Wednesday, August 27, 2008

German Recession Danger Rises As Consumer and Investor Confidence Falls

German business and consumer confidence fell more than economists forecast in August, raising the likelihood that Europe's largest economy may now be steadily slipping into a recession.

Business Climate Worsens In August

The Munich-based Ifo institute's business climate index, based on a survey of 7,000 executives, dropped to a three-year low of 94.8 from 97.5 in July. Ifo's gauge of business expectations dropped to 87, the lowest since February 1993, when Germany was experiencing the worst recession of the past two decades. A measure of current conditions eased to 103.2 from 105.7.

"The German economy is encountering an increasingly more difficult situation,"
Ifo President Hans-Werner Sinn

Consumer Confidence Down Again

At the same time GfK AG's consumer sentiment reading slumped to its lowest level in five years. GfK AG's index for September, based on a survey of about 2,000 people, fell to 1.5, the lowest since June 2003, from a revised 1.9 in August, the Nuremberg-based market-research company said in a statement today.

GfK's sub-index measuring economic expectations plunged to minus 21.8 from minus 8. A measure of consumers' propensity to spend fell to minus 27.9 from minus 26.2 while a gauge of income expectations improved to minus 16.8 from minus 20.

Subdued economic prospects and the expectation of additional price hikes continued to depress consumer sentiment in August. While income expectations recovered slightly from the marked downturn in the prior month, economic expectations were dampened further. The propensity to buy, which in a long-term comparison has been far below average for many months, recorded a further slight reduction.
GFK Press Release

Second Quarter GDP Contraction Confirmed

Further detailed data released today by the Federal Statistics Office confirmed that the German economy contracted in the second quarter, while most of the short term indicators we are now receiving seem to suggest that it may fail to grow in the third quarter as well. While oil prices have receded from a record $147.27 a barrel, they're still up 60 percent over the past year, putting pressure on consumer spending power and just as the slowdown in Southern European economies like Spain and Italy start to weigh heavily on German exports.

The economy contracted 0.5 percent in the three months through June as construction dropped back sharply and companies and households reduced spending, according to the detailed data from the Federal Statistics Office.

Building investment was down 3.5 percent in Q2 from the previous quarter, investment in plant and machinery fell 0.5 percent and consumer spending decreased 0.7 percent. Gross domestic product fell a seasonally adjusted 0.5 percent from the first quarter, when it rose a revised 1.3 percent. The Q2 contraction is the biggest drop since the second quarter of 1998.

Ironically, the headline GDP number was helped by a sharp drop in imports. This drop in imports was the direct result of a weakening in domestic demand (down 0.3% on the quarter), and thus GDP growth was improved by people actually getting worse off.

German exports fell 0.2 percent in the second quarter from the previous three months, when they rose 2.1 percent, today's report showed. However imports dropped even further (due to the weak domestic consumer demand) - by 1.3 percent from the first quarter (when they increased by 3.2 percent). So, despite the deterioration in the export situation, the net impact of trade on GDP was positive (0.4 percentage points were added to growth by this effect, or, if you like, without it the contraction would have been around 0.9%) due to the sharp drop`in imports. This result is even stranger than it seems at first sight, since the strong imports in the first quarter meant that trade in Q1 was in fact a negative for GDP (minus 0.3 percentage points) despite the relatively stronger earlier export performance. As the German Federal Statitistics Office Put It:

"However, growth was supported by foreign trade. Compared with the first quarter of 2008, downward trends were recorded for both exports and imports. As, however, imports decreased much more strongly (–1.3%) than exports (–0.2%), the resulting export surplus (net exports) contributed 0.4 percentage points to economic growth."
Weak Performance Looking Forward

According to the most recent PMIs for Germany, performance in the manufacturing sector continues to deteriorate, and manufacturing barely expanded in August:

while services fared a little better, coming in at 53.1, which was slightly up from July's 52.1.

All in all the outlook which seem to hinge on what happens to German imports and exports in August and September. Looking at what just happened in Georgia, and given the dependence of Germany on exports to Russia and the CEE, it is hard to be optimistic at this point about German export growth.

Thursday, August 21, 2008

Eurozone Recession On the Horizon?

