Austrian Spread Spikes

“For Austria, the actual crisis is yet to come. The decline of the eastern European economy will hit Austria in 2009".
Peter Eigner, Professor of economic history at the University of Vienna”


The yield difference, or spread, between 10-year Austrian securities and benchmark German bunds have been rising substantially of late, and hit 137 points on Feb. 18, the widest yet recorded (see chart below). At the same time Austria now has a higher default risk than those Mediterranean "laggards" Italy, Portugal and Spain, at least according to credit-default swap prices as quoted by CMA Datavision. Austrian swaps were trading at 253.3 basis points on March 3, compared with 17.5 points 12 months ago. That means it costs 253,300 euros a year to protect 10 million euros from default for five years.

The reason for this sharp spike in spreads is, of course, the heavy exposure the Austrian banking system has to the risk of defaults in the East. Austria’s banks have about 201 billion euros ($254 billion) oustanding in loans in Eastern Europe, equal to about 71 percent of gross domestic product, according to data from the Bank for International Settlements. Shares of Austria’s Erste Group Bank, which made more than two-thirds of its profit from emerging European economies in 2008, and Raiffeisen International Bank-Holding AG, which operates only in the region, have both dropped more than 85 percent from their peaks.

To put this in perspective, Austria’s banks could withstand losses of up to 31 billion euros on their outstanding loans, according to stress testing carried out last month by Austria’s central bank. But what if the defualt figure rises beyond this?


Now all these numbers have been causing some controversy of late (see Izabella Kaminska's piece in FT Alphaville ) and Erik Berglof, Chief Economist at the European Bank for Regional Development has taken issue with some critics, specifically referring to the widely quoted BIS figure of $1,700bn, (cited among others Morgan Stanley's Stephen Jen, Yours Truly here, and The Anthropologist's Grandson Ambrose Evans Pritchard in the Daily Telegraph. Specifically, Berglof asks the following question:

The $1,700bn, which is taken from Bank for International Settlements statistics, represents the total claims of foreign banks and their affiliates on eastern Europe. Western banks own some 80 per cent of the region’s banking sector. The BIS figure therefore simply reports the region’s bank balance sheets. At $18,000bn the equivalent figure for western Europe is more than 10 times higher — should we be concerned?

My answer is, yes, we should be concerned, and more importantly, Austria's citizen's should. Let's look at what Berglof says next:

A much better measure of refinancing need is short-term external debt owed by the region’s banking sectors to foreign creditors. According to central bank data, this is about $200bn for all of central and eastern europe.

Thinking about his argument here, a lot of things make sense to me, in a sort of flash of lightening. You see, we are talking about two different things here, one is the level of exposure to default on the loans, not sovereign default, but default by households and companies as the economies contract, and as the currencies slide (or, in the case of the Baltics and Bulgaria, internal deflation is carried out), and the other is the issue of speculative attacks on currencies and reserves due to the gap in the current account deficits. But this would be the point, we are not dealing here with a 1960s type balance of payments crisis (although you wouldn't know that from looking at the measures the EU has been taking, and from the language which constantly refers to balance of payments loans.

What we have is a regional deleveraging process, as economies which have expanded well beyond their short term capacity level of output now contract sharply, in many cases with a boom bust dynamic. This is inevitably going to produce a steady stream of defaults over the next two to three years. One extaimate has been in the (worst case scenario) context of Ukraine that defaults may rise as high as 60%, but lets just imagine they rise above 20% - that would be around a 40 billion bill for Austria, and a 350 billion euro bill for Western Banks in the Context of Eastern Europe as a whole. And if we get a worst case scenario of 40% default, then you just double those numbers. Of course, no one at this point has any idea of the actual level of default we are going to see, or of the posterior recovery rate on the assets, but it doesn't help restore confidence if leading authorities essentially address the secondary issue and not the primary one. That presumeably is why Austrian spreads have risen and continue to rise. It is also why Eastern Europe needs a collective solution to its problems, and it needs one now.

Huf and Puf

Eurozone Inflation Expectations Fall As Output Gap Rises

What follows are a few charts to illustrate further the argument I developed yesterday as regards the significance of the deflation threat which now exists in the eurozone. The argument is that the ECB is once again being far too cautious, and risks allowing the entire eurozone to entire a deflationary cycle which may prove to be a lot harder to get out of than it was to get into. In my view the ECB should bring the refinancing rate close to zero % at next Thursday's rate setting meeting, and then explore what measures can be taken to introduce a zonewide version of US/Japan style Quantitative Easing as quickly as possible.

