Eurozone M3 money plunge flashes deflation alert for 2014

Eurozone in danger of Japanese-style deflation that will cripple Club Med nations as money supply drops to record low levels

By Ambrose Evans-Pritchard

5:35PM GMT 28 Nov 2013

one Euro coin stands on a map of Brussels on December 9, 2011 in Berlin, Germany
 Photo: Getty Images

The European Central Bank said M3 money growth fell to 1.4pc from a year earlier, lower than expected and far below the bank's own 4.5pc target deemed necessary to keep the economy on an even keel.

Monetarists watch the M3 data - covering cash and a broad range of bank accounts - as an early warning signal for the economy a year or so in advance. This is a large dark cloud hanging over the eurozone in 2014; it means the public debt ratios in Southern Europe are at greater risk of exploding,” said Tim Congdon from International Monetary Research.

Source: European Central Bank, SG Cross Asset Research / Economics

Loans to non-financial companies shrank at an accelerating pace of 3.7pc, but with drastic differences between North and South. Yacine Rouimi from Societe Generale said total credit plunged by 5.7pc in Italy, 6.6pc in Portugal, and by analarming19.3pc in Spain.

Source: European Central Bank, SG Cross Asset Research / Economics

Jacques Cailloux from Nomura said the ECB’s actions have yet to restore a functioning interbank market in Europe, and it remains unclear whether the nascent recovery will be enough to lift the region out of “dangerously low inflation”. Nomura said eurozone risks being trapped in “secular stagnation until the middle of the decade.

The dire credit data may force the ECB to take bolder measures. The Süddeutsche Zeitung said the bank is exploring a variant of the Bank of England’s funding for lending, offering credit lines to banks provided loans are passed on to credit-starved firms.

“The ECB needs to cut rates to zero and launch quantitative easing (QE) to head off deflation, but they are not there yet,” said Lars Christensen from Danske Bank. “The debt problem in Italy will be much worse if they let nominal GDP fall, leading to yet more austerity.”

Chart: Spain's financing of non-financial corporations

The ECB’s governing council appears deeply divided. While doves have opened the door to QE and a negative deposit rate to force down the euro, a German-led bloc of hawks remains adamantly opposed to such steps. The two German members opposed the bank’s quarter point rate cut last week

Mr Congdon said regulators have made matters worse in Europe by forcing banks to raise capital buffers too fast. “This is causing them to dump assets and destroy money. The regulators think they are curing the patient but they are killing it instead,” he said.

A report by PricewaterhouseCoopers said European banks face capital shortfall of €280bn in 2014 to meet Basel III rules and the ECB’s asset quality review, with €180bn of this coming as fresh capital. European banks are facing another turbulent couple of years,” it said.

There was broad consensus among monetary experts at an Institute of Economic Affairs forum this week that “pro-cyclicalregulation is a key reason why recovery has been so weak.

Lord Skidelsky, the biographer of John Maynard Keynes, said that even Keynes would have viewed the current clamp-down on banks as folly. He cited a letter written by Keynes to President Franklin Roosevelt in 1933 warning that US policies intended to achieve recovery and reform” at the same time were in conflict. Keynes said recovery must come first.

The ECB’s own policies appear to be in contradiction. Its latest Financial Stability Review warned that bond tapering by the US Federal Reserve could lead to an interest rate shock, with a sharp rise in bond yields. Yet it has been slow to mitigate the dangers with pre-emptive stimulus.

Mario Draghi, the ECB’s president, told an audience in Berlin last week that bank needs a “safety margin against deflationary risks” after eurozone inflation fell to 0.7pc.

He warned that low inflation makes it harder for crisis states in Southern Europe to control their debt trajectories while at the same time carrying out internal devaluations within EMU to regain competitiveness, though he denied that the two goals are inherently contradictory.

“If average inflation is allowed to drift too low, adjustment runs into major head winds as demand suffers and real debt burdens rise,” he said.

Mr Draghi has to walk through a political minefield. The German constitutional court has not yet ruled on the legality of his back-stop plan for Italian and Spanish debt (OMT), making it very risky for him to push his case too hard. While Germany does not have a legal veto on ECB decisions, it has a de facto political veto.

Veteran EU watchers say the sacred contract of monetary union is that Germany will never be overruled on crucial matters. Mr Draghi has to work in tandem with Germany’s ECB board member Jörg Asmussen. The bank is in reality a twin-headed institution

Europe News

Netherlands Loses Triple-A Rating, Spain Outlook Raised

S&P Cites Netherlands Weakening Growth Prospects

By Maarten van Tartwijk and Christopher Bjork

Updated Nov. 29, 2013 6:43 a.m. ET

Credit-ratings firm Standard & Poor's raised the outlook for Spain's sovereign-debt rating, but cut the Netherlands' credit rating, in moves that reflect how parts of the crisis-hit Southern Europe are starting to stabilize, while some economies in Europe's stronger North are weakening.

The Netherlands became the latest country to be stripped of a coveted triple-A credit rating Friday. S&P downgraded the country to double-A-plus, citing worsening growth prospects.

S&P raised Spain's outlook on Friday to stable from negative, while keeping the rating at triple-B-minus, just a notch above junk-bond status. The improved outlook reduces the danger of a further downgrade to junk for the euro zone's fourth biggest economy.

S&P also upgraded Cyprus, which received an international bailout this spring, to B-minus from triple-C-plus

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The ratings changes made little impact on financial markets, which no longer react as sensitively to ratings changes for euro-zone members as they did at the height of financial panic in the 17-country currency bloc. But S&P's moves mirror recent economic data that suggest the worst may be over for Spainwhereas the Netherlands faces growth and financial worries even though it is seen as part of Europe's healthy economic "core."

Spain returned to slow growth in the third quarter after more than two years of recession. Spain's economy is expected to contract in 2013 as a whole, but to recover slowly from 2014.

The Dutch economy, however, is expected to grow by only 0.2% in 2014, making it one of the weakest performers in the euro zone, according to European Union forecasts.

While the Dutch economy returned to growth in the third quarter, the recovery is expected to remain subdued in 2014 and beyond, S&P said. "We do not anticipate that real economic output will surpass 2008 levels before 2017," S&P said. "The strong contribution of net exports to growth has not been enough to offset a weak domestic economy."

Consumer spending in the Netherlands is sliding thanks to Dutch households' heavy mortgage debts and slumping housing market. Dutch households are among the most indebted in Europe, and around one in four households have more mortgage debt than their home is worth.

Dutch government austerity measures, mostly consisting of tax increases, are further weighing on domestic demand.

S&P was in recent years the rating agency most critical of Spain's creditworthiness and once warned that the country was on a path toward effective insolvency. Just a year ago, many observers fretted that an S&P downgrade of Spain to junk could trigger a large-scale financial panic in euro-zone government bond markets.

S&P sounded a much more positive note Friday than in recent reviews of Spain's credit solvency, saying budget cuts and structural reforms are making the country's finances more sustainable, while the economy is on a modest growth path.

S&P said it expects Spain's real GDP to contract by about 1.2% in 2013 but then slowly recover. It added it expects Spain's GDP to grow by 0.8% next year, and by 1.2% in 2015.

The forecasts are roughly in line with Spain government's, and include warnings that all isn't well for Spain, as domestic demand remains very low and Spanish unemployment is very high at around 26% of the workforce.

—Peter Nurse in London and David Roman in Madrid contributed to this article.