Is the first zone wide recession in the short history of the eurozone about to be registered? Certainly the flash PMI estimates for August give the impression that it might. The Royal Bank of Scotland Group Plc's composite index came in at 48 after 47.8 reading in July. Any result under 50 indicates contraction. Unfortunately we only get flash estimate breakdowns for France and Germany, but it isn't that difficult to deduce from the composite number that Spain and Italy continue to contract - although given that the composite rebounded slightly, while both services and manufacturing slowed in Germany, and in France manufacturing contracted more sharply in July while the contraction eased a bit in services, then it may be that Spain and Italy weren't contracting quite so strongly in August as they were in July.


The German manufacturing index fell to 49.9 in August, its lowest level in three years, after slipping back index to 50.9 in July.

Helping to push down the manufacturing indicator was the export component, which fell to its lowest level since June 2003, according to the report from Markit Economics.

The services PMI reading was not much better, falling to 50.6 in August from 52.1 in June. As things stand German services are riding just shy of contraction if the flash reading is borne out in the final result.

In its report, Markit Economics noted that the business expectations sub-index for Germany had slipped to the lowest level since November 2002.


Activity in France's manufacturing sector contracted at the sharpest rate in over six years in August, with a contraction of 45.1 being registered, down on July's 47.1 and the lowest level since December 2001.

The service index came in at 48.5, above July's 47.5 but still only its second time in negative territory since mid-2003. New business logged by service firms shrank at its fastest pace since the data was first collected in May 1998.

"If you extrapolate these figures through to the third quarter you're probably looking at stagnation of GDP (gross domestic product)... This is not a harbinger of imminent upturn," said Chris Williamson at data compiler Markit Economics. "Nothing points to a fundamental turnaround... I think there's been a spillover effect from Italy, Spain and now Germany, and France has followed suit."
So Is It Recession, and Will We See Rate Cuts From the ECB

Gross domestic product fell 0.2 percent in the second quarter from the first, when it grew 0.7 percent, according to the data released ny Eurostat (the European Union's statistics offic) last week, and it now seems clear that this contraction may well pass over into the third quarter. In fact Germany's Economy Ministry said only yesterday that the economic outlook in Germany has worsened even beyond the second quarter, when gross domestic product shrank for the first time in four years.

European consumers are not getting much relief from falling oil prices either, since while oil prices have fallen 20 percent from a record $147.27 a barrel on July 11 the euro has dropped 7 percent ($1.4780 today) from its peak of $1.6038 hit on July 15, taking a lot of the edge off the drop. The fall in the euro will however make exporting outside the zone easier, the difficulty is that the demand for exports is slowing generally as the global economy slows.

The European Central Bank, which raised its benchmark rate by a quarter point to 4.25 percent in July, currently predicts growth will slow to about 1.8 percent this year from 2.7 percent in 2007, but today's PMI data would seem to confirm that the ECB's growth projections are no longer realistic and that the time to move over into rate cuts mode is fast approaching.

The Rain In Spain Falls Mainly On.... The Construction Companies

Well, as they say "it never rains but it pours", and while on the Spanish beaches millions may be idly languishing in the sun doing their best not to think about what awaits them on their return to reality in September, on the Spanish plain the rain never ceases to fall, and torrentially so. On Monday it was Caja Madrid, on Tuesday Metrovacesa, on Wednesday Cortefiel, and today it is the turn of Ferrovial, since Ferrovial, which is Spain’s number 2 construction group, was yesterday faced with the serious possibility it may have to sell three of its British airports over the next year, following a damning report by UK competition authorities which attacked its dominance of the industry and its inefficiency.

In its findings the UK Competition Commission provisionally concluded that Ferrovial’s subsidiary, BAA, should be forced to sell two of its three London airports – Heathrow, Gatwick and Stansted – and either Glasgow or Edinburgh in Scotland. The most likely candidates for sale appear to be Gatwick, Stansted and Glasgow.