The key argument I am presenting is that it is a mistake to focus at this point on what is happening to energy, food and other commodity prices. The key issue is what is happening to core prices, and what will continue to happen to them as output contracts further. The other side of the coin are inflation expectations, and as we will see below these are now falling rapidly across Europe. It is very important at this point that these expectations do not get "locked in" to price fall expectations.

It is evident that the degree of economic slack in the OECD is now widening rapdily as unemployment rises and capacity utilization falls. The OECD output gap (the difference between current levels of output and some estimate of what "capacity" output could be at this point) continues to widen and is now only second in importance to the output gap seen in the early 1980s. In fact, the output gap is likely to have widened further since the OECD last made its forecasts in November 2008 (the OECD leading indicator has, for example, continued to decline since that point) but the output gaps shown for the US, the UK and eurozone in the chart below are already sufficiently pronounced to make the point quite clearly I think.

In fact, spare capacity is a phenomenon which extends way beyond the OECD, and economies throughout the world are operating at below their potential and look set to do so for both the remainder of this year and most of 2010. Global manufacturing has been contracting and global trade has collapsed. Here is the latest JP Morgan Global Manufacturing PMI.

The IMF currently estimates that the cumulative global output loss relative to potential over the period 2008-2010 will be as much as 5% (see chart below).


And inflation expectations are falling rapidly. The latest findings in the European Commission’s own consumer questionnaire show that the net balance of respondents in the UK and the Euro zone expecting prices to be higher this time next year is now at the lowest recorded level - just 2.7% and 4.1% respectively ( see chart below).

Global Manufacturing PMI February

The performance of the worldwide manufacturing sector remained very weak in February. Although the JPMorgan Global Manufacturing PMI rose further from December's record low, at 35.8 it was still well below the critical no-change mark of 50.0. Rates of decline eased for production and new orders, but accelerated to reach a new survey record for employment.

"The PMI edged higher for a second successive month in February. The data are still pointing to marked declines in output and new orders, but the gains in these indexes indicate that the rate of contraction has begun to ease in global industry. Production cuts are likely to remain deep near-term while companies reduce inventory." David Hensley, Director of Global Economics Coordination at JPMorgan

Employment declined for the eleventh successive month in February. The performance of the US manufacturing labor market was especially weak, with staffing levels falling at the fastest pace in the sixty-one year ISM series history. Employment also fell at survey record rates in the Eurozone, Japan, the UK, Australia and Switzerland.

Eurozone

Final Purchasing Managers’ Index data confirms that the rate of deterioration of the Eurozone’s manufacturing economy continued to gather pace in February. The Markit Eurozone Final Manufacturing PMI fell from 34.4 in January to 33.5, the lowest reading in the 11.5-year history of the survey and also slightly below the earlier Flash reading of 33.6. The renewed downturn in the PMI was driven by output falling at a new record rate, and to a greater extent than signaled by the Flash, registering the ninth successive monthly fall in production.

Slower rates of decline in Germany, Spain, the Netherlands, Greece and Austria were countered by sharp accelerations in rates of contraction in France and Ireland and a more moderate acceleration in Italy, with all three latter countries seeing record falls in output.

Commenting on the PMI data, Markit chief economist, Chris Williamson said: “The final Eurozone PMI data are a further disappointment on the earlier Flash numbers for February, and indicates that the rate of decline of manufacturing has yet to stabilize. The data are consistent with manufacturing output and employment falling at annual rates in the region of 12 and 5 percent, respectively. Germany is currently seeing the steepest downturn in demand, though sharply falling sales remain widely reported by country and product sector.”

Germany

Operating conditions remained extremely tough in the German manufacturing sector in February as a near-record downturn in new orders led to another rapid reduction in output. Lower workloads and subsequent excess capacity led to further staff restructuring in February, with data pointing to the fastest rate of job shedding since the series began in April 1996. Meanwhile, the deflationary dynamic in factory gate prices strengthened in February, with charges reduced sharply in response to low demand and a marked fall in raw material costs.

