European Digest And Forecast From Erik Nielsen

From Goldman's Erik Nielsen

Europe this week

Happy Saturday,

With no particular reference to Denmark’s fine victory this evening, I am just wondering what European football would look like had it not been for the smaller countries - be it Denmark, the Netherlands, Switzerland, or Serbia …  Its certainly difficult to see much hope in England, France, Spain or Italy – or in Germany after that last performance.  Away from football, these are my thoughts on Europe on this fine evening in Chiswick:

  • We are through another week of good real-economy data releases and (grudgingly) improving markets.
  • The EFSF has been formally established.  Along with the Commission’s and IMF money, I think it’s a serious defence mechanism which ought to help further stabilise markets.
  • Stress tests for the banking system will be published next month.  Good, because that’s what the market demands, but I worry we might be heading into a disappointment because markets might expect testing against extreme tail-end risks considered as absurd by policymakers.
  • The ECB has now bought €47bn worth of sovereign debt - still peanuts in any reasonable comparison, but I think they may be looking to wind down the purchases once the EFSF is up and running in July.
  • The IMF spoke this past week on Greece (okay with program); Spain (happy with policy reforms); and France (marginally critical on fiscal - too polite).
  • G20 meeting this coming week; I wonder if the heat will turn on Germany now that China has announced a re-introduction of some FX flexibility.
  • We are heading into PMI-week in the Euro-zone; we are looking for slight improvements.
  • The UK will see the government’s emergency budget on Tuesday; big budget cuts on their way.
  • The Swiss National Bank will publish its May balance sheet this week confirming their huge FX-interventions.
  • In Sweden we’ll get the key KI/NIER economic tendency survey on Wednesday.  It’s already at its highest level since August 2007, but we remain shamelessly optimistic.
  • Poland holds presidential elections tomorrow with a likely second round on July 4.  Outcome very important for policies.
  • The central banks in Norway, Hungary and the Czech Republic will all meet this week to consider their interest rates; we expect all three to leave rates unchanged.
  • The IMF arrives back in Ukraine on Monday for a week’s talk on how to restart the program.  We do not expect agreement this week.


