The inflation for the Euro Area was at 1.4% in January after 1.6% in December. The main reason for this drop is the negative impact of the oil price. The energy contribution to the inflation rate was 1% in October and just 0.25% in January. This will continue and the contribution will become negative during the first quarter of this year. This reflects that the oil price is currently lower than in 2018 and this will continue allover the year. As the core inflation rate is circa 1%, the headline inflation rate will close but below 1% in 2019.
Except in the US, the mood perceived through all the Markit surveys is negative. In the Euro Area the index is just above 50 at 50.5 but the German index, its main engine, is now in the contracting zone. Japan is converging rapidly to 50. This US will not have the possibility to pull up the global activity. Its momentum is not strong enough. Moreover, this US index has also to be interpreted with the Fed new monetary policy framework. The US central bank has stopped its monetary policy normalization at its January meeting and I can’t imagine that it’s mainly linked with external downgrades. It would be the first time ever that the Fed makes a change in its monetary policy orientation on external elements. I can’t believe that the Fed change is not dependent mainly on the US outlook.
The European Commission has just told Italy to revise its 2019 budget plan: the deficit does not look excessive (2.4%), but the figure is deemed to be fragile as growth projections are overly optimistic….and with a government that emerged from a watershed vote, we should expect a certain degree of laxity on spending to boot. The government was not elected to do the same thing as its predecessors, i.e. there is a risk that the budget will spiral out of control and move above the notorious 3% of GDP threshold, which is incompatible with a stabilization in public debt. Italian public debt stands at close to 132% of GDP, well above the standard 60%, and this is not sustainable. Yet does a sustainable trend automatically involve a drastic cut in the public deficit? Maybe not.
There are a number of points worth raising on the budget/Italy/European Commission issue. Continue reading →
The Italian budget program, which sets out a budget deficit of 2.4% of GDP for 2019, 2020 and 2021, did not go down very well with investors. Uncertainty on Italy is making a comeback and the yield on the 10-year government bond rose sharply as shown by the chart below (as at 15.00pm CET today).
What were last week’s major changes? The main change was in Italy with a strong and rapid drop in the interest spread with Germany.
Why ? Since the new coalition government came to office, fears have emerged on exactly how the campaign-trail program would translate into the forthcoming budget – an answer to this question is expected on September 27.
The government’s stance so far has been to be fairly relaxed, especially on the 3% threshold (of budget deficit as % of GDP), which explains why the yield spread with Germany widened considerably over recent weeks.
This was a source of concern as the Italian economy would soon have run up against financing difficulties due to the reluctance of non-resident investors – who hold around 35% of the country’s debt – to revisit the Italian market after withdrawing their investment in the country all summer. Italians cannot and do not want to leave the euro area, so additional pressure on liquidity and interest rates could have hampered funding for Europe as a whole.
However, the economic situation is swiftly changing in Italy, as economic activity slowed sharply over the summer months, Continue reading →
League chief eclipses senior coalition partner with anti-immigration broadside
Matteo Salvini heads the junior coalition partner in the populist government that took office in Italy on June 1. Yet the leader of the far-right League has seized control of the political agenda — eclipsing the anti-establishment Five Star Movement led by Luigi Di Maio, which won nearly twice as many votes in the March elections but is struggling to project its voice in power.
The adjustment on the upside is not over on Italian rates. The 10 year bond’s rate is converging to 3%. The spread with the German 10-year rate is now circa 270 bp. This also reflects a safe heaven effect for German bonds.
With a rate at 3% % while the inflation is at 0.5% (in April), the real rate is way too high in Italy compared to real growth prospects. But such a level on the real rate (2.5%) would be just above the average seen since the beginning of the Euro Area (2.2%). It’s too high when the GDP trend is close to 1%. This has deterred investment and it will continue limiting the capacity to grow. We have to expect a slowdown in the economic activity in coming months. It will come from the real rate level but also from the uncertainty in the Italian economy. An austerity program that can be expected from a transition government is not good news for Italy but also for the rest of the Eurozone.