The headline seasonally adjusted Markit/BME Purchasing Managers’ Index (PMI) – designed to give a single-figure snapshot of operating conditions in the manufacturing economy – posted 32.1 in February, little-changed from the earlier ‘flash’ figure of 32.2. Although the PMI remained indicative of a sharp retrenchment of the German manufacturing sector, the index rose for the first time since March 2008.

The slight rise in the PMI, from 32.0 to 32.1, was largely the result of a slower contraction of production levels compared to January’s survey record.



New order volumes continued to fall at a near survey record rate in February, reflecting a general reluctance among clients to commit to new work. Anecdotal evidence also pointed to shrinking demand from companies in the automobile sector.

Input prices fell rapidly in February and the rate of deflation was little-changed from the previous month’s survey record. Meanwhile, data pointed to a fourth successive drop in factory gate prices, with the rate of deflation the fastest since the series began in September 2002.

Commenting on the final Markit/BME Germany Manufacturing PMI survey data,Tim Moore, economist at Markit Economics said: “German manufacturers suffered another brutal month in February as the slump in demand from abroad showed little sign of abating. Severe weakness in manufacturing exports will continue to weigh heavily on GDP in the first quarter, with the latest drop in new export orders by far the fastest of the big four Eurozone nations. The survey also indicates that official manufacturing employment numbers will fall at the fastest annual rate for around 15 years in Q1.”

Spain

Spanish manufacturing conditions continued to deteriorate in February at levels similar to a month earlier, though off December's record low. The indicator rose in February to 31.8 from 31.5 a month earlier, both readings significantly off December's record low of 28.5.

"Although the headline PMI ticked up again in February, operating conditions remained extremely tough. It is still too early to start talking of a recovery in the Spanish manufacturing sector," said Markit economist Andrew Harker.

Over half of those surveyed reported lower orders in February due to falling demand and noted particularly sharp declines in demand from abroad, especially Europe. Both output and input prices slipped to record lows as the economic environment deteriorated, with raw material prices easing and producers cutting prices to stimulate demand.

"The series record falls in both input prices and output charges signal that deflationary pressures are set to intensify, with consumer price deflation possible in the near future," said Harker.

Italy

Italian manufacturers faced another month of deteriorating operating conditions during February. Output, employment and outstanding business all fell at series record rates, while new business from both domestic and foreign markets fell sharply. The headline seasonally adjusted Markit/ADACI Purchasing Managers’ Index posted 35.0 in February, down from 36.1 in January and a reading only marginally above November’s survey low.

New business received by Italian manufacturers fell for the 14th straight month during February, and at an accelerated rate from January. The far-reaching impact of the economic downturn was cited by respondents as the principal factor underlying the latest decline. The drop in demand was broad-based with falls in new orders reported in both domestic and overseas markets.

Employment at Italian manufacturers fell at the fastest pace on record during February. Panel members reported that plummeting workloads had been the primary force lowering staffing levels during the month.

Deflation remained evident in the sector during February as both input and output prices fell at series record rates. A sharp drop in raw material prices was cited as the key factor driving down costs. The fall in input prices partially accounted for the record decline in factory gate charges. The economic downturn increasing competitive pressures was cited as a further key factor forcing manufacturers to lower tariffs. More generally, panelists reported that liquidity constraints had forced them to request longer crediting periods, thereby impacting on their ability to make new purchases with vendors. Combined with reduced production requirements, Italian manufacturers subsequently lowered their purchasing activity and (where possible) utilized existing stocks of purchases.



France

French manufacturing activity contracted at a record pace in February as new orders remained weak.The weakness in the sector's activity level was reflected in the manufacturing purchasing managers index, which fell to an all-time low of 34.8 in February, down from both the 35.4 figure expected and January's 37.9 figure. According to Markit, the reduction in output was due to ongoing declines in new orders levels, with data suggesting both domestic and foreign markets are deteriorating.

"Another steep drop in new orders suggests that extremely weak demand is becoming entrenched, with firms remain focused on reducing their inventories of both purchases and finished goods," Markit economist Jack Kennedy said in a press release. Furthermore, with the PMI pointing to record low levels in both input and output price components, deflationary pressures are likely to grow, adding to arguments for further monetary easing in the euro zone, Kennedy added.

Asia

Japan

Japan's February manufacting PMI showed manufacturing activity contracted for a 12th straight month in February, underscoring the fact that the depressed state of Japanese industry is likely to continue. The Nomura/JMMA Japan PMI edged up to a seasonally adjusted 31.6 from a record low of 29.6 in January.