The commission’s findings – which will now be put out for consultation – raise serious questions about the wisdom of Ferrovial’s purchase of BAA for more than £16bn (€20bn), including debt, in 2006. Ferrovial, which had net debt of €30.2bn in December 2007, may well find it difficult in the present cilmate to sell assets. On top of which buying dear and selling cheap is hardly a sound commercial strategy, especially for a company heavily in debt. Ferrovial's original 8.75-billion-pound ($16 billion) hostile bid was originally rejected by BAA in May 2006. Ferrovial then raised its bid to 9.73 billion pounds ($18.1 billion) but BAA said it was still too low. The final price was eventually over 10 billion pounds, to which must be added the 3 billion pounds for new investment included in the refinancing of 13.3 billion pound ($24.8 billion) completed only 3 days ago (August 18). Not only do many Spanish companies seem to have made a serious error of judgement in getting so involved in a UK market which was also heavily inflated by its own property bubble (I mean really they couldn't have chosen a worse venue on on this count, except, perhaps, for all those ventures out in boom-bust countries to the East, which we will look into in more detail on another occasion). And in addition, as the pound sterling difts down and down, there are those little details of relative currency values to think about here.

Ferrovial shares are down 46 percent since the it closed the purchase of BAA on Aug. 15, 2006. The deal was funded by debt loaded onto the airport operator, forcing it to focus on what is the world's largest-ever refinancing amid an ongoing global credit crunch. BAA, which runs seven U.K. airports, completed a 13.3 billion- pound reorganization only two days ago. BAA stock has lost 31 percent this year amid steadily increasing speculation about its future and about its ability to carry out its function effectively following the cancellation of 600 flights on the opening of Terminal 5 in March.

And those of us who live in Spain, and are "aficcionados" for the finer details of these things, may like to notice how earlier this month, and while half of corporate Spain was starting to fall apart, the Spanish media had a major campaign whose main objective seemed to be to tell us just what "bad people" Ryan Air were. Looking at the situation of almost all out war which exists between Ryan Air and Ferrovial at the moment, this intense media pressure becomes a little more intelligible. Ryanair Holdings Plc, which is Europe's biggest discount carrier and the largest airline at Stansted, issued a statement today calling BAA an "abusive monopoly'' and declaring that a breakup would bring better facilities and lower prices. This, of course, is not the version the Spanish public are getting. And Ryanair’s David O’Brien, chairman of the airlines consultative committee at Stansted, is quoted as saying that the report confirmed the company’s near-monopoly was “bad for consumers and bad for Britain”. Clearly there is little love lost between Ferrovial and Ryan Air at this point in time.

"We are delighted by the decision, which we have been calling for years,"
Ryanair director of legal and regulatory affairs Jim Callaghan told Reuters.

Spanish Bank Lending Slows Again in June

We also now have the June bank lending data from the Bank of Spain. Surprisingly, month on month the lending was up over May, at a provisional 8.4 billion euros versus 4.8 billion euros in May (net increases month on month), and 6 billion in April. In fact the net lending increase in June is the highest figure we have seen since November 2007.

So things are getting better? Well not exactly, since the details matter, and looking at the fine print we find that the mortage component is only up by something under 1 billion euros of that total (850,000 euros approx) while other lending (which is mainly personal, car and home improvement type unsecured lending) was up by slightly over 7 billion euros, a huge increase over the 1.5 billion euro increases in April and May. And the reason for this is obvious: these loans carry a higher interest rate, and thus they are easier for the banks to intermediate since they themselves can afford to pay more to borrow the money (you know, the 7% they are offering on time deposits etc). The thing is all this money does still have to be paid back, even if it goes up in thin air rather down in cement, something which those lying on the beach in Cancun or having a restful month in Japan might care to think about at this point.

Anyway, whatever the distribution of the lending, the year on year rate of increase continues to trend steadily down, reaching 8.5% in June.

And do remember, it isn't only household lending which is being hit by the credit squeeze on the Spanish banks. As we are now seeing day in and day out, corporates are also being badly affected, and of course the interannual rate of credit increase to corporates is also steadily trending down, hitting an inter-annual 7.2% in June.

Credit Recovery Swaps

Reuters has an article today about how trading in recovery swaps kicked off in Europe this month. Recovery swaps are a credit derivative instrument which analysts think are likely to gain popularity as Europe's economy slows and more companies (as we are seeing in Spain) start to come under stress.

Recovery swaps are bets on the expected percentage bondholders will get of the amount they are owed in the event that a company defaults. No money changes hands unless there is a default and the swap expires unused if the company does not default.

According to Reuters the market in recovery swaps in Europe involves only three or four big dealers and 10 names at the present time - NXP, Hellas Telecommunications, ONO, Ineos, LyondellBassell, Seat, Truvo Subsidiary which is also known as WDAC, M-real, Thomson SA and Norske Skog.

