The Swiss central bank cut its interest rate close to zero today and started buying foreign currencies to stem the franc’s appreciation in the face of a deepening recession and a looming deflation threat (Hat Tip`MacroMan). The result was pretty predictable, the franc plunged the most against the euro since the single currency was introduced, dropping as much as 3.2 percent after the announcement, and hitting 1.5304 per euro at one point. Heady days ahead folks, fasten up your safety belts for what is now bound to be a bumpy ride. Central banking has never been so interesting.

With Switzerland’s economy set to shrink between 2.5 percent and 3 percent this year, according to SNB forecasts, and prices about to decline by at least 0.5 percent this year (with inflation “very close to zero” in 2010 and 2011) the bank is obviously very worried about following Japan into the deflation hole, and is determined to at least go down fighting. Dropping your currency violently is one of the best know remedies to fight deflation (see Lars Svensson – various, and now Deputy Governor of the Riksbank – if you have any doubt), that and pumping liquidity hard and fast into the system. But what if the UK, the US, the Eurozone and Japan all want to “ward off deflation” in the same way? Won’t we be back to the 1930s. Exactly. So someone has to play the part of the “big man” here, and take deflation firmly on the cheek. I don’t exactly see the candidates lining themselves up right now, although China is stepping up to the plate at the moment (more out of fear of what would happen if they devalue I think, than out of conviction it is a good policy for them). Will the eurozone be next? Watch Jean Claude Trichet’s after-the-rate-meeting April comments for the next episode in this thrilling story.

The economic situation has deteriorated sharply since last December, and there is a risk of negative inflation over the next three years. Decisive action is thus called for, to forcefully relax monetary conditions. Against this background, the Swiss National Bank (SNB) is making another interest rate cut and acting to prevent any further appreciation of the Swiss franc against the euro. To this end, it will increase liquidity substantially by engaging in additional repo operations, buying Swiss franc bonds issued by private sector borrowers and purchasing foreign currency on the foreign exchange markets. The SNB is lowering the target range for the three-month Libor by 25 basis points, narrowing it to 0–0.75%, with immediate effect. It will use all means at its disposal to gradually bring the Libor down to the lower end of the new target range, i.e. to approximately 0.25%. Thus, the Libor now has a narrower target range of 75 basis points, compared with 100 previously.
SNB Statement

Update Friday

It seems over at the Financial Times they broadly agree with the above interpretation, since in an article in today’s edition headed “Swiss action sparks talk of ‘currency war’” by Peter Garnham you can find the following:

Analysts said the move was likely to increase talk that countries were set to engage in a bout of competitive devaluation.

“Let the currency wars begin,” said Chris Turner at ING Financial Markets.

Countries around the world faced with the constraint of zero interest rate levels might feel it was acceptable to intervene to weaken their currencies in order to ease monetary conditions, he said, adding that other export-dependent economies such as Japan would “probably be at the head of the queue”.

Michael Woolfolk at Bank of New York Mellon agreed.

“Market intervention by a major central bank such as the SNB opens up the door for other central banks, namely the Bank of Japan, to follow suit,” he said. “The yen is widely perceived in Japan to be overvalued.”

Well sometimes it never rains but it pours, and as far as Germany is concerned, economically speaking (and my condolences to each and every German for yesterday’s tragedy) more than a “rainy season” what we seem to have is a monsoon, with a torrential downpour one day after the next. The lastest piece of bad news comes on the export front, with German exports dropping for a fourth consecutive month in January, as what is still Europe’s largest economy fell ever deeper into what is now its worst recession in 60 years. Working day and seasonally adjusted sales abroad fell 4.4 percent from December (when they dropped 4 percent). According to provisional data from the Federal Statistical Office, Germany exported goods to the value of EUR 66.6 billion and imported commodities to the value of EUR 58.1 billion in January 2009. Exports were thus 20.7% down in January when compared with January 2008, and imports were 12.9% down.

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The macroeconomic data coming out of Estonia in recent weeks are truly shocking even in the context of the ten percent annual drop in GDP for 2009 that most observers are now forecasting. Perhaps the most evocative number of all is not the 27% year on year drop in industrial output registered in January, but the announcement this week that Estonia’s registered unemployment rate rose to a record 7.4 percent during the first week in March, with a total of 47,774 job-seekers registering with the unemployment offices, up 3,019 in a week. Of course, for many outsiders these are not large numbers, but then Estonia is not a large country. Still this was the highest number since the Labor Market Board started disemminating data in 1993 (although not as measured by Eurostat, which uses a different methodology). The level was up from 7.1 percent at the end of February and 6 percent in January, although the important thing is not the volume of unemployment, but the rate of its increase.

At the same time it is estimated that nearly 250,000 Estonians are currently living in homes whose market value is insufficient to cover the outstanding mortgage loans which their owners have taken out, making “exposure risk” a growing problem for the country’s banks. During the boom, house sale transactions were commonly financed with a 90% loan to value (LtV) ratio. This is a very dubious practice at the best of time, but in the face of a sharp fall in both house values and wages it becomes well nigh disastrous. Continue reading →

“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 has 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.

