situation of financial distress, credit easing appears as the appropriate response. We believe that the ECB will cautiously go down the road of credit easing, but not take a single step along the path of quantitative easing.
- Credit easing is not necessarily sterilised. EUR60bn, however, only amounts to about 4% of the Eurosystem’s current balance sheet. The ECB appears to consider sterilisation important for medium- and long-term credibility.
- Trichet also announced that the EIB will get access to central bank liquidity. This move will help to increase investment in vulnerable sectors and regions. It is not targeted at alleviating government budgets and will do little in this respect.
Published on Tue, May 12 2009, 15:53 GMT
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DM Economic Surprise Index (DM ESI
Thu, Apr 9 2009, 16:40 GMT
by Danske Research Team
• The Danske Markets Economic Surprise Index (DM ESI) is a quantification of the latest macro data into an index. The index measures how positively or negatively the data has surprised -measuring the difference between actual release and consensus forecast. The index can thus be interpreted as whether the data was better or worse than consensus expected.
• The DM ESI gives a fast overview of surprises in historical and latest macro data. This is a useful input when determining current market drivers. Another use is that the index in some periods leads the market movements.
• The DM ESI so far operates for US growth and price data. It is scheduled for release every week to assist in giving an overview of the weekly surprises in macro data. In the future similar indices will arise in respect of the eurozone.
Published on Thu, Apr 9 2009, 16:40 GMT
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CEE: External balances are improving
Fri, Mar 20 2009, 14:14 GMT
by Stanislava Pravdova, Lars Christensen, Lars Rasmussen
• We have long argued that the large external imbalances in a number of Central and Eastern European economies would ultimately lead to a sharp drop in economic activity and a hard landing in a number of countries in the event of a "sudden stop" to the external funding of the CEE economies. Unfortunately this is what has been happening in these last few months.
• Hence, with the external funding of the CEE economies "drying" up a sharp correction in the external imbalances becomes unavoidable. This correction can happen in two ways - either domestic demand drops sharply and/or the CEE currencies weaken significantly. Both are materialising at the moment.
• The Baltic States were the first CEE economies to experience a sharp drop in economic activity. The imbalances were especially large in these economies and we are now seeing a vast improvement of their current account balance. Most notably the Latvian current account deficit has improved from -25% of GDP at the low point in mid 2007 to -13% of GDP in Q4 2008.
• The external imbalances have also been large in Bulgaria and Romania - in Bulgaria the current account deficit reached -27% of GDP in Q2 2008. However, in these economies correction of the external imbalances has begun to show in the last couple of quarters as the trade balances have improved. Furthermore, the Romanian Leu has weakened considerably in the last months.
• In Poland, Czech Republic and Hungary the external imbalances have not begun to correct yet. The current account deficits have, however, been the smallest in these countries at levels of -3 to -7% of GDP. However, with the significant weakening of the currencies in these countries in the last few months and the declining economic activity we expect an effect on the current account balance in the coming quarters.
Published on Fri, Mar 20 2009, 14:14 GMT
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Exposure to the crisis in Central and Eastern Europe
Tue, Feb 24 2009, 09:26 GMT
by Frank Øland Hansen
• Euro area banks' losses on loans in Central and Eastern Europe (CEE) will be substantial due to an unfortunate mix of collapsing property prices, economic downturn and exchange rate depreciation.
• Austria is by far the most exposed country, but the government can afford to absorb the losses. Belgium, which is a high debt country with a fiscal budget that's already stretched, is in for smaller losses, but they also have less room for manoeuvre.
• We look at three risk scenarios. A mild scenario, which is comparable to the Swedish banking crisis; a hard scenario, where the hardest hit CEE countries face more substantial looses; and finally an ugly scenario which is more comparable to the Asian crisis. In these scenarios Austrian banks face losses of 3½-11% of GDP, Swedish banks loose 2-6% of GDP and Belgian banks loose1-3½% of GDP.
• Governments in the euro area will not be eager to provide rescue packages aimed at supporting lending in the CEE region. The CEE governments will be much more willing to provide rescue packages or direct loans, but they are less able and will need support from international institutions.
Published on Tue, Feb 24 2009, 09:26 GMT
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Financial downgrading and monetary policy asymmetries
Mon, Feb 2 2009, 16:12 GMT
by Søren Dijohn
• In a process ignited by the financial downgrading of some European countries by the rating agencies, EMU bond yield spreads have widened recently. The countries that have been downgraded are also those with the largest imbalances and therefore where the largest deterioration in government budgets is anticipated and the perceived risk greatest.
• We present a set of striking correlations indicating that the recent financial downgrading and widening of spreads relative to German bunds relates to economic policy during the period between 2002 and 2007. Therefore, recent financial downgrading appears to be closely connected to lax economic policy and lack of structural improvements in preceding years.
• For some member countries, including Greece, Ireland and Spain in particular, monetary policy rates set to be consistent with conditions in the euro area as a whole were persistently and significantly below that prescribed by a "country-focused" Taylor rule. Large asymmetries have not been offset by a sufficiently tight fiscal policy and/or structural improvements, and have consequently been allowed to have real economic effects, for example, through the booming housing market.
• This is also a lesson for the future. Politicians in all euro countries still have an obligation to run their own country to the best of their ability. They have to secure long run sustainable growth through appropriate fiscal policy and structural improvements. The euro is not a substitute for appropriate and timely policies at national level - there is no free lunch.
Published on Mon, Feb 2 2009, 16:12 GMT
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ECB reverses course and widens rate corridor
Fri, Dec 19 2008, 14:58 GMT
by Danske Research Team
• ECB has re-widened the rate corridor to 200bp effective on 21 January, reversing its 9 October decision. The move is an attempt to discourage the use of ECB's deposit facility, revive bank lending, and help normalize money markets.
• The move is likely to lead to lower eonia rates and perhaps slightly lower euribor rates. But the effects are likely to be quite small. The widening of the rate corridor also puts pressure on the already hardpressed banking sector.
• We do not expect this initiative to revive bank lending, and are somewhat puzzled by ECB's obsession with the amount on deposit, i.e. ECB would get much better results from proceeding with plans for a clearing house for interbank loans.
Published on Fri, Dec 19 2008, 14:58 GMT
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Euroland: Exports hit by CEE collapse
Thu, Dec 18 2008, 17:05 GMT
by Søren Dijohn
• In recent years Euroland exports have been buoyant. The fast growing central and eastern European (CEE) countries have played a pivotal role contributing 3-4 percentage points, or about a third of total Euroland export growth. Accordingly, the importance of these countries for total Euroland exports has doubled over the past 10 years and they currently account for almost 20% of total Euroland exports (excluding trade among the euro countries).
• In recent months it has become evident that growth in the CEE has collapsed. The impact on Euroland exports is immense. We estimate that the collapse in CEE growth drags real Euroland export growth down by 1.5 percentage points in 2009 and about half of that in 2010. Thereby about half of the slowdown in Euroland exports may be ascribed to CEE slowdown, due to the escalation of the financial crisis. However, GDP growth is muted as Euroland imports usually track exports quite narrowly.
• Among the major Euroland countries Germany is affected the most. Being word champion of exports is tough when export markets in general slow down and in particular when the markets that have been a major driver in recent years collapse. In Germany exports amount to nearly half of GDP or almost double the exports to GDP ratio in France, Spain and Italy. In addition, the CEE is the destination for a larger share of total exports in Germany than in the other large Euroland economies.
Published on Thu, Dec 18 2008, 17:05 GMT
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Denmark: Equity losses dampen consumption
Tue, Nov 11 2008, 16:17 GMT
by Frank Øland Hansen
• Danish households have lost around DKK 400bn on the stock market and DKK 170bn on the housing market in just over a year.
• The loss on equities means that private consumption next year will be around DKK 4bn lower than would otherwise have been the case - while in 2010 it will be all of DKK 7.5bn lower. This is the equivalent of shaving half a percent off consumption next year and almost a full percent in 2010.
• Shrinking home equity will dampen consumption growth further, meaning overall consumption will be DKK 6bn (0.75%) lower next year and DKK 11bn (1.4 %) lower in 2010 than it would have been without the downturns in the equity and housing markets.
Published on Tue, Nov 11 2008, 16:17 GMT
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Euroland: Public finances shattered by crisis
Wed, Nov 5 2008, 09:59 GMT
by Søren Dijohn
• The growth outlook has deteriorated markedly throughout Euroland with the effects on public finances profound. Through the so-called automatic stabilisers budget balances are highly sensitive to growth and policymakers in most Euroland countries are currently planning various fiscal policy initiatives in order to stimulate growth and employment.
• We estimate that for the whole of Euroland budget balances will deteriorate sharply from a deficit of 0.6% of GDP in 2007 to a deficit of 2.2% of GDP in 2009. Budgets may even worsen further as the last initiative has not yet been unveiled. In addition, uncertainty surrounds both the size and effect of many of the measures already announced.