China

China’s manufacturing shrank for a seventh month in February as the global financial crisis cut exports and growth across Asia. The CLSA China Purchasing Managers’ Index rose to a seasonally adjusted 45.1 from 42.2 in January.

“Manufacturing activity is still contracting, only at a more moderate pace than at the end of 2008,” said Eric Fishwick, head of economic research at CLSA in Hong Kong. Increases in the PMI and measures of orders are “encouraging,” he
said.

The index for export orders rose to 39.5 in February from 36.3 in January. A measure of orders climbed to 44.2 from 39.9. Output gained to 43.9 from 39.7. An employment index rose to 46.6 from 45, its first increase in seven months.

India

Indian manufacturing activity shrank for a fourth straight month in February as the global downturn hurt demand and soured business sentiment, a survey showed on Monday. The ABN AMRO Bank purchasing managers'index rose to a seasonally adjusted 47.0 in February from January's 46.7.




The Indian economy grew 5.3 percent in the fourth quarter of 2008 (calendar), according to Indian government data released last Friday, below forecasts of 6.2 percent and the previous quarter's growth of 7.6 percent.




Central and Eastern Europe


Russia

Russian manufacturing contracted for a fifth month in a row in February as the ruble’s devaluation increased corporate costs and demand slumped at home and abroad, according to the latest report from VTB Capital. VTB’s Purchasing Managers’ Index was at 40.6, after a 34.4 reading in January. The duration of the index contraction now matches the decline registered in 1998, when the government dropped its support of the ruble and defaulted on $40 billion of debt. And the contraction doesn't seem set to end anytime soon.

“The data suggests that the current downturn will be more pronounced than in
1998, with a sharp V-shaped rebound appearing unlikely,” Dmitry Fedotkin, an
economist at VTB Capital in Moscow, said in the report.

Hungary

Hungary's manufacturing purchasing manager index came back slightly from its all-time low of 38.5 in January to 39.7 in February, according to the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM), the publisher of the PMI. While the contraction of the manufacturing industry that started last October continues, the rate of contraction has eased slightly.




Czech Republic

The Czech Purchasing Managers' Index (PMI) rose to 32.6 in February, from 31.5 in January, the first upward move in a year, but the reading still indicated a rapid contraction, according to the press release from Markit Economics and ABN Amro. The figure for output continued to fall at a sharp rate overall in February for the eighty month. However, seasonally adjusted output rose for the second month running from December's record low, indicating the weakest rate of decline in three months. New orders remained well below the no-change mark of 50.0 in February, indicating a seventh successive monthly drop. For the third month running, over half of the survey panel reported lower new orders, linked to the worsening climate of demand both at home and in key export markets.



Poland

The Purchasing Managers' Index for the Polish manufacturing sector rose in February for the second month in a row and came in at 40.8 (from 40.3 in January). However, the figure for output fell to 40.2 points from a previous 40.6 points. Analysts said the February PMI figure probably marked a rebound after earlier sharp declines and suggested a weaker zloty may have helped cushion perceptions of the downturn by making exports cheaper. But they added that the outlook for growth remained grim.



USA


Manufacturing contracted in February as the PMI registered 35.8 percent, which is 0.2 percentage point higher than the 35.6 percent reported in January. This is the 13th consecutive month of contraction in the manufacturing sector. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI in excess of 41.2 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the PMI indicates contraction in both the overall economy and the manufacturing sector. Ore stated, "The past relationship between the PMI and the overall economy indicates that the PMI for February (35.8 percent) corresponds to a 1.7 percent decline in real gross domestic product (GDP) on an annual basis."

"There Is No Deflation Threat In Europe" - Jean Claude Trichet - Oh Really!

He's at it again. Last year he was trying to worry us that inflation was all set to get out of hand among the 16 countries who make up the eurozone. Now the President of the European Central Bank Jean-Claude Trichet is busy trying to convince us that these same countires are facing no credible deflation threat. Apart from getting it wrong on both occasions, the common point here would be a certain inbuilt "inflation bias", a bias which was earlier called "the original sin of the Bundesbank" by nobel prize winning Italian economist Franco Modigliani.

"There is presently no threat of deflation," Trichet told a committee of the European Parliament on Wednesday 14 February. "We are currently witnessing is a process of disinflation, driven in particular by a sharp decline in commodity prices." ..."It is a welcome development," he said, adding that the fall in energy, and other prices should help boost struggling economies.