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by Claus Vistesen and Edward Hugh

Most sports coaches – irrespective of whether they work in soccer, baseball, rugby or even American football – have playbooks; small books or pads filled with notes, decision rules and strategies for each and every possible situation they can envision. Of course, in some cases the playbooks are mental rather than physical, but every good coach lives and dies by his ability to adapt and react to new and changing situations and in order to do this effectively what he needs above all is a good playbook.

So what has all this waffle about football, baseball and whatever got to do with the ECB and how it should respond to the Eurozone’s “fluid and evolving” economic and financial crisis? Well, the point surely would be that whatever playbook the ECB works with (and it is sometimes pretty hard to see clearly which one it actually is) they do not seem to have included a section on what to do when interest rates finally hit the zero bound (not this month evidently, but maybe, or possibly the one after….as Bank President Trichet said after today’s decision to reduce the rate to 1.5%: “We didn’t decide ex-ante that this was the lowest point that we could attain” ). Nor do the ECB seem to have a page which explicitly handles the currently fashionable state of the art set of tools known collectively as quantitative easing. And this omission may, as the zero bound looms and outright deflation threatens, turn out to be a rather large and unfortunate one. The question is, what exactly are we going to do if (or even when) the Eurozone as a whole enters a deflationary rather than a disinflationary dynamic, and even more importantly, what happens if price movements fall into deflation mode and stay there? Continue reading →

I don’t have a chart for this post, or anything of the kind, and the reason will become obvious in a minute. Romanian economic growth, the fastest in the European Union in the third quarter of 2008, slowed dramatically in the last quarter, coming in at an annual rate of 2.9 percent, the slowest in more than three years, and down (dramatically) from a revised 9.2 percent in the July-September period, according to data out today from the Bucharest-based National Statistics Institute.

The point is, we have no idea at all of what the quarter on quarter rate of change is, since the data provided by the Romanian Statistics Office is among the worst in the EU, and more comparable to China than an EU state in this regard. We simply do not know at this point what is happening to the Romanian economy, at least in the sort of detail that matters. Not everyone is so happy to stay in complete ignorance however, and analysts at Raiffeisen Bank did do some calculating of their own. In a research note published on 27 February, they estimate likely fourth quarter growth at 3.5% and put this provisional number through their calculating machines. On this basis they come out with the incredible result that, on a seasonally adjusted basis, the Romanian economy may well have contracted by between 2 and 3 percent from one quarter to the next. This is a very large number, and implies the economy has entered tailspin, especially when we remember that the final result was 2.9 percent year on year (ie below the 3.5 percent number they were working with).

The statistical office will release the GDP figures for Q4 2008 on 4 March. The GDP growth rate in Q4 2008 should be substantially below the levels in the previous quarters. Although GDP expanded by 9.1% yoy in Q3 2008, it may expand by just 3.5% yoy in Q4 2008 (in spite of the still large positive contribution from the agriculture). This is because the final months of 2008 were marked by a rapid deceleration of activity in all sectors of the economy (industry, construction, retail sales). In Q4 2008, industry plunged by 10.4% yoy, while the growth rate in the construction industry stood at 16.8% yoy, down from 28.5% yoy in Q3 2008. Also, the growth rate of retail sales decelerated only to 4.3% yoy in Q4 2008, from 17.4% yoy in Q3 2008. According to our estimations, the rapid deceleration in the annual GDP growth rate reflects a contraction in real GDP in Q4 2008 by 2-3% from Q3 2008 (based on seasonally adjusted data).

Going on the data we do have consumption shrank 2.8 percent year on year, while financial activity fell 1.5 percent. Agricultural output, on the other hand, was up 18.2 percent, sustaining growth to some extent. The statistics institute said it will provide a more detailed breakdown of economic growth on March 19, but since Eurostat reports provide no harmonised Romanian GDP data in their quarterly reports, I am not optimistic.

“I am worried,” Finance Minister Gheorghe Pogea told reporters in Bucharest today. “These are the initial effects of the crisis manifesting itself in Romania. I am thinking about how to compensate for this, to re-launch the economy. The amplitude of the slowdown is big.”

Romania’s prior growth was based on a lending bubble. This has now burst. Private lending growth slowed to an annual 34 percent in January, down from over 63 percent in June as overdue debt payments more than tripled. Exports, which comprise almost a third of Romania’s gross domestic product, fell an annual 17 percent in December. So Romania’s economy is being hit on two fronts, exports are hit by economic contractions among its customers, while the credit crunch has put a sharp brake on domestic consumption.

Since it is more or less certain that the Romanian economy contracted in the last quarter of 2008, and since it is more or less impossible that we see an expansion in the first quarter of this year, I would conclude that the Romanian economy has now entered recession.

Spanish unemployment shot up again in February to 3.48 million in February, whilst consumer confidence took another knock amidst fears Spain’s jobless would now hit 4 million as early this summer, and maybe 4.5 million, or nearly 20% of the workforce. Right, this the latest in my monthly reports on Spain, but before I go further, a quick joke. How do you know when there is an economic crisis in a country? When everyone around you in the metro is busy reading the economics page in the newspaper.