• Public finances in France are by no means prepared for the marked slowdown in economic activity which we expect. So far France is the only major country whose deficit is expected to exceed the Maastricht Treaty's 3% of GDP threshold. However, we estimate that 2009 budget deficits in both Spain and Italy are close to the 3% threshold with risks that they may worsen further.
• Financial sector support plans first and foremost affect the debt to GDP ratio. The deficit to GDP ratio is only affected in so far as rising debt implies higher interest payments. The precise scale of the rescue plans depends on developments over coming months. Commitments made so far and the maximum amounts guaranteed result in a very broad deficit ratio range. Based on such commitments we estimate total Euroland debt at 66.75% of GDP in 2009, fairly unchanged over 2007. Assuming implementation of the full amount guaranteed the average debt to GDP ratio would increase to 70% of GDP by end 2009.
Published on Wed, Nov 5 2008, 09:59 GMT
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Denmark: Biggest drop in inflation since 1990
Thu, Oct 30 2008, 14:18 GMT
by Frank Øland Hansen
- • We expect inflation to fall from 4.2% in September to 2.8% in November, which would be the largest drop in inflation over a two-month period since early 1990.
- • The sharp fall in Danish inflation is the result of plummeting oil prices and the continued fall in global food prices. Further, a big increase in prices exactly a year ago is also helping to pull inflation down now.
- • Inflation is set to slow from 3.5% this year to 2.1% next year, contributing to handsome real wage growth next year. With expected pay rises of 4.4% in 2009, we expect real wages to grow by 2.3%.
Published on Thu, Oct 30 2008, 14:18 GMT
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Russia: The party is over
Mon, Oct 27 2008, 13:56 GMT
by Lars Rasmussen
- • The Russian economy has been hit by a series of negative shocks in the past few months, making it likely that economic growth will be significantly dampened going forward. The shocks relate to in-creased political uncertainty, partly as a consequence of the Russia/Georgia stand-off. Moreover, the sharp drop in oil prices intensified the sell-off in Russian equities as foreign investors dumped Rus-sian assets. Finally, the liquidity situation worsened due to capital outflows and fears of excessive lending in foreign currencies.
- • The Russian government and central bank (CBR) have implemented measures to provide liquidity to the market. However, market response has been lukewarm. Short-term interest rates and rouble-forward-rate risk premiums have skyrocketed in recent weeks.
- • Overall, the outlook for the rouble has worsened, and we expect to see a mild depreciation versus its dual currency basket going into 2009 as demand for the rouble drops. The C/A balance could turn negative as early as 2009. Further, public revenues will drop significantly and the fiscal budget sur-plus is threatened.
- • While we expect overall growth for 2008 to hover just below 7% y/y, we look for growth to slow to around 2.5% y/y in 2009 and 3.0% y/y in 2010. Cooling domestic demand will be the main driver be-hind the slowdown. Despite lower global energy and food prices, a rapid improvement in inflation rates looks unlikely. Hence, we expect inflation rates to remain in double-digit territory well into 2009.
Published on Mon, Oct 27 2008, 13:56 GMT
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CEE: Fighting an uphill battle
Thu, Oct 23 2008, 16:36 GMT
by Lars Christensen
- • The credit crisis is spreading to Central and Eastern Europe as an inevitable consequence of years of very significant imbalances in the economies of the region.
- • In recent days the increasingly disorderly weakening of the CEE currencies has increased worries among policymakers across Europe, and the need to for a policy response is clearly rising.
- • We take a look at the policymaker's "toolbox" that could be used to curb the disorderly sell-off in the CEE currencies.
- • We conclude that there are instruments available for policymakers in the region, but also that the scope for using these instruments is limited and that there is no getting around a significant deleveraging of the economies in the region and a sharp slowdown in CEE growth.
- • The likelihood of an international "rescue package" for the region - with the participation of the ECB and/or the IMF - seems increasingly likely
Published on Thu, Oct 23 2008, 16:36 GMT
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Euroland: Financial crisis killing off growth
Thu, Oct 9 2008, 15:19 GMT
by Søren Dijohn
- • Since the publication of our September forecast, the financial crisis has hit the Euroland economy. The impact on economic activity is proving dire. Based on historical experience we expect the economy to stall over the coming quarters. We now forecast Euroland GDP to stagnate in 2009 (0.0% GDP growth). Thus we have revised down our 0.7% GDP growth forecast as companies shed inventories and cut down fixed investments in the light of slow domestic and foreign demand and limits to credit. For 2008 we revise down our growth forecast 0.2%-point from 1.3% to 1.1%.
- • The global slowdown is having a profound effect on commodity prices. Consequently we have lowered our inflation forecast for 2008 from 3.6% to 3.4% and for 2009 from 2.6% to 2.0%. By mid 2009 inflation is expected to be around 1.5% mainly due to the negative contribution to inflation from energy prices. Thus inflation is on a clearly downward path until mid 2009. From then a gradual pick up is foreseen, albeit inflation is expected to remain below the ECB's target until end 2009.
- • Following the globally-coordinated central bank rate cut, we expect the ECB to deliver more rate cuts over the coming months. We are looking for the ECB to cut rates in December 2008 and again in February and April 2009, each time by 25bp, meaning that the ECB policy rate will be 3.00% by summer 2009.
- • Uncertainty surrounding our forecasts on growth, inflation and the ECB is unusually high, as much depends on developments in financial markets. Furthermore, historical data in Euroland on how financial sector stress affects the economy is relatively limited, and the size of the impact is highly uncertain.
Published on Thu, Oct 9 2008, 15:19 GMT
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Germany: Recession looming
Wed, Jul 16 2008, 14:03 GMT
by Danske Research Team
- • Germany is the last man standing in the Euroland economy, but it is suffering from a deteriorating international environment and sluggish domestic demand. If Germany falls it will have a profound effect on Euroland growth - and downside risks have risen markedly in just a few months.
- • Although the German economy is in relatively good shape, it cannot shield itself from deteriorating export markets that are giving in to the massive headwinds that have hit most of Germany's trading partners. Domestic consumption is very unlikely to make up for the fading demand from export markets, as consumers are suffering high inflation rates that are eroding purchasing power, and the rather strong employment growth of recent years is coming to an end. Furthermore, investments cannot fill the gap, as they are very sensitive to exports.
- • Thus the German economy is facing a tough time. Negative growth will probably be seen in Q2 due to the underlying weakening of the economy, but because of the unwinding of special effects (i.a. a reversal of the warm weather effect on production, and the build-up of unintended inventories). We expect the economy to stagnate in Q3, but there is a risk of contraction. For 2008 as a whole, we expect GDP to grow by 1.6%. Growth is forecast at 1.1% in 2009, but this may prove too optimistic.
- • What does this mean for ECB interest rates? One thing is sure - it will be harder for the ECB to hike rates further. Furthermore, the 'north-south' tensions in Euroland will evaporate as the conflicting interests of the 'hardliners' in the north (with relatively moderate inflation and high activity) and the doves in the south (with relatively high inflation and fading economic growth) diminish. Whether this means that rate cuts are just around the corner is another question, however. It remains to be seen, for example, how the ECB will interpret the expected rise in core inflation later this year and Euroland wage growth, which we forecast to stay rather elevated well into 2009 despite slow economic growth.
Published on Wed, Jul 16 2008, 14:03 GMT
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Ukraine: Democracy, Stability and Reform
Thu, May 29 2008, 14:32 GMT
by Lars Rasmussen
- • We attended the European Bank of Reconstruction and Developments (EBRD) Annual Meeting and Business Forum in Kiev, Ukraine on 17-19 May. In the following pages we report on our experiences from the trip, and present our expectations for the Ukrainian economy in the medium term.
- • Ukraine has been gradually transforming itself into a free democracy since 1991. The non-violent Orange Revolution in 2004-05 was a milestone in this process that saw the Ukrainian people protest against the massive corruption, voter intimidation and direct electoral fraud that marred the presidential elections in 2004.
- • The political transformation of Ukraine following the Orange Revolution has been rather uneven, and the country has had several governments in the last four years due acrimonious clashes between the acting president, Viktor Yushchenko, the prime minister, Yulia Tymoshenko, and the pro-Russian former prime minister, Viktor Yanukovych. What is needed now is political stability that will allow the reform process to speed up.
- • After several years of strong growth, the economy has moved into overheating territory, with inflation soaring above 30% the highest rate in Europe. The trade deficit is widening as imports accelerate, and public spending is very expansionary. Thus, there are good reasons to cool the private sector.
- • Ukrainian policymakers are very aware of this, but political tensions and a rather passive Ukrainian central bank (NBU) mean our expectations are limited with respect to policy tightening. Failure to tighten may well mean the Ukrainian economy facing a rather hard landing. Indeed, any tightening action may already be too late. Meanwhile, we expect growth to slow to roughly 5.5%-6.0% y/y in 2008 a view we share with the EBRD, which cut its 2008 growth forecast for Ukraine to 5.5% y/y from 6.0% y/y after the conference.