  1. I am sorry to sound like a broken record here in my opening paragraph, but – alas – we are through yet another week of pretty good real-economy data in Europe, further positive signs on the policy front, and stabilising markets.  With a 0.8%mom (non-annualised) growth rate in April, Euro-zone industrial production delivered its 11th consecutive monthly increase, while Poland printed the first hard European number for May, namely a blockbuster 3.4% mom, seasonally adjusted, growth rate in industrial production (i.e. +14% yoy).  The massive increase was (again) led by products in exports-oriented sectors, including the computers, electronics and optics category (+ 95%yoy) as well as chemicals, metals and vehicles.  (Interestingly, while Polish export of vehicle is doing very well, there are stories that Fiat is considering relocating some of its production from Poland back to Italy where deals with the unions are likely to lead to greater productivity.)  As Magda Polan has pointed out, with 52% of Polish exports going to the Euro-zone, half of which to Germany, why do people keep worrying that there is no demand in the Euro-zone – or that German export growth is not benefitting the rest of Europe?  It’s all still looking pretty alright to me on the real side.  Meanwhile, we got more progress on the European policy front (as summarised below), while markets (grudgingly, it seems) continued to improve.  As discussed below, I rather suspect that we might be in for more of the same this coming week.  
  2. In terms of policy measures, the Euro-zone finance ministers formally established the European Financial Stability Facility (EFSF) on Monday to be loaded with guarantees from the Euro-zone member states, excluding Greece, worth up to €440bn.  Klaus Regling has been appointed CEO (great choice on so many levels) and the whole thing is ready to roll as soon as 90% of the €440bn has been committed by the member states, which probably is within the next few weeks.  The present thinking is to over-collateralise any issuance by some 20% (the exact ratio is likely to be negotiated with the credit rating agencies to secure AAA rating – if anyone still cares), making some €365bn available along with the €60bn from the Commission and about €215bn from the IMF (if the indicated EU/IMF ratio were to be maintained), in case a Euro-zone sovereign were to encounter funding problems.  In my view, €640bn is a serious amount of money – enough to fully fund Spain, Portugal and Ireland for about as long as Greece has been fully funded – in other words, a properly loaded bazooka, in Hank Paulson’s world.  If it weren’t for the nagging question what Regling & Co actually will be doing all day in Luxembourg, I would tend to conclude that the combination of the improving economy, policy reforms, better markets, and the size of the bazooka, means that the EFSF might never be used (in which case it’ll most likely fold into something slightly different in three years’ time.)  If, however, it will be needed, the ESFS would sell securities in the market for its share of the first tranche, the proceeds of which would be pooled with the Commission’s and the IMF’s money and disbursed against quarterly policy conditionality.  Some investors have expressed doubt that the EFSF could actually sell any such securities in times of additional stress.  I don’t see any reason why they shouldn’t be able to sell its securities to banks (to be repo’ed at the ECB) and real money accounts.  In other words, count me among those thinking this is good enough. 
  3. On other important policy initiatives, the EU summit agreed to publish stress tests for the 25 biggest European banks, and several individual countries, including Spain, will publish for all their banks.  The decision came after a virtual “demand” from the market that “we want to know”, and being confident that the market is overestimating by a wide margin the problems in the Spanish banking system, Zapatero was the first to agree to publish stress test results for all the Spanish banks.  Supported by Commission president Barroso, the other leaders eventually agreed, although Germany raised a legitimate concern: In most countries the legal system does not give the right of the regulators (or government) to publish such company-specific information; I suppose peer – and other – pressures might be employed.  As we have argued for months, while there are plenty of issues in the European banking sector, we do not see any systemic issues outside Greece, so, in principle, the publication of stress tests is a good thing.  