In a recovery swap with a strike price of, say, 30 percent, the buyer agrees to buy bonds at a recovery rate of 30 percent if there is a default. When the default occurs, he benefits if the actual recovery rate turns out to be higher than the level he agreed to pay. The seller profits if the recovery rate is lower than 30 percent.

Reuters cite Mikhail Foux, a New York-based Citigroup director in credit strategy.
a saying that there are a variety of U.S. investors trading in European recovery swaps including hedge funds, investors in synthetic collateralised debt obligations (CDOs) and capital structure arbitrage players, who seek to profit from dislocations between credit and equity markets.

They also cite University of Texas Professor Henry T.C. Hu as making the evident point that holders of CDS could sabotage a company and other debtholders, because they stand to profit more if it fails than if it survives.

The Cobrador Del Frac

Reuters also has a piece on one of those ever so uniquely Spanish phenomena, the Cobrador del Frac. "El Cobrador del Frac", is the name of a company which specializes in sending men dressed like extras from a 1930s Fred Astaire movie to humiliate debtors into paying up. And according to Reuters business is booming.

Well, at least employment is rising in one sector of the Spanish economy. Maybe they'll be sending people to meet the holiday merrymakers off their planes as they arrive.

Tuesday, August 19, 2008

Cheaper Oil and a Weaker Euro Send The ZEW Sentiment Indicator Ticking Back Up

German investor confidence increased more than anticipated in August following a decline in the euro and an easing in oil prices from the record levels reached in early July. The ZEW Center for European Economic Research in Mannheim said its index of investor and analyst expectations rose to minus 55.5 from minus 63.9 in July. The July reading had been the lowest since the survey began in 1991.

The German economy contracted by a larger than expected 0.5% in Q2, and it is still touch and go whether we will see a technical recession and quarterly GDP in the third quarter too. The Berlin-based DIW economic institute predicted yesterday that gross domestic product would rise just 0.1 percent in the three months through September, and accepting this assessment at face value it is still within a margin of error which could mean contraction.

Inflation is also still proving to be a major area of concern, and German producer-price inflation accelerated to 8.9 percent in July, the fastest pace since October 1981, reinforcing speculation the European Central Bank will keep interest rates at a seven-year high even as the economy cools. Month on month prices rose 2 percent, according to data from the Federal Statistics Office earlier today.

German energy prices gained 25 percent from a year earlier and prices for electricity increased 23 percent. The cost of diesel fuel rose 30 percent from July 2007. Excluding energy, producer prices rose 3.6 percent in the year.

German consumer prices rose 3.5 percent in Julay from a year earlier, according to the Federal Statistics Office on August 14.That's the fastest pace since Germany started measuring inflation using a harmonized European Union method in 1996. From June, prices rose 0.7 percent.

Caja Madrid Mortgage-Backed Bond Default Risk Soars

Well, it's been a quiet week, but bit by bit all the pieces are trickling into place. The latest little hiccup in the system comes from today's news that the cost of default protection on mortgage-backed securities sold by Caja Madrid - Spain's second-biggest savings bank - has soared to a record amid speculation the ongoing property crash may worsen. Credit-default swaps on a top ranking portion of Caja Madrid's Madrid RMBS III FTA transaction have jumped to 500 basis points from 310 at the end of July (RMBS's are Residential Mortgage Backed Securities), according to BNP Paribas prices. A rise indicates deterioration in the perception of credit quality; a decline signals the opposite.

The Madrid RMBS III FTA bonds are part of a 3 billion-euro transaction Caja Madrid sold in July 2007 - pooling mortgages with a loan-to-value ratio of an estimated 92 percent. The notes are among portions of debt from 13 separate transactions that Moody's Investors Service said last month it was reviewing for downgrade after a change in the way it assesses house price declines and risks of default for some Spanish mortgage bonds. Caja Madrid's loan default rate more than tripled to 1.89 percent of its total loans by the end of the second quarter from a year earlier.