Published on Thu, May 29 2008, 14:32 GMT
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Norway: Higher inflation leaves Norges Bank with few choices other than hiking rates
Wed, May 14 2008, 14:29 GMT
by Arne Lohmann Rasmussen
• We have revised our Norwegian inflation forecast higher by 0.2 0.3 percentage points. We now expect core inflation to run at 2.8% in the autumn.
• Our inflation forecast is now approximately 0.5 percentage points higher than the current forecast by Norges Bank. Hence, we now expect Norges Bank to flag a new rate hike in June when the new monetary policy report is released and subsequently hike rates by 25bp to 5.75% in August.
• Given our new rate forecast, we still see upside for NOK rates going forward. Hence, we reiterate our long-held strategies to buy DEC08 NOK 3M FRAs either outright or in a spread against EURIBOR. We also continue to expect a flatter curve 10y2y both outright and in a box against Euroland or Sweden.
• NOK is expected to benefit slightly from a new rate hike from Norges Bank. However, do not expect a big move as the market is already heavily positioned for a stronger NOK.
Published on Wed, May 14 2008, 14:29 GMT
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Denmark: Homebuilding not as exposed to a downturn as in the US
Mon, Apr 21 2008, 11:00 GMT
by Arne Lohmann Rasmussen
- • It would be misleading to equate current developments in Danish and US homebuilding. The national accounts data show that investment in residential construction in Denmark has not fallen at all. True, housing starts showed a sharp decline in Q4 2007, but these preliminary data are subject to significant uncertainty and often show a decline that turns out to be incorrect in the final data.
- • There are several reasons why the Danish residential construction sector should not fear a downturn as seen in the US. Perhaps the primary reason is the widely different funding structures in the two housing markets. There is thus no chance of the Danish housing market facing a subprime crisis with plummeting residential investment.
- • However, the shift in housing market sentiment has led to a backlog of homes for sale not least in Greater Copenhagen. This could put a damper on new residential construction for a while, as new projects are postponed for as long as the supply of homes is high. Luckily, interest rates, price developments and rising disposable income will help offset this trend.
- • The combination of rising disposable incomes and declining interest rates will already this year bring down the housing affordability. This can stabilise the housing market and hence residential construction. Against this backdrop, we expect residential construction activity to slow down in the short term declining 3-5% this year but it may stabilise as early as next year around zero growth.
Published on Mon, Apr 21 2008, 11:00 GMT
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Norway: Era of low inflation is over
Thu, Feb 7 2008, 14:46 GMT
by Arne Lohmann Rasmussen
- • Norways core inflation is expected to jump from 1.8% in December to 2.2% in January. However, the risk is skewed to the upside. Norwegian core inflation is expected to hit the inflation target of 2.5% during the summer of 2008.
- • The era of low inflation is over in Norway. Hence, despite the global downturn, we think it will be very difficult for Norges Bank to follow suit with rate cuts as expected in the money market. In fact we argue that the rising inflation pressure in Norway might force Norges Bank to hike rates in Q2.
- • Ahead of the release of the January numbers on 11 February, we recommend to position for higher rates in Norway either outright or in spreads against Euroland or Sweden. We prefer the latter spread and we are in general a bit cautious about outright exposure due to the global picture. We keep a positive view on NOK, but NOK is very sensitive to changes in the risk appetite at the moment.
- • Next week we will see the annual address from Norges Bank on 14 February. We think Norges Bank will underline that higher rates are certainly still a possibility and that rate cuts are still far away.
Published on Thu, Feb 7 2008, 14:46 GMT
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EU8+2: A Warning not to be ignored II
Mon, Jan 7 2008, 11:39 GMT
by Stanislava Pravdova, Lars Christensen, Lars Rasmussen, Violeta Klyviene
- • We have updated our traffic analysis from February 2007 on the risks of a boom-bust scenario playing out in the EU8+2 countries.
- • The results of the updated analysis are clear: Imbalances have grown even larger in Central and East-ern Europe, and the global credit crunch has increased the risks connected to these imbalances.
- • The Baltic States, Bulgaria and Romania are still the most likely countries to face a hard landing in the economy and experience financial distress.
- • While the risks are lower in Poland, the Czech Republic and Slovakia these countries are now also showing clear signs of overheating. Hence, the boom-bust risk in Central and Eastern Europe has be-come more widespread than in February.
Published on Mon, Jan 7 2008, 11:39 GMT
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ECB: In need of another liquidity dummy?
Fri, Jun 15 2007, 10:15 GMT
by Niels-Henrik Sørensen
- The ECB’s second pillar, namely its focus on M3 growth is becoming increasing ridiculous. M3 growth has in recent months accelerated and is now running at 11% - its fastest pace for twenty years and well above the ECB reference of 4.5%. The ECB has stressed that it will not interpret M3 figures mechanically. However, given the huge divergence between actual M3 growth and reference M3 growth, the ECB owes us an explanation about the drivers of the recent surge in M3, and an estimate of cur-rent underlying liquidity growth. In short, we need to know more about the dummy the ECB will put into its M3 equations to better reveal underlying liquidity growth.
- In this paper we give our view on the liquidity situation in Euroland, the outlook for liquidity, and the likely implications for growth, inflation and monetary policy going forward. We make a number of conclusions. Firstly, the ECB is likely to focus more on credit growth to the private sector and M1 growth rather than on M3 growth when extracting policy relevant information from the monetary pillar.
- Secondly, M1 growth and credit growth are best in terms of forecasting growth, and have been on a gradually easing trend since last summer. This indicates that underlying economic growth is peaking this year. However, note that, in our view, this is likely to be disguised for some time due to the current reacceleration in global industry, which will lend considerable support to Euroland export, manufacturing and economy for the rest of the year.
- Thirdly, both underlying M1 and M3 are probably somewhat relevant when forecasting underlying consumer price inflation trends. However, we cannot be sure of the precise path of underlying M3 growth, and therefore we cannot make safe conclusions regarding future CPI. That being said, it seems as if there are still some moderate upside risks to CPI from monetary variables.
- Fourthly, overall M1 growth and credit growth is easing, but only slowly, even given the recent rise in interest rates. Thus, these variables are likely to send a moderately hawkish signal to the ECB throughout 2007. With only moderate risks from monetary variables, future ECB policy is likely to be governed primarily by economic growth, which we believe will be strong. We maintain our forecast of a peak in ECB rates of 4.75% by Q1 next year.
Published on Fri, Jun 15 2007, 10:15 GMT
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Norway: Norges Bank to go restrictive
Mon, Jun 4 2007, 14:43 GMT
by Arne Lohmann Rasmussen
- We expect the Norwegian central bank, Norges Bank, to hike its policy rate to 6% over the next 12 months. Earlier we expected a peak in rates at 5.5%.
- The reason is a stronger global economy, a Norwegian labour market on the verge of overheating, higher core inflation and strong private and public consumption.
- We expect the ECB to hike its policy rate to 4.75% in 12 months time. In other words Norges Bank will not “walk alone” and the risk of an excessive NOK strength is now smaller, even as the policy spread will hit 125bp in 2008.
Published on Mon, Jun 4 2007, 14:43 GMT
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Euroland: More positive surprises coming up
Fri, Jun 1 2007, 11:53 GMT
by Niels-Henrik Bjørn
- In spite of a significant slowing in the global industrial cycle since last summer, business confidence in Euroland has hardly been hit. Likewise, the German VAT hike has not dampened confidence in the German retail sector, and German manufacturing seems also to have ignored the plunge in consumer demand in Q1. While we have been confident in the underlying strength of the economy, and growth above trend in H2-2007, we have been surprised to see above trend growth in H1-2007.
- Looking forward, the question is whether growth will actually re-accelerate in H2-2007 from its already currently strong level . The most positive factor for Euroland manufacturing will be the reacceleration in global industry, which is already underway in USA and China. Furthermore, German consumer confidence is bouncing leaving much of the VAT related problems behind, and suggesting that the small brake on business confidence will also disappear. These factors are likely to contribute positively to Euroland manufacturing throughout 2007 and into the beginning of 2008.
- On the other hand, the tightening of financing conditions in Euroland via higher short rates and the strengthening of the euro are likely to dampen manufacturing activity and confidence. However, the effects of this tightening are only likely to appear very gradually and last throughout 2008. The net result for Euroland exports and manufacturing is likely to be continued strong growth significantly above trend throughout 2007. However, during 2008 we are looking for significant a slowing of the economy, as global industry turns around and tighter financing conditions also weigh on the economy.
- Continued resilience in Euroland manufacturing throughout 2007 will be a positive surprise. Furthermore, it has important implications for monetary policy, as ECB policy usually correlates well with business confidence, and further tightening is therefore very likely in Euroland during H2-2007. Thus, we revise up our expectations for ECB policy so that we now expect the ECB to hike three times more in 2007 bringing the policy rate up to 4.5% by yearend. The ECB is likely to peak at 4.75% by Q1 next year.
Published on Fri, Jun 1 2007, 11:53 GMT
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Norway: Preview inflation − it's a new trend
Mon, May 7 2007, 14:44 GMT
by Arne Lohmann Rasmussen
- We expect Norwegian core inflation to rise another notch to 1.6% in April from 1.5% in March.