However, I am a little worried whether we are being set up for a disappointment.  First, there are way too many investors who have come to believe that it was the stress tests in the US that put everything to rest on that side of the Atlantic, and therefore similar tests should be conducted and published in Europe.  But a closer look at the events around the US stress tests and their publication (and Fannie and Freddy weren’t even included!) would lead most people to conclude that maybe they weren’t that important.  Second, there is – in my view – a big risk that market participants’ expectations of methodology and assumptions for the tests may be out of sync with what policymakers are preparing.  Specifically, do the two sides agree on how to value the banks’ sovereign holdings? Or their real estate holdings?  The additional information and transparency will be good, and the subsequent capitalization will be welcome and move things in the right direction, but I worry that markets might not be satisfied unless the system gets measured against extreme tail-end events, which is not likely – and then what?  Interbank guarantees?
  4. The ECB said on Tuesday that they bought €6.5bn of sovereign debt last week, taking their stock of these assets to €47bn.  On Thursday, Executive Board member Gonzalez-Paramo  said to FT Deutschland that while he thought he saw better liquidity in some of the market segments, he acknowledged that “ the situation is not yet entirely normal."  My guess is that they may have bought another €5-10bn this past week and that they will continue to hit the market at least until the EFSF bazooka is fully loaded and on the table with Klaus Regling’s finger on the trigger.  By then, I rather suspect that the ECB will start testing the market with a gradual winding down of the purchases.   I believe that the ECB likes to think of the purchases as equivalent to FX-interventions, and I agree, but on that analogy, they really need not be in any hurry ending the purchases.  At recent weeks’ pace it would take them 6 ½ years of purchases to get to own a share of Euro-zone GDP equivalent to what the SNB has bought via FX-interventions – or if you were to think of it as QE (which would not be right, in my view), then it would take them some two years of purchases at the present pace to get to own the same share of GDP as the Bank of England presently holds of UK government securities.  I know that it came as a shock to some when the ECB crossed the Rubicon, but I really fail to share those concerns, given the situation we are in, and the most likely counter-factual.
  5. The IMF was in three different head lines for Europe this past week:  First, along with the EU Commission and the ECB they conducted a (non-comprehensive) review of the Greek program and concluded that things look okay; the state cash deficit was actually lower than projected in the program.  This didn’t prevent Moody’s from downgrading the Greek sovereign by a whopping four notches from A3 to Ba1; i.e. to junk, without any relevant news to my knowledge.  Needless to say, this should have happened about a year ago, but in this case the term “better late than never” just doesn’t apply.  (Incidentally, when I last checked, a 10-year Greek government bond traded at about 52 cents on the Euro with a coupon of more than 4%, and with a rather small risk of a debt restructuring for the next 18-24 months while the primary balance is in deficit, I am just started to wonder – but I’m neither a PM nor a strategist.)  Second, Strauss-Kahn visited Madrid and expressed his strong support for the Spanish government’s reform program.  (His trip created some silly rumours about a big rescue package being negotiated.)  After listening to DSK in Madrid, does anyone still believe that - if it were to be needed - Spain could not (indeed, rather easily) reach agreement on the policy conditionality for a program?  Third, in their annual review of France, the IMF suggested that the government’s growth forecast of 2.5% per year from 2011 is too optimistic, and that fiscal contingency plans should be drawn up in case GDP underperforms.  Apart from this very valid point, I – for one – couldn’t help thinking that the IMF ought to pull off those kids’ gloves in their assessment of France; reforms are happening throughout Europe, but there is an increasing risk that France is falling behind.