Caja Madrid also had 262 million euros of mortgage-backed bonds downgraded by Fitch Ratings in June after the default rate on the underlying home loans doubled in a year. Caja Madrid also hit the headlines in July for its exposure to failed property developer Martinsa Fadesa. The bank's exposure to the firm - which is now in administration - was estimated to be1 billion euros, for which it had earmarked a provision of 250 million. Also we could note that Spain's national flagship airline Iberia had something of a shotgun wedding with the UK's British Airways last month, and Caja Madrid was the major sharholder with 22.9% of the equity. The Iberia decision was in marked contrast to the Italian government's support for the troubled carrier Al Italia, and there seem to be good reasons for assuming that the difference is not simply a question of the Spanish government having a greater disposition towards market-driven solutions.

Also last Thursday Gas Natural raised its potential stake in power generator Union Fenosa to over 50 percent after agreeing to buy a 5.15 percent stake from savings bank Caja de Ahorros Del Mediterraneo (CAM) The two entities have agreed to an equity swap through UBS in which Gas Natural agreed to pay CAM 18.33 euros a share, the same price it is paying hard-hit builder ACS for a 45.3 percent stake in Union Fenosa. CAM will receive an immediate 827 million euros (17.57 euros a share) and the remainder at the end of April, assuming the ACS-Fenosa deal goes through, raising the total to 862.8 million euros and CAM's capital gains to 556 million. This obviously provides Alicante-based CAM with much-needed liquidity as its traditional sources of funding steadily dry up in the wake of the developing housing crisis.

In order to do all this buying-up Gas Natural has itself had to float a 17 billion euro loan, a decision which has lead ratings agency Standard and Poor's say that it may in turn cut its credit ratings outlook on Gas Natural.

"It (the buyout) would result in a material weakening of Gas Natural's financial profile due to the size of the bid and the consolidation of Union Fenosa's approximate 6.9 billion euros of adjusted debt (at end-2007)," Standard and Poor's said.

So while this game may go round and round in circles, there are limits, and these limits are near to being reached. Somone somewhere is simply going to go one bridge too far with the implicit risk that this brings the whole edifice tumbling down like a pack of cards. And just one last "musical chairs" type detail. Guess which bank was on the list of guarantors for Gas Natural's 17 billion euro syndicated loan? You've got it: Caja Madrid.

Gas Natural announced on Thursday that it has mandated Barclays, BNP Paribas, Caja Madrid, Citigroup, ING, La Caixa, Royal Bank of Scotland, Santander, Societe Generale and UBS to lead the loan backing its purchase."The banks are committed to providing the financing for the whole transaction which will be around 17 billion euros," a company spokesman told Reuters Loan Pricing Corp.

According To The IMF Spain Has Comparatively Little Ficsal Room For Manoeuvre

According to Alessandro Leipold, acting director of the IMF's European Department, the Spanish government now has little room left to add fiscal stimulus to boost Spain's slowing economy - beyond that is standing back and allowing the economy to undergo its own natural correction process. Leipold also stressed in an inteview that to avoid a protracted economic slowdown, Spain should as a matter of urgency introduce reforms that would reallocate resources toward high-growth sectors. He also stressed the wage competitiveness issue given the need to start exporting more.

'Wage restraint will also be essential to protect employment and to prevent that higher inflation further damages external competitiveness,'

What Leipold is getting at is not that fiscal support is, in and of itself - undesireable, but rather there is not permanent room for 20 billion euro packages (around 2% of Spanish GDP) - like the one we saw last week - which mainly aim to prop up construction activity, and hope that at some early point everything will return to where it was. Leipold is simply making the point that what are called "automatic stabilisers" will naturally come into play as unemployment rises and tax returns fall, so the deficit will rise of its own accord. At the end of the first half of 2008 we were already running at a 1% annual deficit rate (from a 1% surplus rate a year earlier), so by this time next year Spain will be up against the EU 3% deficit limit without any additional packages being introduced.

Now the point is not that Spain should, at the end of the day be hamstrung by the 3% deficit limit - clearly the position is far more serious than that. But to be able to go beyond the 3% the Spanish government will need first to reconise the gravity of the situation, and then in the second place start to accept that it cannot possibly handle the financial implications of all that is happening hitting the banking sector alone. Brussels will need to be involved (as I am arguing, and as Wolfgang Munchau also argues - and please note that the latest flurry of activity on the FannyMae FreddyMac front on the US is precisely to do with specualtion that it is the US Treasury, not the Federal Reserve, which will have to step up to the plate and inject the cash which will save the failing mortgage providers. See this reuters report today for what ex-IMF chief economist Ken Rogoff thinks about the US outlook).