- It will be the second month with core inflation 0.4 percentage points above the Norges Bank forecast.
- The central bank will have accept that inflation pressure is more pronounced than expected. The higher than expected inflation can not anymore just be seen as a result of monthly variations -it is a new trend
- An inflation number in the range 1.5-1.6% will convince the market that Norges Bank will revise its baseline scenario higher in June when the next monetary policy report is released. It will most likely imply an end-2007 rate of 5.25%
Published on Mon, May 7 2007, 14:44 GMT
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Sweden: Dissent within the Riksbank
Tue, Apr 17 2007, 16:24 GMT
by Roger Josefsson
- In the minutes just released, Deputy Governor Öberg expressed his dissent in leaving the repo rate unchanged at 3.25% and instead suggested an increase to 3.50%.
- Another member of the board thought that, althought it was not necessary to hike interest rates at this meeting there were arguments speaking in favour of a higher interest rate path than envisaged in the Monetary policy report from February.
- Dissent within the executive boardt also means that the successor issue (two replacements to Deputy Governors Persson and Srejber) becomes considerably more interesting.
- On balance, the minutes were more hawkish than what we and the markets were expecting. Interest rates have thus risen and SEK strengthened. However, note that the majority of the board saw no reason to change the interest rate forecast from February.
- However, since we have previously added a hike in October (policy rate peak at 4%), we believe that the increased inflation risks commented on in the Riksbank minutes have already been accounted for in our current interest rate forecast.
Published on Tue, Apr 17 2007, 16:24 GMT
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Sweden: The reform agenda remains intact
Tue, Apr 17 2007, 16:19 GMT
by Roger Josefsson
- Despite falling approval ratings, the government’s preferences for (benign) structural reforms continue to shine through.
- However, some political considerations are predominant; in economic terms the reduction of marginal tax rates should probably rank higher than the abolition of the property tax etc..
- Compared to what has already been communicated we detect nothing new in the spring fiscal policy bill. Now, focus should be on future policy considerations. There has been some mentioning of further diminishing income taxes, and even (finally) the abolition of the top bracket tax rate (värnskatten).
- The main reforms and initiatives in the spring bill have already been communicated and should not surprise financial markets. In spite of this, the Ministry of Finance’s repo rate forecast has attracted considerable attention from both media and financial markets.
- The difference between the forecasts from the Ministry of Finance (MoF) and the Riksbank stems more from competing views on the workings of the Swedish economy than from different views on the economic outlook.
- This implies that forecasts cannot easily be compared. Not only do the starting points differ, with a considerably higher resource utilisation in MoF’s calculations, but also are the views on the interaction between growth, labour market and inflation very different indeed. The Riksbank advocates a view where structural forces have a dampening effect on inflation over the coming few years.
Published on Tue, Apr 17 2007, 16:19 GMT
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ECB: Strict policy would better fit ECB view
Mon, Apr 2 2007, 16:43 GMT
by Niels-Henrik Bjørn
- The ECB hits a “neutral” interest rate, when it most likely raises its policy rate to 4.0% in June. Judging from various rules of thumb, a “fair” rate in the current economic situation may not be as high as 4.0%. However, given ECB interpretation of the economic situation and ECB rhetoric the ECB may feel more comfortable with a slightly tight stance rather than a neutral stance.
- There are only feeble signs that the VAT hike in Germany has had any effect on underlying dynamics. We have been surprised that business confidence has remained stable and that hiring is still strong following the plunge in retail sales at the beginning of the year. Thus, while German GDP growth is likely to be modest or stall in Q1, we are looking for above-trend growth again in Q2.
- In addition, we see support to the Euroland economy from the turnaround in the global industrial cycle, which is already brewing in the USA and Asia. While a tighter policy will dampen Euroland growth, the net result is thus likely to be growth just above trend in H2-2007 and into 2008. This will keep unemployment falling and the ECB on guard to neutralise potential higher wage growth.
- While we believe that there are good reasons to be very cautious about raising rates further, the ECB will probably feel tempted to raise rates further given the fact that they forecast growth above trend, inflation just above the target, and that they continue to see inflation risks on the upside. We therefore adjust upward our target for the ECB to end 2007 at 4.25%. We believe the ECB will raise rates to 4.25% by September, although the rise could also appear later, as the ECB turns more cautious and even data dependent.
Published on Mon, Apr 2 2007, 16:43 GMT
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New Europe: Mind the ratings
Thu, Mar 22 2007, 14:51 GMT
by Thomas Salomonsen, Lars Christensen
- We take a look at the prospects for sovereign debt credit ratings in the EU8+2 countries (Estonia, Latvia, Lithuania, Poland, Hungary, the Czech Republic, Slovakia, Slovenia, Romania and Bulgaria)
- Our analysis shows that the ratings cycle is turning negative for the EU8+2 countries and that six of 10 countries are likely to face negative rating action (either in the form of downgrades or change of outlook in a negative direction) in the coming year.
- Especially Latvias ratings outlook looks negative and we expect Latvia to be downgraded over the coming year. Romania could also be facing a downgrade. Furthermore. Estonia, Lithuania, Slovakia and Bulgaria could be facing negative rating action.
- The Czech Republic could be upgraded over the coming year and Hungary might end years of speculation over possible downgrades as the country gets rewarded for fiscal consolidation with positive rating action. The rating status for Poland and Slovenia are likely to remain broadly unchanged.
- The generally negative prospect for the rating of the EU8+2 countries further underlines the need to be careful about the market risks in the Baltic States and Central and Eastern Europe.
Less bright prospects
Outlook for EU8+2 credit ratings Recently the ratings agency Standard & Poors (S&P) changed its outlook for Latvias sovereign debt to negative from stable, see our Flash Comment Latvia: S&P changes outlook to negative , February 19 2007. The negative ratings action from S&P sparked a mini run on the Latvian lat and wider speculation about the sustainability of the Latvian boom.
Furthermore, the focus on Latvias imbalances and strong credit growth has increased focus on similar problems in other Baltic and Central and Eastern European countries. In our paper Research New Europe: A Warning not to be ignored, February 23 2007, we take a closer look at these concerns and evaluate whic countries in the Baltics and Central and Eastern Europe looks most unbalanced and most likely to face a hard landing in the economy and possibly also financial distress. In this paper we follow this path further and take a closer look at whether these imbalances could lead to possible negative rating action from the three major rating agencies, Standard & Poors, Fitch and Moodys. We focus on the same countries as in our previous research report Estonia, Latvia, Lithuania, Poland, Hungary, the Czech Republic, Slovakia, Slovenia (EU8) and Romania and Bulgaria (EU2). Our analysis starts out by estimating quantitative models based on macro economic and institutional fundamentals for the EU8+2 countries.
Our analysis shows that more countries are likely to face negative rating than positive action. Hence, our analysis indicates that five countries (Estonia, Latvia, Lithuania, Slovakia, Bulgaria and Romania) are likely to face negative rating (either a change of ratings outlook in negative directions and/or downgrades), while only two countries (the Czech Republic and Hungary) are likely to face positive rating action. We expect stable ratings for Slovenia and Poland. Especially Latvia stands out and our analysis clearly shows that the risk of downgrades of Latvia s sovereign debt is substantial.
Furthermore, our analysis shows that ratings of the two EU newcomers, Bulgaria and Romania seem to be a bit too positive given the underlining fundamentals in the two countries and negative news for example lack of progress in EU related reforms and/or a continued rise in the external imbalances in Romania and Bulgaria could lead to negative rating action for the two countries sovereign debt. The outlook is most negative for Romanias ratings and we would expect a downgrade of Romanias sovereign debt rating from at least one of the rating agencies (most likely Fitch).
It should also be noted that Slovakia looks a bit over rated and hence negative news for example postponed euro adoption could trigger negative ratings action. Equally interesting, our analysis indicates that Hungary which for long time have been the prime candidate for ratings downgrades in the region in fact looks under rated. Hence, the ratings of Hungary are in general lower than what our models predict. Therefore, Hungary could in fact face positive rating actions in the coming year, but much will naturally dependent on whether the planned fiscal consolidation has the expected positive impact on public finances and the current account situation. It is striking that our models indicate that the countries, which are most fragile to negative rating actions are to a large extent the same countries that are likely to face a hard landing in the economy and possibly also financial distress. These countries are Estonia, Latvia, Lithuania, Bulgaria, Romania and Slovakia.
For a complete overview of our forecasts for the ratings for the individual countries, see the table in the end of this report. We expect the rating news in general to be more negative in the coming year compared to what we we have been used to in recent years. There are a number of common factors that are likely to contribute in a negative direction to the ratings of the EU8+2 countries sovereign debt. These factors are:
- Signs of overheating leading to increased and unsustainable external imbalances.
- Too strong and unsustainable credit growth.
- Increased inflationary pressures.
- Postponed euro adoption.
- Signs of bubbles in some local property markets.
