The ECB has managed to tighten monetary policy.

The ECB had flagged that its September meeting would deliver further monetary easing but it is testimony to the difficulty in managing market expectations that the net result is that policy is now actually tighter . That may change,of course, depending on how events unfold over the coming months but as it stands market rates have risen, as has the currency and short term bond yields, and excess liquidity in the market  has  actually declined.

Perhaps the most striking change announced by President Draghi was on forward guidance, with the pledge to keep rates at the current level or lower now no longer time dependent but open ended till the inflation target is achieved.The Bank had also spent most of the past five years denying that negative rates were having a materially adverse effect on the banking system but changed tack, with the introduction of a tiering system on deposit rates. Banks are required to maintain a given level of required reserves , currently €132bn, and these are remunerated at zero percent, the main refi rate. Excess liquidity, which stands at almost €1,800bn , is paid at the deposit rate, which at -0.4% cost banks over €7bn a year. The change now means that banks can hold almost €800bn at the zero rate, but still leaving around €1,100bn in excess,  now remunerated at -0.5% i.e. a cost of €5.5bn.

Some relief then for banks ,albeit one that was below market expectations, but the ECB also eased the terms on its latest long term loans package for EA banks (TLTRO III), which is now for up to three years at a rate equal to the main refi rate over the period, which is likely to be zero. Indeed, as with the other TLTRO’s, banks that grow their eligible lending by over 2.5% by end-March 2021 will pay the deposit rate, currently -0.5%. From an Irish perspective it should be noted that eligible loans exclude mortgages, which are the dominant lending for domestic banks.

The ECB also announced that QE will recommence  in November at  €20bn per month, with no set end-date, although it is likely the 33% limit would be hit in many countries after a year or so. The market reaction to all this may change when QE kicks in and when we have seen a number of TLTRO’s but to date policy is tighter than before the meeting; 3-month euribor for December is trading at -0.42%, from -0.54%, while the figure for December 2020 is -0.5% from -0.62%. The outlook for fixed rate mortgages has also changed as  5 year swap rates have also moved higher, to -0.35% from around -0.5% a few weeks ago.

The euro exchage rate, as measured by the effective or trade weighted index, has also appreciated, which one doubts was a policy aim, while short term bond yields have actually risen;  the German 2-year was -0.81% and is now -0.70% with the Irish equivalent rising to -0.49% from -0.64%. Banks are the main buyers of this debt and it is less attractive because they can now hold more reserves at a zero rate.

It’s early days, but the first TLTRO 111 actually reduced liquidity. Banks had borrowed €740bn under the previous scheme which with early repayment had fallen to €692bn, with another €32bn due for repayment next week. The take up of today’s first TLTRO III was only €3.4bn , implying a net drain of €29bn. Banks have had little time to prepare and no doubt the take up will improve but it is still a remarkable result.

The market had clearly priced in a lot from the ECB but one doubts that the Governing Council will be pleased by the result, an effective  monetary tightening. For prospective  Irish mortgage borrowers the result is also likely to mean less downward pressure on rates.

Irish growth averages 6.6% in first half of 2019

The Irish economy grew by 0.7% in the second quarter, following an upwardly revised 2.7% in q1  (from 2.4%) . The figures left  the annual change in q2 at 5.8% from 7.4%, indicating average growth of  6.6% in the first half of the year. Absent revisions, this implies that GDP would have to contract  over the final two quarters to achieve the current 4.4% consensus for full year growth.

As is often the case with the National Accounts the globalised nature of Irish GDP threw up another weird and wonderful figure for investment in intellectual property, with the import of business services ( which captures that component) rising by over €36bn in the quarter and by €38bn over the previous year, As a consequence total imports jumped by 43% in q2, bringing the annual increase to 61%. This surge is  neutral for GDP however, in that imports are either consumed or invested and in this case contributed to a 182% increase in capital formation in the quarter, no doubt largely due to spending on Intangibles. In fact the CSO did not give a figure for spending on that component  for ‘confidentiality reasons’ implying one or two large firms were responsible.

We do know that spending on building and construction rose by 5.6% in annual terms in q2 and that the pace of expansion there is slowing- indeed spending was broadly flat in the quarter itself when adjusted for the normal seasonal upswing. Spending by domestic firms on machinery and equipment has also slowed but picked up some momentum in q2, rising by 3.6% in the quarter.