Of course in all this siren voices do abound. Ambrose Evans Pritchard quotes Bernard Connolly, global strategist at Banque AIG, who apparently said:

the eurozone faces possible disintegration unless there is a fiscal bail-out from Germany that matches - in sheer scale - Berlin's Versailles reparations payments after the First World War. "The bursting of the EMU credit bubble seems imminent, and will reveal current account imbalances among euro area countries as extremely dangerous. The medium-term feasibility of the euro area in its current form must be open to very considerable doubt,''

The comparison with Versailles may seem rather emotive, but we are talking about what are potentially very large amounts of money indeed here (between 300 and 500 billion euros, on my estimation, or between 30% and 50% of Spain's annual GDP). In fact the EMU's credit bubble has already burst on its Southern perimiter (Spain and Greece) even if we still can't see the full extent of the damage, and yes, EMU is not in danger at this point, but continued fudging and failure to act could well mean that it may be in the future.

Talking of fudging, Spain's economy Minister Pedro Solbes told the Spanish news agancy EFE over the weekend that Spain's unemployment could end the year above the government's 10.4 percent forecast (how much above he discretely failed to mention - and not unnaturally he was already warning of widespread government budget cuts next year. Solbes told news agency EFE in the interview that, "at the end of the year we could be above that (10.4 percent forecast)". Unemployment in Spain hit a 10-year high of 2.43 million people in July, with nearly two of every three layoffs coming from the construction sector.

It is also important to remember that even Solbes's negative budget forecasts are still based on his belief that quarterly growth from July to September will be "somewhat better" than in the second quarter when quarter-on-quarter growth slowed to 0.1 percent.

This is extremely unrealistic in my view. Solbes argues that Spanish GDP will benefit from lower oil prices (and declining domestic consumption which will ironically give a boost to GDP via an improved net export position), a good harvest and tax credits including the return of 400 euros to all income tax payers. I have discussed the oil price situation in my analysis of the May balance of payments data, but in the short term the Spanish GDP will get some statistical uptick from changes in the trade dynamic (although since this implies reduced consumption of imports, Spanish consumers will hardly feel this to be a benefit), but I think the sharpness of the downturn will mean we will soon see GDP growth in negative territory, and, of course, as an when oil prices start to pick up again this positive effect will turn into a negative one.


Metrovacesa SA have decided to sell more assets than planned after the Spanish company's real estate holdings lost value, according to El Economista yesterday, citing a company report. Metrovacesa now plans to divest offices, hotels and shopping malls valued at 1.53 billion euros ($2.3 billion), the newspaper said. The company previously aimed to sell assets worth about 303 million euros. The Spanish press has also been reporting that Metrovacesa’s sales rate has fallen from 8 properties per working day last year, to just one a day now. Metrovacesa’s income has collapsed 76% as a consequence, to 45.4 million Euros. Metrovacesa is one of the biggest residential property developers in Spain, and is listed on the Madrid stock exchange.

And even those properties the developers manage to get an initial sale on don't always work out as planned. El Pais reported yesterday that the number of buyers backing out of purchases on new developments - and losing their deposits in the process - is starting to create a new headache for developers: with up to 15% of sales unravelling according to experts.

The problem of buyers backing out after signing a private-sale contract and paying a deposit is illustrated by the latest half-year results published by Acciona, a large listed Spanish developer. Acciona booked more deposits – 16 million Euros – in the first quarter of the year than it did in the first half of the year, which it closed with deposits of just 13 million Euros. The reason being that many of the sales made in the first quarter of the year subsequently unravelled, with Acciona having to return deposits.

Oh, and just to sum it all up for today, Spanish builder Acciona SA have agreed to sell a 75 percent stake in its funeral-service company, Memora Inversiones Funerarias SL, to 3i Group Plc in a transaction that values the company at 330 million euros ($486 million) including debt. Acciona shares fell 30 cents, or 0.2 percent, to 135.35 euros on the news. Obviously they feel they won't be needing Memora's services, since they can obviously get buried in their own rubble - and at a far lower cost.

Friday, August 08, 2008

Italy Enters Recession, But When Will It Leave?