- Pro-cyclical fiscal policy.
- Continued high political uncertainties.
- Negative external shocks: Continued tightening of monetary policy in Euroland and moderation of wider European growth. This will be negative for the financing conditions and export growth in EU8+2.
Published on Thu, Mar 22 2007, 14:51 GMT
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Switzerland: Monetary tightening despite zero inflation
Wed, Mar 14 2007, 16:51 GMT
by Tobias Thygesen
- There is no doubt about the outcome of the forthcoming policy meeting at the Swiss central bank. The bank will raise its benchmark interest rate by 0.25 percentage points to 2.25% - anything else would be a huge surprise.
- After more than a year of more or less predictable policy decisions, uncertainty about rate decisions will begin to creep in to an increasing extent.
- We still expect the SNB to go on hold after the June meeting, at which interest rates will be hiked yet again, to 2.50%. In the light of exceptionally low inflation and still slowing growth, the SNB can afford to bide its time. This will reduce the risk of policy mistakes that might blow the expansion off course in a situation where the inflation target is not at risk.
- If our macro policy outlook holds water, monetary policy should continue to be easy after the June meeting. In other words, the risk to our outlook seems to be that the SNB might tighten up more than we are expecting over the coming year - or that policy might be tightened further in 2008.
- As far as the Swiss franc is concerned, the latest unrest in the financial markets has not changed our fundamental expectation that it will be some time yet before domestic events begin to drive the CHF upwards. Hence, we continue to believe that the CHF would only strengthen in the short term if global risk aversion increases further.
SNB to tighten up again on 15 March
The Swiss central bank (SNB) has tightened up monetary policy by 0.25 percentage points a meeting for five consecutive quarters. This has taken the Swiss benchmark policy interest rate up from 0.75% to 2.0%. The rate hikes have more or less been anticipated by market participants, since communications from the SNB have been relatively clear. The SNB has not wavered - as long as the economy has seemed to be on a steady upward path, the bank has pursued a course of taking policy rates up to normal from an exceptionally low level.
The SNB has repeated this message several times over the past few months. In other words, we would be much surprised if the SNB does not tighten up its policy again at its meeting on 15 March - most likely by 25bp.
Economic upswing is still alive
The Swiss economy is without question in good condition. In 2006, it expanded by 2.7%, beating the growth rates of the previous five years. However, the pace of growth slowed during the latter half of 2006, and especially fourth-quarter growth data, which were released only recently, were a bit disappointing. The economy expanded by 0.5% on the quarter - somewhat less than expected - but note that this is still slightly above the trend growth rate for Switzerland. On top of this, underlying data were not that weak after all. Consumer spending increased at a tidy rate - on top of a couple of quarters of relatively strong growth, and exports also gave a solid performance.
Moreover, after falling for seven months, the leading KOF indicator began to signal stronger economic growth in February. Although it is still too early to say whether the signals from the KOF will hold water, they are an important sign that the economy is no longer losing momentum to the extent seen earlier.
Labour market developments are also giving grounds for optimism. Unemployment keeps surprising positively, employment has increased even more than unemployment has decreased and the number of job vacancies has been rising fast over the past couple of years. Moreover, corporate capacity utilisation is higher than at any time since the Swiss economy overheated in the beginning of the 1990s. The positive development on the labour market means that the upswing is becoming increasingly self-reinforcing, while high capacity utilisation may ensure continued tidy investment growth over the next couple of years.
Add to this that we believe the global economy will remain afloat in the coming years, and there is a lot to indicate that the upswing in the Swiss economy will keep on track in both 2007 and 2008. We expect the economy to expand by 2.2% in 2007 before slowing to 1.7% in 2008. The upswing should continue to be broad based, with growth contributions from consumer spending, investment and net exports.
Since the SNB takes account of the condition of the economy in its overall policy aims, the economic outlook seems to give the go-ahead for further tightening of monetary policy. All else equal, monetary policy should not contribute towards speeding up the pace of growth of an economy that is already growing at a steady rate and whose labour market is tightening. On the other hand, since the economy is not actually booming, the SNB should not tighten up too aggressively
SNB´s problem (?): Zero inflation
The SNB faces the perhaps enviable problem of no inflationary pressure in the economy. Annual inflation in February was 0.0%, while core inflation was, respectively, 0.3% or 0.5%, depending on the definition used. Further, the outlook for the coming years points to the low level of inflation continuing. We expect inflation to average 0.2% in 2007 and rise to 0.7% in 2008. This rise will come mainly on the back of a fading base effect from declining energy prices in the latter half of 2006.
Our inflation forecast is a little lower than the one presented by the SNB at its latest meeting, in December, when it estimated inflation at 0.4% in 2007 and 0.9% in 2008. However, the SNB will have to revise down its numbers a little, as the first two months of this year show its Q1 forecast to already be 0.3 percentage points above the mark. Moreover, the SNB forecast assumes an un-changed monetary policy rate, while the new fore-cast will be based on a policy rate that is 0.25 percentage points higher than our expectation.
Whither the SNB?
Monetary policy remains accommodative in Switzerland despite the low level of inflation - real interest rates are hovering around the average of the past 15 years. Without further hikes from the SNB, real rates will fall significantly towards the end of 2007, as the fall in energy prices will drop out of the data. Further, if one looks at nominal growth in relation to the current policy rate, then the rate is, in principle, 2 percentage points too low compared to the average of the past 15 years.
Estimated Taylor rates suggest interest rates of around 2.75% at the end of 2007 rising to 3% at the end of 2008. A classic Taylor rule would pre-sent almost the same picture - albeit with the policy rate close to 3.25% at the end of 2008.
The above calculations are, though, built on the important assumptions that the forecasts hold and that the central bank is acting in a world free of uncertainty. But in the real world there is a wealth of uncertainties and hence the central bank, in principle, must make the decisions that, on paper at least, ensure the best possible outcome with the least possible risk to the economy. In other words, monetary policy perhaps ought to be tightened, but the inflation outlook provides the room to delay possible hikes and to monitor economic developments than would otherwise have been the case. Tightening too aggressively could mean that the SNB would risk derailing the upswing.
This point is further underlined by the economy having - despite everything - lost some steam and the fact that it is expected to slow to trend growth in 2008. Remember, as mentioned earlier, this is not a blistering upswing, and there is also the risk of a major slowdown in the global economy occasioned by a hard landing in the USA. The overall risk for economic growth is probably more down-side than upside in the coming years, while inflation is rather unlikely to exceed the official target of 2%.
Generally speaking, there is no doubt that the SNB will tighten monetary policy further from the cur-rent level - initially in the form of a 25bp rate hike at the March meeting. However, how quickly and how far rates will be hiked after this remains un-certain - and depends mostly on how robust the SNB views the upswing to be. As outlined, the economic outlook could, in principle, justify the SNB continuing its gradual normalisation of monetary policy throughout 2007. However, we are inclined to believe the SNB will go on hold for the remainder of the year after another hike in June. Doing so means the SNB will reduce the risk of making a policy mistake whereby the upswing ends up be-coming derailed even though inflation is not a threat. Hence we maintain our call on the SNB, which we also had before the December meeting.
The risk to our SNB call is to the upside. What has shifted our risk perception is not the economic growth and inflation as such; it is the still very aggressive statements emanating from the SNB. Hence, there is a fair chance that the SNB will maintain its mantra of gradually normalising monetary policy in the press statement after the policy meeting. If so, we may adjust our call on the SNB
Solid economy still not enough for the CHF
Recent turmoil in the financial markets provided a brief tailwind for the Swiss franc, with EUR/CHF dipping slightly below 160, although the cross is once more trading close to 162 after calm has returned, for now at least, to the financial markets. The episode clearly illustrates that while the CHF perhaps no longer has the safe haven status it once enjoyed, it is still relatively undervalued and a rise in risk aversion like that just witnessed will typically lead to a stronger CHF. Supporting the effect is that the low cost of borrowing in Switzer-land has meant the CHF being much used as a loan currency, and some of these positions will be closed down in such a situation.
Hence, the short-term prospects for the CHF are rather dependent on whether calm really has re-turned to the financial markets. If not, the CHF could, at least temporarily, be strengthened beyond what we have stated in our forecasts (see FX Crossroads, March 7, for more details).
Apart from a further rise in global risk aversion, we still do not foresee the CHF strengthening much in the near term. Even if the SNB sticks to its course of gradually tightening monetary policy - and even though the risk to our SNB call is to the upside - the ECB also looks likely to tighten monetary policy in June. And while one more hike from the SNB is more than priced into the fixed income market (3-month forward rate in December trading at x.xx%), the ECB hike is not yet fully priced in. Hence, there is no indication that relative rates will move in the CHF’s favour in the coming months, and so we maintain our expectation that EUR/CHF will remain around 1.62; or 4.60 when it comes to CHF/DKK.
Looking at developments in the CHF in the days either side of SNB meetings, there has been a clear tendency over the past year or more for the CHF to weaken immediately after meetings - per-haps due to market disappointment that the SNB did not signal more aggressive tightening going forward, or some players reckoning on rates rising by 50bp. However, this time around it is difficult to imagine that anyone could have such expectations, and hence we do not believe the pattern will be repeated at the upcoming meeting.