Robust government spending has been a feature of the economy of late and that is evident in 2019, with annual growth in government consumption averaging 4.1% over the first half of the year. This is outpacing consumer spending of 2.8%, and the latter is also  lagging  household income growth, implying a rising savings ratio; the past year has seen a remarkable increase in household deposits, despite virtually zero rates of return.

A large run down in inventories was also a feature of the q2 data, and the main driver of  overall GDP growth was again the export sector, witha 2.8% increase in the quarter bringing the annual rise to over 10%. This includes offshore contract manufacturing and the latter has been on a softer trend over the past year, perhaps indicating that trade tensions are having an impact. None the less  the aggregate figure is still remarkably strong.

The  high frequency data  has pointed to some slowing in the pace of activity of late; unemployment has risen in recent months, retail sales have fallen, credit growth has eased and confidence surveys have plumged. This is likely to be largely Brexit related and as such a prolongation of the uncertainty regarding the outcome is a main negative for the outlook, at least in terms of domestic demand. However domestic spending is now small in relation to GDP ( consumer spending accounts for less than a third for example) , albeit important for employment, so it will be the  export picture that will determine what happens to the overall growth rate.



Every Irish Budget since 2008 has been Contractionary

The Irish Budget gets much media attention and the process itself is now more transparent than in the past, although the net impact on demand in the economy is generally small and certainly far less important than developments in employment and wages. Indeed, given the scale of mortgage debt in the economy and the prevalence of variable mortgage rates ( declining as a share of the market now but still dominant in terms of outstanding debt) monetary policy has had a far bigger impact, particularly in recent years, and it is surprising that the actions of the ECB and our own Central Bank does not receive more scrutiny from the Oireachtas.

The stance of fiscal policy ( i.e. is the Budget adding to demand in the economy or reducing it) does get attention from the economic community and a standard criticism of fiscal policy in Ireland is that it is pro-cyclical , meaning that the Government tends to boost demand in an already strong economy by  cutting taxes and/or raising expenditute. What is therefore surprising is that an examination of the evidence shows that every Irish budget since 2008 can be said to have been contractionary, at least as delivered by the Minister ( the outcomes are often quite different)

The change in the actual budget is not a good measure of the fiscal stance as the General Government balance is itself  impacted by the economy; tax receipts will  rise in a boom, for example, and fall in a recession, with the reverse operating in terms of government transfers such as unemployment benefit.

These forces act as ‘automatic stabilisers’  in that a downturn will increase a government deficit, thus offsetting, at least in part. the decline in private sector spending , a process which the current Minister of Finance has suggested Ireland would allow in the wake of a significant weakening in activity following Brexit (should it happen). A better measure of the fiscal stance, therefore, is to adjust for the economic cycle, an inexact science to say the least but one that is published in the Budget every year by the Department of Finance. A final tweak is to adjust for interest payments on the debt, which are not at the discretion of the  Government ( and are falling rapidly in Ireland’s case ) to arrive at the structural primary balance, which is the preferred measure of the fiscal stance by many economists, including those at the IMF. For example, the 2019  Irish Budget projected a primary surplus of 1.4% of GDP  or 0.8% when adjusted for the economic cycle.

Using that metric, we can see that the 2008 Budget was the last that could be called expansionary , with a planned structural primary surplus of 0.7% of GDP against an expected 2007 surplus of 1.6%. The following budgets saw massive spending and tax cuts, of course but it is surprising and contrary to the perceived narrative that this contractionary process is still at work. For exampe the 2016 Budget saw a projected shift in the adjusted primary balance from zero to a surplus of 0.5% of GDP. In 2017, the projected surplus rose again, from 0.5% to 1.1%, followed in 2018 by a projected 1.3% from an estimated outturn of 0.9%. In 2019 the change in stance was marginal, it has to be said, but nonetheless the projected adjusted primary surplus still rose, to 0.8% from 0.7%, with much larget surpluses projected over the coming years.

These may never materialise , of course, and as noted the implied stance at the delivery of any budget can look very different at the end of the year in question. Moreover, the  above takes no account of what the budgetary position might have been had the suthorities not made the discretionary choices they did, and again it is a common charge in Ireland that  governments have tended to spend  most of  any tax windfalls. One can  therefore debate whether  fiscal policy could and should have been tighter but it is the case that in terms of the actual policy stance as  delivered by the Minister it is over a decade since we have seen an expansionary budget.