According to preliminary data from national statistics office ISTAT this morning Italy's GDP fell 0.3 percent in the second quarter compared with the first three months of the year and was unchanged year-on-year (ie zero percent annual growth). Final data and a detailed breakdown for the second quarter will be released on Sept. 10. In the first quarter, GDP rose 0.5 percent quarter-on-quarter and increased 0.3 percent year-on-year.

European Central Bank President Jean-Claude Trichet stated yesterday that economic growth was expected to be "particularly weak" in the third quarter after bank policy makers left borrowing costs at 4.25 percent, so it is not unreasonable to anticipate a second consecutive quarter of negative growth in Q3, and hence in all probability Italy is now in recession.

Italian consumer confidence in July slumped to the lowest since 1993, when the country was also - we should note - in a recession following abandonment of the EMS. The Isae Institute index fell to 95.8 from 99.9 in June. In November 1993, the 26-year-old index hit a record low of 95.4.

Italy's manufacturing sector contracted for the fifth straight month in July, posting its weakest performance in over six-and-a-half years, according to the results of the latest Markit/ADACI PMI survey. The Markit Purchasing Managers Index dropped to 45.3 from June's 46.9, sinking further below the 50 divide between growth and contraction.

If we look at the seasonally adjusted output index we can see that Italian industrial output has been dropping almost continually since the November/December 2006 peak, and we might well ask ourselves the question, with energy prices up where they are when will this index ever rise again abover the late 2006 peak?

The Italian services sector purchasing managers' index also in fell in July, to a seasonally adjusted 45.6 in July from 48.5 in June. So the contraction continues, and even accelerates into the third quarter of the year.

And Italian retail sales declined in July for the 17th month in a row. The seasonally adjusted PMI for retail sales was at 38.2, up slightly from the 36.3 shocker registed in June.

Public Spending Cutback?

Earlier this week Italian Prime Minister Silvio Berlusconi survived a confidence vote in parliament over plans to raise taxes on oil companies and reduce salaries for mayors and public employees in a bid to balance the budget by 2011. Italy currently has a debt to GDP ratio of around 105% - way above the official EU limit of 60%. Italy is commited to at least achieving the common target of a balanced budget by 2011, but this looks to be fraught with difficulty to me, given Italy's very poor economic performance and all the negative headwinds going forward.

Berlusconi managed to clear this particular hurdle this time round without too much difficulty, since his allies in the lower house of parliament voted 312 to 239 to approve the necessary amendments to current legislation, and then passed the entire package 314 to 230.

The budget increases the corporate income-tax bracket for energy companies to 33 percent from 27.5 percent and raises taxes on oil and gas inventories. Banks and insurance companies also will pay more. Finance Minister Giulio Tremonti has called the measures ``Robin Hood'' taxes.

On the spending front, the government plans to cut city, town mayor and local administrator salaries by 20%. It is not clear how much of this is serious and how much "window dressing", but since the government estimates that budget cuts at ministries will generate savings of 9 billion euros ($13.9 billion) next year, the salaries of more than a few mayors and public dignataries must be involved.

The broader economic policy outlined in the budget aims at boosting revenue and cutting spending by 36 billion euros over the next three years. And even with these cuts the deficit is expected to widen to 2.5 percent of gross domestic product this year from 1.9 percent last year, largely as a result, of course, of the current recession.

Now, if the Italian government are serious about this, and we will need to watch and wait to know since past performance is far from reassuring, then it will leave us with the clear possibility going forward of seeing an Italy with negative GDP growth in full years 2008, 2009 and 2010. Since the little average underlying net growth that Italy manages to achieve these days will largely be undermined by cut backs in government spending and the impact of continuing high energy prices on headline GDP growth.

So the big question is: are the Italian people ready for three consecutive years of falling living standards and cuts in everything, or is Berlusconi going to have trouble holding his coalition together?