On the other hand, there is some suggestion that the CHF (and expectations on the SNB) will in future be more sensitive to news and data. Expectations on the SNB have, for the past year or more, been pretty fixed and thus have not been influenced by the data coming out a little stronger or weaker than anticipated. Now that a neutral rate is closer at hand, however, uncertainty is greater and the data will mean more for the SNB, for expectations on the SNB and hence for the currency too.
Published on Wed, Mar 14 2007, 16:51 GMT
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Norway: Steeper baseline scenario
Tue, Mar 13 2007, 08:57 GMT
by Arne Lohmann Rasmussen
- We expect Norges Bank to raise the leading interest rate by 25bp to 4.0% at the next monetary policy meeting on March 15
- Norges Bank is expected to raise its baseline interest rate scenario slightly, indicating a leading rate close to 5.0% at end 2007. The central bank is expected to indicate that interest rates are expected to peak at close to 5.5% during 2008. The so-called output gap is expected to be raised significantly
- We expect higher market rates after the release and a stronger NOK
Key event of the quarter
In our opinion the new Inflation Report from Norges Bank, to be published on March 15, will be the most important event in the Norwegian market this spring. It will set the agenda for both the Norwegian FX market and the Norwegian fixed income market for the next three months.
To summarise our view, we expect the following message from the central bank this week:
- Leading interest rates to be hiked 25bp to 4.0%
- The baseline scenario for interest rates in 2007 is to rise slightly. It should indicate a leading rate slightly below 5% at year-end 2007
- Interest rates are expected to peak at slightly below 5.5% in 2008
- Interest rates to be be raised gradually. No reference to the phrase “in small not too frequent steps”
The message regarding the real economy will probably be that growth has surprised on the upside since the release of the latest Inflation Report, and that the so-called output gap is much higher than expected.
In our view, the Inflation Report will be a wake-up call to the Norwegian fixed income market, which we believe expects too little tightening from the central bank in 2008.
The report is expected to renew market interest in the NOK. We expect EUR/NOK to fall below 790 in three months’ time.
Labour market is the key
The labour market is the key to understanding Norwegian monetary policy. Unemployment fell markedly during the course of 2006 and is close to previous record lows at 2.8%, and there is little to suggest that demand for labour is set to drop off. In November, Norges Bank expected the LFSunemployment rate to average 3% in 2007. We expect the central bank to revise its 2007 forecast down to 2.5%. Norway has not experienced such a tight labour market since 1986-1987. There is no doubt that Norges bank has been underestimating the strength of the labour market.
According to Statistics Norway’s business tendency survey, many businesses are reporting a shortage of labour as a limiting factor for their output. The same picture was painted by Gallup’s expectations survey at the end of February, with the number of businesses expecting to have more employees in a year’s time, growing from 44.7% in Q4 to 49.8%, and only 5.8% of businesses expecting to have fewer employees. Hence, there are no signs that the accelerating growth in labour demand during 2006 is about to slow down.
Norges Bank is concerned that further growth in demand for labour will trigger a serious wage price spiral. After the latest monetary policy meeting, central bank vice governor, Jarle Bergo, said that the bank was eager to see the so-called TBU-report that was released end February.
The report on wage developments in 2006 revealed a record-high wage overhang into 2007. The report showed that the so-called wage overhang into 2007 will be as high as 2.0%, which is much higher than the 1.2% of the last three years.
The wage overhang shows that wage growth was relatively strong at the end of 2006. If we presume a wage drift of 1.5% in 2007 it means that wage growth is at 3.5% before the central wage round has even started.
Norges Bank will also have access to a fresh report from its regional network, ie, interviews with Norwegian businesses. We are fairly sure that the message here will be that output is in top gear, but that a shortage of labour is an accelerating problem. The stage is therefore set for Norges Bank to follow Statistics Norway’s lead and upgrade its wage growth forecast for 2007 to 5.5% from 5.0%.
Higher output gap
Our forecast for the Norwegian economy relative to the forecast put forward by Norges Bank in November differs on one important issue. We expect the above-potential growth period in Norway to continue for longer than the Norges Bank predicts. We do not think, as the central bank does, that growth will slow significantly below potential growth in 2008-2009. We believe that Norges Bank this time will expect above or at least on-trend growth in 2008. Hence, the output gap will not start to fall before 2009.
Furthermore, when the latest set of very strong Q4 06 GDP numbers were released, there was a strong revision to 2004 - 2006 mainland GDPgrowth,. In summary, it means that the aggregated pressure in the Norwegian economy was much higher than expected by the central bank back in November. In economic terms, it means that the output gap has been significantly underestimated. Norges Bank is expected to publish a significantly higher output gap in its new Inflation Report.
Inflation expected to climb higher
Despite the extremely tight labour market, Norwegian inflation has been very stable over the last couple of years. However, if we look at the central bank forecast from November it seems that Norges Bank in general has been expecting a too-benign inflation outlook this winter.
We expect the central bank to present a slightly higher inflation path this time given the tighter labour market. The inflation forecast could very well be very close to our forecast.
But the inflation path itself is not that interesting. What we want to focus on is the rhetoric. We expect the central bank to repeat that monetary policy has now moved away from the risk of inflation being too low to inflation being too high. On this topic see the research paper “Research Norway: From deflation to inflation fears” from February 7.
Steeper interest rate forecast
In the Inflation Report, Norges Bank will present its new interest rate scenario for the next three years and the “strategy interval” for the next four months.
In the November 2006 inflation report, Norges Bank said that it expected the sight deposit rate to be 3.25%-4.25% in the period before the next Inflation Report. So, if we are right in expecting a rate hike at this meeting, interest rates will be 25bp higher than the mid-point of 3.75%. In the new report we expect a strategy interval of 4%-5%. This would indicate two rate hikes at the next three monetary policy meetings. We expect Norges Bank to skip the next meeting in April and raise rates in May and June, bringing the leading policy rate to 4.5%.
Regarding the interest rate baseline scenario we forecast that Norges Bank will publish a slightly steeper baseline, indicating that the sight deposit rate will hit almost 5% at end 2007. In November, the interest rate scenario signalled a sight deposit rate of 4.75% at end 2007. The central bank is expected to signal that interest rates will peak slightly below 5.5% as in November. However, we believe the central bank will signal that this level will be reached one year earlier, during 2008.
Looking at market expectations, it would seem that the market more or less agrees with this view for 2007. But if anything we see a risk that Norges Bank might hike at a quicker pace or more “frontloaded “.
But in our view market rates are definitely still too low for 2008, both relative to the current baseline scenario and that which we expect to be presented on March 15. Hence, if one were to position for a steeper Norwegian money market curve we would recommend concentrating on the 2008 segment of the curve.
If Norges Bank presents a baseline scenario according to our expectations, it will still be marginally lower than our forecast for the sight deposit rate.
Below we list our expectations regarding future monetary policy changes from Norges Bank.
Published on Tue, Mar 13 2007, 08:57 GMT
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Russia: Investments vital to sustain growth
Thu, Nov 30 2006, 11:37 GMT
by Lars Rasmussen
- This report intends to give an overview over the macro economic development in the last 5-6 years in Russia. After the financial crisis in 1998, Russian growth made a strong rebound, initiated by large spare production and considerable terms-of-trade improvement. In recent years, growth has been driven by the positive development in oil and gas prices – Russia’s main export articles.
- With rising wages and falling unemployment, domestic demand is accelerating and private consumption is fuelling imports, which is sprinting ahead by 20% y/y. At the same time, the export industries - mainly the oil and gas sector - are beginning to look stretched on the back of years of low investments in new production possibilities and infrastructure combined with rapid production growth since 1998.
- We argue that for Russia to sustain its solid economic growth, it will have to increase its level of investment - especially in the oil and gas sector. To lift investments, Russia has to deal with serious corruption issues and red tape.
- In our forthcoming paper, we will give an overview of the development in the external balances and the monetary policy as we argue that being bullish on the rouble is much like being bullish on the oil price.
Russian growth situation
Rebounding after the 1998 crisis
The Russian economy has made significant progress since the financial crisis in August 1998. The crisis led to the collapse of the banking sector, falling GDP, a massive rise in unemployment, and a strong jump in inflation as a result of the government default on debt and the devaluation of the rouble. After the crisis in 1998, initial growth fundamentally reflected large spare production capacity, and considerable terms-of-trade improvement on the back of the devaluation of the rouble (RUB).
Recent years’ growth driven by private demand
Economic growth has been strong in recent years with yearly growth rates above 6% in real GDP since 2000 and above 7% y/y in Q2 2006.
Growth has been supported by strong domestic demand - mainly stemming from private consumption, but also from investments. Public consumption has had a slightly positive effect on growth in recent years, while net exports have contributed negatively to real growth since 2001. The latter fact is at first glance surprising as Russia is a large net exporter of both oil and natural gas. This illustrates the hefty demands for import goods.