Apart from manifesting a spectacular lack of economic judgement, the Financial Times's Banker of the Year in 2007 forces us to ask the question just how "out to lunch" can you get and hold down your job, and come up with answer "bastante" (quite a lot). A quick look at the data shows us that Eurozone inflation is already significantly undershooting the European Central Bank’s target - which is to keep the annual rate “below but close” to 2% - and by all appearances is about to head straight off into negative territory.

If we look at headline HICP inflation on an annualised basis, we will find that it fell more than expected last month to 1.1 per cent, according to Eurostat, down from a peak of 2.7 per cent in March last year. This was the lowest level since July 1999, and a sharp drop from the 1.6 percent rate registered in December. On a month-to-month basis, prices were down 0.8 percent. The "core" inflation rate - that is consumer inflation without the volatile elements of food, energy, alcohol and tobacco - we find it still stood at 1.6%, since the biggest impact on headline inflation comes from the decline in food and energy costs. But if we look at the monthly movement in the core index, we find that it dropped by a very large 1.3% (see chart below).



Now if we come to look at the core inflation rate over the last six months, we find that the index has only risen 0.1% (or an annual rate of 0.2%). This gives us a much more accurate reading on where inflation actually is at this point in time, and where it is headed. The chart below shows the six month lagged annualised rate for the last twelve months, and the sharp drop in January is evident. If things continue like this, then the eurozone as a whole is headed straight into deflation, for sure.



Why Should Prices Continue to Fall?

So what are the grounds for thinking that inflation may be now heading into negative territory (ie that we are entering deflation right now), despite the fact that the ECB revised forecast is likely to come out at about 0.7 per cent this year and 1.5 per cent in 2010, according to estimates from Julian Callow, European economist at Barclays Capital. Well let's look at a chart produced by Paul Krugman showing the relation between the US output gap and the inflation rate.



Now as Krugman explains the figure plots an estimate of the output gap — the difference between actual and potential GDP, as a percentage of potential — and the change in the inflation rate. (Both series are taken from the IMF WEO database, for convenience, and use data from 1980-2007).

The fit, as he says, is not perfect, but the correlation is evident, and there is an implied slope of about 0.5 — that is, every percentage point by which real US GDP fall short of potential tends to reduce the inflation rate by about half a point over the course of the year. Now I am not going to advance here estimates of the present output gap in the eurozone, but we do have clear indications of a sharp and ongoing contraction in demand in the GDP numbers. Eurozone GDP contracted by 0.2% between the second and the third quarters of last year, and by 1.5% between the third and fourth quarters.

What's more the key indicators suggest that the contraction is accelerating at this point. The February Markit euro-zone composite PMI reading dropped to a record low of 36.2 from 38.3 in January. Any reading below 50 on these indexes indicates month on month contraction.

Barring some spectacular (and entirely improbable) turnaround in March it now seems likely that the Q1 GDP contraction will be worse than the Q4 2008 one, and considering (as mentioned previously) that the eurozone contracted by 0.2% in Q3 2008, and by 1.5% in Q4, then, in my humble opinion, the data we are seeing for this quarter are entirely consistent with a 2% quarterly contraction (or an annualised 8% rate of contraction). For those of you who simply don't believe that PMIs can tell you so much, take a look at Markit's own chart (below), showing the strong underlying relationship between movements in GDP and the *flash* composite PMI. The results they achieve are pretty impressive I would say.

and if we look at an additional indicator (the EU's own Economic Sentiment Indicator for the eurozone) we will see that it hit yet another low in February (see below) which again suggests that the contraction is accelerating at this point, and substantially so.



So the core HICP index is on the point of turning negative on a six monthly basis, and the situation appears set to get even worse, and our Central Bank President assures us that "there is presently no threat of deflation". So which world am I living in, or which is he?

There are further reasons to anticipate a sharp downward pull on prices from some countries in the zone (like Spain and Ireland), since they have housing and construction nooms which are in the process of unwinding, and the only way they can recover the competitiveness they have lost is by conducting a sharp and significant downward revision in prices and wages (since in a currency union there is effectively no currency to devalue). The two charts below show the loss of competitiveness experienced by the Irish and the Spanish economies (respectively) with regards to the German economy since 1999 as measured by real effective exchange rates.



