My friend John Rathbone wrote this today, and he's a smart bugger
Weekly Bulletin – 14th November 2011
Last week was a satisfying one for those conspiracy theorists who continue to believe (with increasing justification) that the designers of the euro, led by Jacques Delors, knew all along that, without full political union, the single currency would at some stage enter a crisis of such terrifying proportions that nations would be prepared to sacrifice their sovereignty to sort out the mess and, in the process, move to full political union. This script is being played out perfectly as first Greece, then Italy have had to accept the removal of their governments, which, though both deeply flawed, were at least democratically elected. Messrs Lucas Papademos and Mario Monti, respectively the new Greek and Italian leaders, are perfect for the federalist cause. Monti is a committed European federalist, who has served as a European Commissioner (though he is not currently an MP). Indeed, it appears that his emergency government will not contain a single elected member. Meanwhile former ECB deputy president, Papademos, who has never even been an MP, has already declared that his top priority will be to keep Greece in the eurozone. Does he literally mean that he would put eurozone membership above all else: healthcare, pensions, defence, for example? His baptism into Greek politics looks set to be fiery indeed.
Last week was when events finally caught up with Italy. European leaders – particularly the notoriously anti-market Angela Merkel – are fond of stating that they refuse to be dictated to by the markets but last week, the ‘Frankfurt Group’ used the markets to devastating effect against Silvio Berlusconi. As the bond markets cast their judgment, selling off Italian government debt so vigorously that, on Wednesday, with LCH Clearnet having raised margin requirements, the 10 year yield hit a euro-era high of 7.45%, the ECB could have intervened to help out Italy but apparently saw an opportunity to depose the country’s errant prime minister instead. At the time, much was made of the fact that neither Ireland, Greece or Portugal had survived without a bailout after yields had gone above the 7% level and the markets held their breath. However, let down by ‘eight traitors’ Silvio Berlusconi was forced to fall on his sword and, by Thursday, 10 year yields were back down below 7%. (At the time of writing, they are over 100 basis points below the peak and this morning’s 5 year auction raised EUR 3 billion at 6.29%). The Italian Senate approved the austerity measures demanded by the EU, followed by the lower house on Saturday and Monti’s national unity government is expected to be in place by Wednesday with a goal of balancing the budget by 2014.
Thus in Italy, as in Greece, the electorate have been denied a vote on the euro and find themselves governed by unelected technocrats. We have always said that, within a democracy, it would be unimaginable for any Club Med country to regain the competitiveness lost in the euro-era. Any government attempting to push through the required draconian expenditure cuts and tax rises would find itself facing civil unrest or worse in the short term, and in the medium term would be voted out. It is not at all clear how the situation will change now that the elected leaders of Italy and Greece have been conveniently removed. It is just possible that the people of both countries are so tired of years of corruption and incompetence that they will regard the caretaker governments as preferable to what would have been. However, even if this view does, indeed, dominate, it seems extremely unlikely that it will continue to do so once the technocrats start to show their teeth through their austerity packages. With Italian industrial output down 2.7% in the year to September and even German output down an identical 2.7% month on month in September (largely due to falling demand in the eurozone), it seems that the official view that the eurozone faces a ‘mild recession’ will prove to be an understatement.
With the eurozone in so parlous a state, it was something of a surprise to note that the European Commission estimates next year’s growth rate to be 0.5%, compared with a barely better 0.6% for the UK. With the UK’s austerity programme already in place, the banks substantially recapitalized and the Coalition government representing 60% of voters at the last election (a fact that contributes to London’s status as a safe haven and continues to drive the super-prime residential property market), it would be a shock were the UK not to outperform the eurozone by more than 0.1% in 2012.
This morning we learnt that eurozone industrial production declined 2% between August and September – the most in 2 ½ years. In the UK, this week will see the Bank of England’s Quarterly Inflation Report (Wednesday) which is expected to reinforce the Bank’s view that inflation will fall quite spectacularly next year. Hopefully from the Bank’s perspective, this view will already have gained some more credibility after tomorrow’s release of October inflation data, which is expected to show CPI falling from 5.2% to 5.1% and RPI falling to 5.5% from last month’s 20 year high of 5.6%. Core CPI is also expected to fall to 3.2% from last month’s worryingly high 3.3%. Less palatable for George Osborne will be the Bank’s expected revisions to its growth forecasts – expected 1% for this year, down from 1.5% only three months ago – and 1% for 2012, down from 2% in August. Unemployment data on Wednesday are expected to show the ILO rate increase from 8.1% to 8.2%. Average earnings data, also on Wednesday, are expected to show a fall from 2.8% to 2.5%. While this would please Mervyn King, some forecasters are predicting a fall to as low as 2.2%, which would have negative implications for consumer sentiment. Thursday’s retail sales data are expected to show a 0.5% fall year on year. If this string of UK data comes in broadly as expected, it will be difficult to escape the conclusion that the government’s plan to remove the structural deficit by 2015 will involve considerably more pain than hitherto expected.
JCD Rathbone