The increase in the natural gas and oil price since 2002 has played an important role for the private sector, as it has lifted private and public exports earnings.
As energy related earnings went up, the economy enjoyed higher income, increased wages, and falling unemployment. Since 2000, real wages have been rising yearly around 10%, and the unemployment rate has been halved to 6.6% in October 2006 since beginning of 2002. This has boosted private consumption.
Higher incomes have spilled over to higher credit lending to the private sector and domestic credit as a share of GDP has now risen to 25%.
Growth in bank lending to private households has accelerated since 2002 and is currently growing over 80% y/y, whereas bank lending to the corporate sector is growing more modestly at 30-40% y/y.
Booming imports and a stagnating export sector
Positive development in energy prices has boosted the export sector. The composition of Russian exports shows that the share of nominal exports related to the oil or gas sector has gone up from 40% in early 1999 to around 65% in mid 2006.
Given the relative high importance of energy-related products in exports, net-exports growth is closely related to the oil price. Evidently, the rise in energy prices has provided Russia with a huge windfall gain.
The large and increasing surplus in net-exports only tells a part of the Russian trade story. Adjusted for prices, a different story appears. Looking at exports and imports in real terms - measured in volumes - net-export balance is, in fact, deteriorating - explained by increased demands for imported goods. In fact, real imports have been growing at 20% y/y over the past 4-5 years. In the same period, real exports have only been growing only around 10% y/y and the tendency has clearly been negative in 2005 - where exports only grew by 5.3% y/y in Q3.
Low investments behind drop in exports growth
Low real growth rates in exports are due to low in-vestments in the energy sector. The chart below shows a substantial growth pick-up in oil production after the 1998 crisis - where growth rates initially were facilitated by the sizeable spare production capacity - has flattened out and has even been falling this year.
Growth rates in oil production peaked in 2003-04 - going over 10% y/y, but have since then been declining rapidly due to rising scarcity in production capacity. Gas production is still growing, currently around 3-5% y/y, but the International Energy Agency (IEA) has stated its concerns over the possibilities of increasing gas production further with-out substantial increases in investment levels.
Another reason is the decreased competitiveness of the Russian industrial sector on the back of a strong real appreciation in the rouble showing signs of Dutch disease symptoms, which we shall discuss more in detail in our forthcoming paper.
There are two dominating suppliers in the Russian oil and gas industry - Lukoil and Gazprom. Gazprom - 50% owned by the Russian state - provides 90% of Russian gas supplies and controls 16% of the world's gas reserves. Lukoil is the biggest oil producer in Russia, supplying roughly 20% of Russian oil. Both companies are running low on excess capacity due to years of underinvestment in future production and infrastructure. Scarcity in production capacity, due to underinvestment, is a general issue for other major players in the Russian energy oil and gas market. According to its latest oil report (Nov. 2006), the IEA projects that Russian oil sup-ply growth will be negative throughout 2006.
Investment levels are not only low in the energy sector, but also in the rest of the economy. Comparing Russia with a broad class of countries, we see that Russian investment as a share of GDP in 2005 is at levels with richer Western European countries and way below peer income countries like Baltic States and most of the Central- and Eastern European countries. China stands out with yearly investments as a share of GDP well above 40%.
Although there has been some pick-up in investment in production capacity in 2006, as the chart below indicates, the impact from low investment has led to a doubling of the average age of the capital stock since 1990.
Combining this with low excess capacity in the production sector and low storage capacities in the oil and gas sector, there is a very high demand for new investments in order to bring labour productivity and competitiveness up, and thereby enhance potential GDP growth over the medium term.
Inflation has been reduced, but still seen high
After the very high inflation in 1998, price growth is now more stable. Producer prices are currently growing at single digit numbers for the first time since 2002, and the consumer price is looking to grow by 9% y/y this year.
Continuing the road towards even lower inflation has a high priority in the government and the central bank. This is good news for Russia, as it will increase competitiveness in export sectors not related to the energy industry.
Investor concerns
Corruption and red tape are main concerns
We believe investments are weak due to an unsatisfying investor climate infected by corruption, red tape, and national intervention in the energy and banking sector as a concern to potential domestic as well as foreign investors.
In 2003 CEO of Yukos, Mikhail Khodorkovsky was imprisoned and Yukos was charged with tax evasion for an amount of over US$7 billion, which led to the breakdown of the company. Speculation as to whether the government’s actions against Khodorkovsky and Yukos were in retaliation for Khodorkovsky's support of political groups that oppose the government's policies has been a major concern for many foreign investors.
The impact was a sharp downturn in FDI inflow to Russia as foreign investors became more reluctant to move into Russia. In fact FDI inflow as a share of total investments dropped from 11% in 2003 to 5% in 2004, as a more or less direct impact from the Yukos case.
Another issue which especially concerns foreign investors is the Russian state’s growing role in the energy sector. This was lately seen from the Kremlin’s determination to increase pressures on foreign oil companies involved in Sakhalin-I and Sakhalin-II projects, and on its decision that Gazprom should develop the world's largest offshore gas field, Shtokman, without any foreign energy companies as partners. In fact, there is widespread criticism of Russia’s tendency to use its energy re-sources as a security policy instrument. This was lately exemplified when Russia came to an agreement on natural gas prices with the Ukraine and Georgia respectively. The Ukraine secured its gas delivery at half the price of Georgia’s deal.
Earlier this year, an annual survey was taken of 155 foreign corporate investors for The Foreign In-vestment Advisory Council (FIAC) - an organisation established in 1994 to improve the business climate in Russia. The survey shows that investors are deeply concerned over issues such as corruption and administrative barriers. 80% of participants in the survey mention corruption among the biggest disincentives to investment. About the same number mention administrative barriers. Al-most two-thirds of current foreign investors believe their company has been affected by corruption in Russia - especially involving tax authorities. Transparency International publishes annually a survey on corruption across 150 countries.
Unlike the Ukraine, which has fought corruption with some success since 2000, and the Baltic States, which have been even more successful, there has, according to the survey, been no real progress in fighting corruption in Russia since 1998. In 2006, Russia was placed 121st in the survey out of 163 countries. The same level as Rwanda.
On top of widespread corruption among tax-authorities, traffic-police, courts, judicial authorities, custom officials etc., and on top of significant administrative barriers, the latest relapse in the democratic development is extremely concerning. This includes the killing of central banker deputy Kozlov, who led the fight against corruption in the banking sector, and the killing of Anna Politkovskaya, known for her opposition to the Che-chen conflict and Putin administration.
The tendency is clearly negative in terms of democratic development. According to surveys from Transparency International Russia has not moved towards being a more free and democratic country in the last decade. Looking at sub-components in the index has worsened mainly on the back of less free banking sector - where the two state owned banks Sberbank and Vneshtorgbank are the dominant players in the banking sector - reduced protection of intellectual property rights and an un-even implementation of new laws. In fact many foreign investors have experienced problems in executing court rulings, and in obtaining satisfaction from contractual agreements.
According to the FIAC survey, many investors still see the Russian market as a big potential, on the back of the size of the Russian market and the country’s impressive economic growth that has improved the average Russian’s purchasing power against a background of increasing wages and falling unemployment. The survey further suggests that foreign investors see a slight improvement of the investment climate in 2006 compared to 2005, and the majority expects this to improve even more in the coming years. In this light, it is a positive step for Russia that it can now step into the final stage of entry talks with the WTO’s 149 members, as a membership could force a reform process in Russia.
Outlook for Russia
Challenges for growth
We believe that the economy could be up for 5-7% y/y growth over the next years, being around 5% if the oil price weakens from current levels around 7% if the oil price heads over USD 65 per.
To sustain high growth in the longer term, Russia will be to speed up pace in investment growth, and reduce its exposure to the energy sector.
To lift investments, the Russian authorities will have to speed up the structural reform process in order to invoke transparency and create a fair playing field. This could be on issues such as the respective roles of the state and private capital in the development of key sectors of the economy, particularly in natural resources. It involves a sincere effort towards fighting corruption at all levels.
This will help the business climate and improve investor sentiment, so that in the longer term Russia will have a more diversified productive sector, reducing the economy’s dependence on oil and its exposure to the fluctuating energy prices.
It is important to stress that unemployment is falling and is now under 6.6%. Population growth in Russia is negative (700.000 a year) and the labour force is projected to start declining from 2010 on-wards. This will enhance the need to bring up labour productivity via bringing up the technological level of capital stock, together with a top priority to further increase educational levels.
It is encouraging that Russia is now approaching WTO membership as it will commit politicians to bringing copyright laws and enforcement systems into line with WTO rules on intellectual property. But do not expect any miracles, this is a long process.
Published on Thu, Nov 30 2006, 11:37 GMT
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ECB: German industry paves way for early 07 hike
Fri, Nov 10 2006, 11:12 GMT
by Niels-Henrik Bjørn
- The slowing global industry has so far done little damage to the German recovery. In fact, during the second half of this year we have witnessed the largest decoupling between German and US business confidence in German favour since following the re-unification.