Moving to this coming week:

  1. G20 meets in Toronto on Wednesday and Thursday.  President Obama has urged other G20 members to boost their domestic demand, and in an implicit reference to China he “underscored” that flexible FX-regimes are “essential” for global growth, while – in an apparent reference to Germany – he worried about too early policy withdrawal in countries with weak private sector demand and external surpluses.  Conveniently, earlier today, the People’s Bank of China announced that they’ll  further reform their exchange rate regime and enhance the CNY flexibility (see my colleagues’ comments on this).  While they have appreciated against the Euro in recent months, this is a further positive development also for Europe.  I don’t think G20 should expect Germany to reverse their plan for a gradual fiscal consolidation, starting next year, and frankly, I am not sure that they should.  Public debt sustainability is an increasingly hot topic in many countries (including the UK, as discussed below), and announcing a multi-year consolidation plan seems pretty sensible to me, particularly at a time when markets are looking to Germany to de facto anchor the entire Euro-zone system.  (Needless to say, this view of mine does not exclude the need for further reforms in Germany, including of the non-tradable sector.)  Otherwise it feels as if we are getting closer to agreement of some sort of taxation of the financial system.  
  2. In the Euro-zone, the traditional round of monthly business indicators are due out again this coming week, and although last month saw some general softening of sentiment, we expect most of the major business surveys to have stabilised, if not even improved a tad, again in June.  For the Euro-zone flash PMIs on Wednesday (both with EMEA-MAP relevance of 5), we expect small rises in both the manufacturing and services indices.  Ahead of the PMIs we’ll get the German Ifo survey (EMEA-MAP 3) on Tuesday (we expect a modest increase), and the French INSEE (EMEA-MAP 4) on Wednesday morning, which we think might ease a bit this time.  On the consumer side, we’ll get the latest reading on Italian consumer sentiment (EMEA-MAP 1) also Wednesday; it has been on a downward trend since the beginning of the year, but we think it might have firmed slightly this month.  In France, consumer spending numbers will surface on Thursday (EMEA-MAP 2), and here we also expect a rebound after disappointing prints the past few months.  Finally, Trichet speaks tomorrow, Monday, at the European Parliament, but he is very unlikely to provide any important news or interpretations.
  3. For anyone living in the UK, time is up!  The new government is wasting no time (and rightly so) in addressing the huge budget deficit, and when the emergency budget is presented on Tuesday we’ll know more about the distribution of the pain.  As Ben Broadbent points out, following last week's OBR report, in which the estimate of the structural deficit was raised to 8% of GDP, we expect a tightening on the order of 7% of GDP over the next four years.  That will be enough to push the primary balance comfortably into surplus and ensure - conditional on nominal growth matching or exceeding gilt yields at that point (something that's quite clearly the case currently) - that debt-to-GDP is on a declining path well ahead of the next general election.  We are less pessimistic about the size of the structural deficit and about how rapidly the economy is returning to trend, so we would expect the debt ratio to peak somewhat earlier.  (Incidentally, as we argued in Thursday’s European Weekly Analyst, one needs to take the numbers on structural deficits with a serious grain of salt.)  Of the expected 7% of GDP cut in the deficit, existing measures are enough to give you 1.4 percentage points this year, planned cuts in capital spending a further 1% pt.  A VAT hike measure might provide another 1% of GDP, leaving around half the 7% total to be met through reductions in current spending.  Part of this is likely to be achieved through a public sector pay freeze, worth around 0.5% of GDP per year.  Stay tuned for a more detailed discussion of all this from Ben Broadbent.
  4. In Switzerland, the SNB will publish on Monday its balance sheet for May in its entirety.  Needless to say, the key will be the confirmation that FX investments surged a whopping 51% from the previous record of CHF 153bn to CHF 232bn, as already indicated by the provisional release by the Federal Statistical Office of their balance.  (A speech also Monday by SNB Chairman Hildebrand is likely to include some discussion of the SNB’s policy of FX interventions.)   Also of note in Monday’s release will be broad money (M3) growth, which we expect to decrease from +5.4%yoy to +5.2%yoy as the trend moderation of liquidity in the private sector continues.  The key data will be the net export data for May.  After very strong growth in real exports in April (+3.1%mom), it is reasonable to expect some pull-back in Tuesday’s release but, with the external demand conditions facing Swiss exporters (particularly to emerging Asia) remaining robust, the trend of improvement in Swiss net trade is likely to continue – again defying the strength of the trade-weighted CHF.
  5. In Sweden the key KI/NIER Economic Tendency Survey is out on Wednesday, which, along with the Manufacturing PMI, is a key barometer of Swedish growth (EMEA-MAP Relevance Score: 5). The headline index is now at its highest level since August 2007, but we still see some room for further upside in the June release.  Even an unchanged reading in June would bring the quarterly average of the KI/NIER survey to 108.2 - on past form, a level consistent with approximately 1%qoq GDP non-annualised growth in Q2 2010.  Now they didn’t make it to South Africa they surely are working hard at home!
  6. Poland is holding presidential elections tomorrow Sunday.  Acting President Komorowski and opposition PiS leader Jaroslaw Kaczynski – the “new and soft” twin brother - are most likely to go into the second round because neither will get 50% tomorrow, with Komorowski winning in a close race on July 4.  This would open the way for the governing coalition to revive important policy initiatives previously vetoed by the deceased President.  An upset second round victory to Kaczynski could destabilize the current governing coalition and lead to early parliamentary elections, as argued by Magda Polan.
  7. There’ll be central bank meetings this coming week in Norway, Hungary and the Czech Republic; we expect no change in any of the rates, but Norges Bank is likely to revise down its policy rate projections.  In the Czech Republic, it will be the last meeting Governor Tuma will chair; Miroslav Singer will take over from the next one.  The appointment came as no surprise, but it is worthwhile noting that Singer is (another) Czech Euro-sceptic – and with the cool attitude towards the common currency in the three parties forming the new government, it looks like the idea of setting a Euro adoption date, briefly lifted before elections, is firmly gone from the agenda.
  8. The IMF is back in Ukraine on Monday for a week of discussions how to proceed.  Negotiations are likely to be tough; the Fund is less lenient than last year, while the Ukrainian authorities’ progress on reforms has been at best mixed. It will be tricky for them to agree on unpopular measures ahead of looming local elections, and the government has clearly started looking for other sources of financing while the talks drag on.   

… and that’s the way Europe looks from Chiswick on this Saturday night after hope in South Africa has been restored.


Erik F. Nielsen
Chief European Economist
Goldman Sachs