Germany says Nein and Ja

Marc To Market's picture

Germany appears to have capitulated.  The Bundesbank has dropped its opposition to extraordinary measures, like ending the sterilization of the SMP bond purchases, and has even dropped its visceral opposition to QE, if it can be structured properly to keep within the ECB's mandate.

As Jurgen Stark's recent op-ed piece in the Financial Times makes clear, this is not an endorsement of a new policy initiative.   The former ECB board member, who resigned over the Trichet's sovereign bond purchase scheme (SMP), argues against the need to take fresh initiatives. 

Stark argues that deflation in the euro area as a whole is unlikely and that no one is even forecasting it. Even the IMF, which is urging the ECB to take unorthodox measures, forecasts only Greece to experience deflation this year.  He offers the usual refrain that the drop in inflation is primarily driven by a decline in energy prices, and commodities more broadly, and the euro's appreciation. Stark also notes that past tax increases are dropping out of measures.  

Most of all Stark wants to draw a distinction between bad deflation and good deflation.  Bad deflation depresses consumption as people and businesses defer purchases, waiting for lower prices.  Good deflation is the relative price adjustments in the periphery to boost competitiveness.  

Stark warns against the official talk of the need for urgent action.  "With the economic recovery in the eurozone stabilising, and leading indicators pointing upwards, the most likely medium-term scenario is stable prices and a modest upturn over the next two years. No further action by the ECB is required."

Perhaps, investors and other observers get too caught up with rhetoric.  Many see Germany steadfast in its opposition to fresh initiatives and increasingly isolated.  However, look at what is happening on the ground suggests something different.   There are three separate developments that have gone largely unnoticed. 

First, German consumers are shopping.  In real terms, retail sales jumped 1.7% in January, the largest monthly rise since June 2011.   Real retail sales rose another 1.3% in February.  The back-to-back rise is the most in seven years.  The March report is due out April 27. 

Second, German wages are going up faster than inflation.  Last month, the more than two million public sector workers got a 3% wage increase and a 2.4% increase for next year.   Chemical workers struck a 14-month agreement that saw pay rise 3.7%.  Last year, IG Metall negotiated a 3.4% pay in increase in 2013 and a 2.2% increase this year.  Higher German wages mean that others may not have to squeeze wages down (unit labor costs) as much to restore competitiveness. 

Third, Germany is buying more from other eurozone countries.  In February, the latest data available, German imports from other eurozone countries are up 8.4% on a year-over-basis.  Overall German imports were up 6.5% from a year ago. 

We also note that the Bundesbank Target2 claims have been trending lower.  In March, the claims stood at 470 bln euros, the lowest level since late 2011.  This means that external imbalances within the euro area have been reduced in aggregate. 

Some observers are worried that the sanctions against Russia will take a toll on Germany.  Its exports to Russia were about 36 bln euros last year.  This is about 4% of German exports.  The ZEW survey did show a decline in investors confidence.  While the events in Ukraine and tension with Russia may not be helping matters much, the expectations component has fallen for four consecutive months after reaching a multi-year high at the end of 2013.    Moreover, the current assessment measure was not only stronger than expected, but stands at its best level since July 2011.

Germany is arguing against exaggerating the significance of low inflation, for which Stark teaches, the ECB does not target.  Additional that additional measures will likely be ineffective and counterproductive.  The last time that some the premiums that the periphery pays over Germany were this small, European officials were warning that the markets were mis-pricing risk.  How much lower do the advocates of QE want those premiums and yields to go? 

Moreover, there are positive developments in the German economy that are more promising for the euro area as a whole.  Under the rubric of German's ordo-liberalism, which (even) Draghi recognizes to be enshrined in the ECB, slow and steady wins the race.