- Consistent with this decoupling our GDP model points to continued strong growth in Germany in Q3. While the impetus from exports has slowed substantially during this autumn, the domestic investment recovery has gained further pace thus off setting most of the negative impulses from exports.
- Looking forward, we still expect slowing in the German and Euroland economy during H1 next year, before re-accelerating through H2-2007. However, in the remainder of the year, key figures from Germany could continue to surprise on the upside, as the German VAT hike gives a yearend boost.
- The ECB is likely to give some kind of hint with regard to policy in 2007 at the December meeting. At that time the information available will be mostly hike-friendly. Activity will seem robust, inflation expectations will not fall clearly below 2%, credit growth will continue to be strong, and most ECB members will still feel they have some more normalising of rates to do. Thus we push forward our expectations to the next rate hike from H2 next year to Q1 next year, and we continue to expect two rate hikes in 2007.
Investment recovery strengthening
Negative export impulses absorbed
The slowing of global industry has so far not damaged Euroland industry in any significant way.
While the momentum in exports has slowed significantly throughout 2006, the overall manufacturing sector in Euroland has proved more robust. Exports is usually the main driver of the momentum in the overall manufacturing sector in Euroland, but not this time.
In the chart below the tight correlation between exports growth and the manufacturing sector is obvious. While the strong manufacturing sector in Euroland may be due to lagged effects from strong exports in 2005, there is also another explanation.
The domestic recovery in Euroland, and in particular, Germany, has been cooking for some time, and it now seems to off set much of the weakness observed in global industry. In the chart below this is evident when looking at domestic capital orders in Germany, which is growing at its strongest pace since following the re-unification.
While we since last summer have been optimistic on the chances that the domestic economy could finally get started in Germany, we have been surprised to see the kind of dynamics witnessed during this summer and autumn.
Thus, in spite of slowing exports momentum, the domestic investment recovery in Germany has kept the overall industry on fire this autumn. In the chart below we have estimated Euroland industrial production on exports and German domestic capital orders. These two variables describe most of the dynamics in total industrial production. From the contributions, also shown in the chart, it is clear to see that domestic capital orders are contributing strongly to industrial production at the moment.
This means that Euroland will post decent GDP growth in Q3. And in Germany the economy will even maintain the strong speed from H1-2006. We expect GDP growth in Germany in Q3 of around 0.7%q/q. The investment recovery in German is simply making Euroland more robust.
This situation looks a lot like 1998, where Euroland industrial production kept up momentum in spite of global slowing. At the time we also saw a couple of excellent quarters from the domestic investment recovery in Germany, before it stagnated late 1998.
In all circumstances, the activity in Euroland continues to grow decently. Given the likely VAT impulse to ifo current conditions over the next couple of months, the impression of a continued recovery will prevail.
Looking into 2007
When looking into 2007 we still see downward risks in H1-2007. The global industry is still on a downward trend, although probably at a lower pace than over the past 3-6 months. In addition, the lagged effects from the euro strengthening early this year will be feeding through making Euroland manufacturing lose some of its momentum compared to global manufacturing, see chart below.
Unless domestic capital orders continue to explode we will thus see some slowing of manufacturing in Euroland during H1 2006. However, we remain of the view that global and Euroland industry will reaccelerate during H2-2007, see also our research paper: Business confidence heading down from 31. May 2006.
Implications for ECB
The more robust growth picture indicates that the ECB will not pause in hiking rates during 2007. In stead of hiking twice in H2-2007 as we have originally expected, we now expect a rate hike in March next year. Whether the ECB will hike rates again in Q2 remains an open question to us, but we still believe the ECB will end its hiking campaign at 4.0% by end 2007.
Published on Fri, Nov 10 2006, 11:12 GMT
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Germany: VAT rollercoaster − but recovery intact
Mon, Oct 30 2006, 09:34 GMT
by Niels-Henrik Bjørn
- One would be excused for thinking that a VAT rise from 16% to 19% would hardly have any large impact on the German economy. After all, the price of a washing machine will only rise from 500 euro to 515 euro. However, experience shows that a VAT rise of this size could have a strong impact on economic data - especially in the short run.
- Most of the VAT rise is likely to be passed through to prices implying a rise in German CPI by about 1- 1.25% and a rise in Euroland CPI of around 0.3%. A price rise of this magnitude would normally only dampen consumer demand by some 1% in Germany and some 0.25% in Euroland. However, the experience with VAT hikes is that it often generates powerful dynamics. While we are likely to see a boom in demand in the coming months, demand is likely to implode in early 2007, as consumer demand fall back sharply.
- This implies that even Euroland GDP will be hit hard. On the back of the VAT rise we expect Euroland GDP to growth by about 0.75-1.0%q/q in Q4, but to stall in Q1 next year.
- Some effects of the VAT hike are already showing in the economy. One is consumer willingness to buy, which is surging dramatically. We also estimate that the VAT rise has a significant say in forcing a historical large wedge between surveys of expectations and current conditions in the German economy. This divergence is likely to reverse strongly during H1-2007, as current conditions will worsen, while expectations could start to rise.
- In general we expect the German VAT rise to support the tendency towards slower German growth, which is being fuelled by a global industry that is heading down. However, we do not expect the German recovery to end. The strong recovery in the construction sector, in business investments, and in the labour market is robust enough to carry on. After a weak first quarter next year, we therefore believe the economy will re-accelerate, as underlying consumer demand is robust and as global industry picks up speed again. This will be supported by the falling oil price, which, if stable, will neutralise most of the VAT rise.
- To ECB the VAT rise creates a dilemma. On top of slowing sentiment and upside risks to inflation, the VAT hike could bust demand but boost wages. Uncertainty about the precise impact may be the best argument for the ECB to take a wait-and-see approach before deciding what to do in 2007. The VAT rise poses a clear risk that the ECB will not pause its tightening campaign in H1-2007 as we currently expect. We continue to expect the ECB refi rate at 4.0% by yearend 2007.
Published on Mon, Oct 30 2006, 09:34 GMT
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Euroland: New Europe − Be careful! Risk on the rise
Tue, Sep 26 2006, 15:10 GMT
by Rene Kallestrup, Lars Christensen
- There is a significant risk of a substantial downward correction in Central and Eastern European (CEE) currencies. Political tensions are on the rise, populist policies are in vogue, external deficits are substantial and so are "hot money" inflows.
- Though the economic backdrop is not directly comparable, we see certain parallels with the Asian crisis in 1997/1998. We therefore recommend being underweight CEE currencies in the coming months and single out TRY, HUF, RON and SKK as being the most vulnerable. PLN and CZK enjoy better fundamentals, but both may suffer from contagion effects. In contrast, the currency boards of Estonia and Lithuania appear stable and credible.
Published on Tue, Sep 26 2006, 15:10 GMT
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Euroland: Could inflation hit 3%?
Thu, Aug 17 2006, 09:49 GMT
by Niels-Henrik Bjørn
- The eagerly awaited inflation figures for Euroland over the next couple of months will most likely not see inflation dipping below 2% as many had originally predicted. In stead focus will turn to the inflation outlook for 2007. We expect both the ECB staff and consensus to adjust up their forecasts for inflation next year.
- Last autumn we predicted that there would be virtually no second round effects in inflation by now. With stable core inflation our predictions have proven correct. While we now expect core inflation to inch slowly up during the coming year, the real danger to inflation in Euroland is still the oil price.
- However, if the oil price continues to rise at the same pace as over the previous couple of years, that rise will take average headline inflation in Euroland up to 3% next year, even if second round effects in core inflation will only build slowly. In fact, even if energy prices remain stable at the current level, a rise in headline inflation to around 2.7% is on the cards by Q1 next year.
- This owes partly to the fact that the planned German VAT hike will boost inflation by around 0.4%- points next year. But it also owes to the fact that the lagged effects from the historical rise in the oil price upon energy prices in Euroland are larger than many envisage. Finally, it also owes to moderate second round effects in core inflation. Hence we adjust upward our forecast for inflation next year from 2.3% to 2.5% (ECB staff 2.2%, consensus 2.2%).
- Given our 2007 forecasts of modest growth but high inflation, we expect the ECB to be in a huge dilemma around New Year. While business confidence may signal growth below trend, headline inflation will be begging for further rate rises.
- In stead of focusing on a fall in inflation the next couple of months, which is unlikely to halt the ECB in itself, markets should prepare for an upward revision from the ECB staff to inflation to be published at the meeting 31. August.
Published on Thu, Aug 17 2006, 09:49 GMT
Archive
- In Asia we trust
Published On Wed, Sep 2 2009, 08:52 GMT - Arguments for ECB to hike in 2010
Published On Wed, Aug 26 2009, 09:08 GMT - The Spanish public budget
Published On Wed, Jul 29 2009, 07:18 GMT - The Spanish banks
Published On Tue, Jul 28 2009, 08:53 GMT - The Spanish recession
Published On Mon, Jul 27 2009, 10:34 GMT
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