The latest unemployment data released yestreday (Tuesday) show that the number of unemployment benefit claimants rose by 154,058 in February, down from last months increase of 198,838, but still nearly four times the 40,000 increase in Germany which has almost twice the population, and where the economy is apparently contracting at an even more rapid rate. Could we conclude that one stimulus package is working rather better than the other, at least in preserving employment.

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“Saying that the situation is the same for all central and eastern European states, I don’t see that……you cannot compare the dire situation in Hungary with that of other countries.”
Angela Merkel, Brussels, Sunday

“Happy families are all alike; every unhappy family is unhappy in its own way”
Tolstoy

In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral.
Paul Krugman

Bank regulators from Bulgaria, the Czech Republic, Poland, Romania and Slovakia met today and issued a joint statement, ostensibly to reduce the some of the impact of what they term “alarmist comments” from the Austrian government about how the regional banking system is now in such a precarious state that it requires urgent action at EU level to prevent meltdown. The Austrian government are, of course, concerned about the impact of any meltdown on their own banking system. The result of this “reassuring statement” can be seen in the chart below (10 years, HUF vs Euro).

Within minutes of the joint statement Hungary’s currency plummeted to an all-time low against the euro and to a 6.5-yr low versus the US dollar. In fact the HUF rapidly depreciated to 312 per euro from 307.50 before climbing back in later trading to 310. And the reason for this swift reaction? Hungary was not invited to join the statement. As the forint plunged, Hungary ‘s banking regulator hurriedly signed up to the statement, blaming the original omission on a communications mess-up, but the damage was already done.

“Each of the CEE Member States has its own specific economic and financial situation and these countries do not constitute a homogenous region. It is thus important first to distinguish between the EU Member States and the non-EU countries and also to clarify issues specific to particular countries or particular banking groups.”

Well this just takes us back to Tolstoy, each of them have their own specific problems, but the underlying reality is that they all face problems, and are vulnerable, each in their own way.

Hungary’s economic fundamentals are clearly much weaker than those to be found in the Czech Republic and Poland as things stand, but what about Bulgaria and Romania? And the Czech Republic and Poland are about to have a pretty hard time of it as a result of their export dependence on the West, and Poland has the unwinding of the zloty options scandal still to hit the front pages. So there is plenty of food for thought here before throwing Hungary to the wolves. A default in Hungary could very easily lead to contagion elsewhere, and then the impact in the West is very hard to foresee. We should not be playing round with lighted matches right next to our fireworks stock. “Hey, it’s dark in here” and then “boom”.

Yesterday it was Latvia’s turn, and the cost of protecting against a Latvian default (Latvia is the first European Union member priced at so- called distressed levels) rose to a record following the announcement that the unemployement level rose from 8.3% in December to 9.5% in January, the highest level in nearly nine years. In fact credit-default swaps linked to Latvia increased nine basis points to an all-time high of 1,109 basis points, according to CMA Datavision in London. The cost is above the 1,000 level, breached last week, that investors consider distressed, and is now about 270 basis points above contracts linked to Lithuania, the next-highest EU member.

So two countries are being systematically detached here – Latvia and Hungary – and statements by EU leaders are unwittingly aiding and abetting the process. But we should all remember, after they have eaten Latvia and Hungary for breakfast, the financial markets will undoubtedly chew on other luckless countries over lunch (Romania’s Q4 GDP data was out today, and it was a shocker, and S&P have already said they are “closely monitoring” the situation), before perhaps moving on to bigger game for supper.

And we should remember here, no one is too big to fall, and I have already been warning about the gravity of Germany’s situation, with a rapidly ageing population, a hefty bank bailout of its own to swallow, and total export dependence for GDP growth. Final data from Markit economics out today showed that Germany’s composite PMI fell to 36.3 in February from 38.0 in January. That was the lowest level registered since the series began in January 1998. And it means that the German economy – which is highly interlocked with the whole of Eastern Europe (Austria holds the finance and Germany the industrial exposure) – is certainly contracting more rapidly in the first quarter of this year than it was in the last quarter of 2008, and may well contract in whole year 2009 by something in the order of 5%. Further evidence comes from the latest VDMA machine producers association report which shows that exports orders for German engineering companies were 47 per cent down on a year earlier in January. Overall industrial machinery orders were 42 per cent lower than in January 2008, with domestic orders down 31 per cent, while foreign orders fell 47 per cent. This is more or less Japan territory in its scale. So maybe someone over there in Germany should be reading the poem you will see below to “our Angela” right now, just so she doesn’t miss the point (Oh, and if you don’t speak German, you can find a translation here).

Als die Nazis die Kommunisten holten,
habe ich geschwiegen;
ich war ja kein Kommunist.
Als sie die Sozialdemokraten einsperrten,
habe ich geschwiegen;
ich war ja kein Sozialdemokrat.

Als sie die Gewerkschafter holten,
habe ich nicht protestiert;
ich war ja kein Gewerkschafter.

Als sie die Juden holten,
habe ich geschwiegen;
ich war ja kein Jude.

Als sie mich holten,
gab es keinen mehr, der protestieren konnte.

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

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