REERs attempt to assess a country's price or cost competitiveness relative to its principal competitors in international markets. Since changes in cost and price competitiveness depend not only on exchange rate movements but also on cost and price trends the specific REERs used by Eurostat for its Sustainable Development Indicators are deflated by nominal unit labour costs (total economy) against a panel of 36 countries (= EU27 + 9 other industrial countries: Australia, Canada, United States, Japan, Norway, New Zealand, Mexico, Switzerland, and Turkey). Double export weights are used to calculate REERs, reflecting not only competition in the home markets of the various competitors, but also competition in export markets elsewhere. A rise in the index means a loss of competitiveness.



Now the eurozone being a common currency area presents us with specific problems in the context of deflation since, as the Irish economist Philip Lane argues a member of a currency union comes up against a natural limit in national-level deflation. Thus, he argues, while a country like Ireland may well face a sustained period of inflation below the euro area average (such that it may be negative in absolute terms for a while), the situation should tend to be self-correcting since the deflation implies an improvement in competitiveness, which should generate a boost in export driven economic activity and, over time, a return to an inflation rate at around the euro area average. I'm not sure that this argument is 100% valid, since sufficient internal demand lead deflation can so effect household and corporate solvency that debt deflation can at least send a country off into a decade long correction before the price level falls sufficiently to generate sufficient export activity to offset the decline in domestic demand and enable balance sheets to recover. But still, leaving that rather theoretical point aside, there is a more concrete reason for worrying about what is happening at the moment in the eurozone, and that is that the benchmark country, in this case Germany, may be about to see internal price deflation which is every bit as sharp as the fall in prices which is taking place in those economies which are supposed to be correcting vis a vis Germany itself.


If we look at the two relevant charts below (for Spain and Ireland) we will see that in each case core indexes are falling more or less in line with the German one. In fact, both the Spanish and the German indexes are unchanged over the last six months, the Irish one is down 0.5%. At this pace (1% a year) Ireland would recover its 1999 comparative position with Germany in around 30 years. But the point here is not that prices are falling in Ireland and Spain (they have to do this) but that prices are also set to fall in Germany, and this is where monetary policy from the ECB becomes vital, since if Germany is allowed to fall into deflation then it will be extremely difficult for Spain and Ireland to "correct" (the drop in wages and prices would have to be sharp indeed) but also monetary policy from the ECB would be in danger of becoming a complete mess.






Of course not everyone on the ECB governing council shares Trichet's rosier than rosy view, and in a comment that offered an insight into how at least some ECB council members are thinking, Mario Draghi, Italy’s Central Bank Governor said recently that “the governing council is keeping a close watch on the real cost of money”. What he means is that, if Spain's 1.5% drop in core prices over the last three months turned into a 6% annual drop, then the real rate of interest currently being applied would be around 8%, which would constitute a very tight monetary policy in the context of Spain's worst recession in living memory.

Perhaps some readers may feel I have been unduly hard on Jean Claude Trichet in this post, but I would simply close by reminding everyone of the conclusions reached in a once widely quoted paper - Preventing deflation: lessons from Japan's experience in the 1990s, by Alan Ahearne, Joseph Gagnon, Jane Haltmaier and Steve Kamin (2002) - where the authors argued:

We conclude that Japan's sustained deflationary slump was very much unanticipated by Japanese policymakers and observers alike, and that this was a key factor in the authorities' failure to provide sufficient stimulus to maintain growth and positive inflation. Once inflation turned negative and short-term interest rates approached the zero-lower-bound, it became much more difficult for monetary policy to reactivate the economy. We found little compelling evidence that in the lead up to deflation in the first half of the 1990s, the ability of either monetary or fiscal policy to help support the economy fell off significantly. Based on all these considerations, we draw the general lesson from Japan's experience that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus, both monetary and fiscal, should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity.

As some economist or other I read is in the habit of saying "history has a nasty habit of repeating itself, the first time as tragedy and the second time as tragedy". Or put another way, here we go again. Hello, is there anyone out there?

East Europe Bank Support

From the Financial Times today:

East Europe banks set for €24.5bn loan
By Stefan Wagstyl in Zurich and Alan Beattie in Washington

Published: February 27 2009 03:06 | Last updated: February 27 2009 13:53

A group of multilateral lenders on Friday unveiled a lending package of up to €24.5bn ($31bn) to help central and eastern Europe’s battered banking systems weather the financial crisis.

