An independent Catalonia: a tricky economic scenario

The Catalan question is fascinating as it seems to be driven by purely political considerations, while the economic aspect is not thought to raise any great difficulties: the prevailing view seems to be that it will all fall into place.

Yet economics are at the very heart of this question of independence. Independence is highly unlikely to be a success if it is unable to garner robust economic momentum, at least in the initial years.

There are two points worth looking at in this respect – the final outcome of the Catalan question when a decision is truly taken and applied i.e. when Catalonia is actually independent or when it remains definitively part of the Kingdom of Spain, and, secondly the whole transition period, which is currently filled with uncertainty with the first step involving elections planned by the government for December 21. Continue reading

2018: more risks lie ahead than expected next year

2018 will not just be the natural extension of 2017, even if growth is still robust and monetary policy are set to remain fairly accommodative in the absence of inflation.

2018 will be different because expectations will change, as the economic situation is changing radically. Optimism reigns across the various institutions, as we have recently seen in the IMF’s half-year data. Business leaders also have a more positive outlook on their environment: in September 2017, French manufacturing sector industry leaders’ confidence on the economic situation hit its highest point since October 2000. Companies are seeing a change in economic pace. Markit surveys on the manufacturing sector are all in positive territory. This assessment of the immediate future will lead to more jobs and more investment, which will underpin growth, as we witness a virtuous situation, which is poised to satisfy all onlookers: the uncertain past is getting further and further away and now is the time for revival.
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The ECB keeps its hands on monetary policy

As expected the ECB has maintained the level of its three interest rates and reduced the size of its asset purchase programme (APP).
The refi rate is still at 0%, the deposit facility rate at -0.40% and the marginal lending facility rate at 0.25%. They will remain at this level way after the ECB will have stopped its asset purchase programme.
This latter has been reduced to EUR 30bn per month from January 2018 until September 2018 except if the profile of inflation doesn’t follow the trajectory as expected by the central bank. In that case the programme could be extended in size and/or duration. (that could be the case as the ECB forecast for the inflation rate is just 1.5% in 2019 (the core inflation rate is also expected at 1.5%). This is way below the target at close but below 2%)).
There are no changes in the forward guidance: 1 – the ECB keeps open the possibility to increase the amount purchased or to extend the period on which it purchases assets. 2- The interest rate will increase only way after the end of the asset purchase programme. It means that Draghi will not not necessarily hike interest rates before the end of his mandate in October 2019.
The ECB will reinvest all the proceeds of its portfolio. It will give details on the 12 month profile of these reinvestments when it will be necessary.
The ECB has not discussed the composition of its APP (between sovereign and corporate bonds) and Draghi said that the APP process was flexible enough to manage the technical constraints that can be faced (not enough bonds to buy in Germany). He didn’t go further in the discussion. (The ECB will be able to mix the APP and the reinvestment to manage the constraint)

Comments:
The ECB is doing like the Fed: it doesn’t want to surprize investors by its decision. No one is surprised by the reduction in the level of the asset purchase programme. The question was on the amount and on the period. But the choice was limited as the ECB gave the open options in the minutes of its last meeting. Moreover speeches from ECB members were transparent on what they could do.
The main surprise is the stability of the forward guidance. Therefore the change in the APP level appears as a technical adjustment and not as a change in the monetary policy stance.
The ECB doesn’t want to tie its hands in the conduct of its monetary policy. It doesn’t want to create the possibility of divergent expectations on investors side. Therefore the forward guidance remains unchanged but this guidance can be changed by the ECB itself without investors pressure. The balance of strength is still on the ECB side and this will not change in coming months. We will still depend on what they want to say, not the reverse.

The situation has improved, so now is the time for reform

The situation is currently better in the euro area, so now is time to shake it up.
The long period of lackluster growth since 2011 led to a drop in potential growth. High unemployment and lack of investment dented the mainsprings of European growth. The euro area no longer has the same facility it had before the 2008 crisis to grow at an average pace of 2%. In the current circumstances, 2% looks close to the economic cycle peak, and the situation is even more stark in France, where growth stood at around 2% on average before the financial crisis, while the 2017 figure is poised to come to 1.8% at best. These figures along with statistics for 2018 are close to the cycle peak and we should expect growth to take a downturn from 2019 onwards. The role of economic policy should be to promote an improvement in potential growth to keep the economy on a stronger growth path over the long term.

Key areas for consideration. Continue reading