The World Bank, the European Bank for Reconstruction and Development and the European Investment Bank, which announced the package in London, hope the move will encourage the international banking groups that control most of the region’s banks to support their subsidiaries.

They also want to convince west European states, where most of these parent banks are based, not to discriminate against foreign operations when providing public aid for banking.

The move comes amid rising concern about the effects of the global credit crisis in eastern Europe, particularly in vulnerable states with big external financing needs, including Ukraine, the Baltic states and Hungary.

Thomas Mirow, EBRD president, said: ”We are acting because we have a special responsibility for the region and because it makes economic sense. For many years the growing integration of Europe has been a source of prosperity and mutual benefit and we must not allow this process to be reversed.”

Under the two-year plan, the EBRD will provide up to €6bn in equity investments and loans to banks, the EIB, the European Union’s investment bank, will offer some €11bn in lending to small and medium-sized businesses, and the World Bank will lend €5.5bn for banking, infrastructure and trade finance and up to €2bn in political risk insurance.

The programme has been co-ordinated with the International Monetary Fund, which has already provided emergency loans to Hungary, Latvia and Ukraine and may soon be asked to support other vulnerable states.

While much of the money comes from existing resources, the three institutions hope that by accelerating their activities and focusing on banking they will provide support where it is most needed and encourage others – including parent banks and European Union governments – to co-operate.

Mr Mirow told the FT: “Of course, this is not the whole answer to the whole question. But we do think that in terms of finance it can be constructive enough convince others, particularly parent banks to take their share [of responsibility] in terms of recapitalisations and providing new lending.

Philippe Maystadt, EIB president, said: “This joint action plan will help speed up the delivery of vital finance through the banks to support the real economy of hard-hit countries in central, eastern and southern Europe, and particularly to help small businesses survive in these turbulent times.”

Robert Zoellick, World Bank president, said: “This is a time for Europe to come together to ensure that the achievements of the last 20 years are not lost because of an economic crisis that is rapidly turning into a human crisis.”

The funds are earmarked for a wide region that includes eastern Europe, most of the former Soviet Union and Turkey, but excludes Russia, where the oil-rich state is judged to have sufficient funds of its own to support banks.

Scandinavian Recession

Sweden is in the middle of a much more serious recession than previously thought, according to official figures for the fourth quarter of last year that revealed the economy contracted by nearly 10 per cent on an annualised basis.

Figures from the Swedish statistics office published on Friday showed gross domestic product contracted 2.4 per cent quarter-on-quarter in the final three months of last year, equivalent to an annualised decline of 9.3 per cent. Consensus expectations were for a fall of 6.5 per cent.





“Today’s national accounts confirmed the Swedish economy is falling off a cliff,” said Nicola Mai, economist at JP Morgan, in a research note. “The report confirms Sweden is in the midst of a very deep recession.”

There were no positive signs in the latest GDP figures, with consumer spending falling sharply, fixed investment contracting, productivity worsening and trade on the decline.

The dismal growth number increases the chance that the Riksbank, Sweden’s central bank, may join other central banks around the world by introducing a zero interest rate policy and implementing a policy of quantitative easing.

The central bank has been preparing the intellectual ground for zero rates in speeches by its board members in recent months, and economists argued the accelerating pace of the economic downturn now makes such a move more likely.

“The figures point to an economy that is contracting far more rapidly than the Riksbank had been estimating. On balance, the report supports our forecast that the Riksbank will go to zero in April and engage in quantitative easing soon afterwards,” said Mr Mai.

The central bank has been cutting rates aggressively in a bid to offset the effects of the global recession, but to little avail. It has reduced rates by 400 basis points to their current 1 per cent, giving it little further flexibility for the use of conventional monetary policy.

The growing sense of crisis in Sweden has been compounded by a slew of sackings at some of the country’s major manufacturers and the uncertainty over the future of Saab, the car maker that has been put up for sale by General Motors, the stricken US manufacturer.

Other Nordic countries are also starting to feel the full effects of the global slowdown, ending a honeymoon period in which they appeared to have escaped the worst of the crisis.

Denmark’s economy contracted 3.9 per cent year-on-year in the fourth quarter, while Finland, which is a member of the EU and Eurozone, entered a recession in the fourth quarter.