Thursday, August 07, 2008

German Exports Rise Again In June

The silver Swan, who living had no Note,
when Death approached, unlocked her silent throat.
Leaning her breast against the reedy shore,
thus sang her first and last, and sang no more:
"Farewell, all joys! O Death, come close mine eyes!
"More Geese than Swans now live, more Fools than Wise."
Orlando Gibbons: The Silver Swan

German exports rose again in June, defying the recent downward trend and pushing the trade surplus to a record. Sales abroad, adjusted for working days and seasonal changes, increased 4.2 percent from May, when they fell 3.4 percent, according to the Federal Statistics Office in Wiesbaden earlier today. This is the largest month on month increase since September 2006, although it is important to bear in mind that May exports were at a pretty low level by recent standards, and in absolute terms this months exports did not get back to the level achieved in April (which was also an unusual month due to the early timing of Easter). So it is hard to read a trend here, but my overall feeling - and strongly so - is that the tendency is down. The trade surplus widened to 19.7 billion euros ($30 billion) from 14.3 billion euros in May, and in general the surplus over the last three months taken together has been stronger than in January to March, so that should be something positive for the otherwise pretty gloomy Q2 GDP numbers.

Exports were up 7.9 percent on June 2007. Imports fell 0.1 percent from May and rose 5.3 percent from a year earlier. The surplus in the current account, the measure of all exports including services, widened to 18.5 billion euros from 7.5 billion euros in May.

Industrial Output Also Up Slightly

German industrial output rose a seasonally adjusted 0.2 percent in June from May, according to preliminary data from the Ministry of Economy and Technology. The May figure for the month-on-month decline in industrial output growth was revised to 1.8 percent from 2.4 percent.

Manufacturing output rose a seasonally adjusted 0.5 percent in June from May, but output in the construction industry fell 2.1 percent, while output in the energy sector dropped 1.3 percent. Year-on-year, May industrial output rose 4.1 percent in unadjusted terms, and was up 1.7 percent after being adjusted for the number of working days.

For the two-month period spanning June and May, industrial output decreased a seasonally adjusted 1.8 percent from the April-March period and was 1.5 percent higher in unadjusted terms, compared with the same period of last year. And if we look at the chart for the seasonally adjusted index (see below), we will see that the level of output has been dropping more or less steadily since January/February.

But Future Orders Down

On the other hand German  manufacturing orders, as reported on this blog yesterday, fell by an unexpectedly steep 2.9 per cent in June, underlining the rapid deterioration of the country’s economic performance and raising fears about the health of the European economy as a whole.

The drop, which was much larger than expected, was the seventh consecutive month-on-month fall, the longest such downward spell in nearly 20 years. The latest figures left the average order level in May and June down 4.4 per cent from a year ago. While the headline orders figure was disappointing, the detailed breakdown is even more preoccupying, since it showed that the weakness in orders had come mainly from abroad. Orders from outside Germany fell 5.1 per cent on the month against a 0.6 per cent fall for domestic orders.

Another cause for concern was the fall in orders from within the eurozone. The drop of 7.7 per cent was almost double the 3.1 per cent drop from outside the region. As we can see in the chart below, sales to the eurozone were up again in June, but this position is hardly sustainable with the zone as a whole more than likely moving off towards recession. Indeed it was the drop in demand last autumn from Spain and Italy which initially set German exports off on their downward trend, in my opinion.

So my guess is that June's exports and industrial output were the pre-summer swansong (or last gasp for breath) before we get into the really serious business of recession.

Wednesday, August 06, 2008

The German Economy May Have Contracted By 1% In Q2 2008

As anticipated on this blog (and in my two posts on RGE European EconMonitor - here, and here) the German economy contracted in the second quarter, possibly by as much as 1% according to the Süddeutsche Zeitung newspaper who somehow or another seem to have gotten an advance glimpse of the economic data which is due to be officially released next week.

The Financial Times reports that government officials initially declined to confirm the report but that one spokesman later told the Financial Times: "The contraction will be in the order of magnitude of minus one per cent." The official added: "Bear in mind, though, that this is partly a correction after the exceptionally good first quarter."

This decline in economic output, if confirmed, is pretty steep and shows that the German economy, like much of the eurozone, is now possibly staring a looming recession straight in the face.

What most analysts seem to have failed to notice was that the 1.5 per cent jump in growth registered in the first quarter – which was the fastest increase in almost 12 years – contained a very strong (0.7%) component due to a sudden sharp rise in inventories. Strip these out of the second quarter - as inventories are reduced again - and you are bound to see some sort of significant correction. Add to this that demand for German exports is slowing, and you get contraction. What we now need to see is the extent to which this negative momentum carries over into the third quarter.

There is of course no suggestion whatsoever that the unusual leaking of the GDP
data out of Berlin could be intended to influence the European Central Bank ahead of its scheduled meeting on Thursday, when it is expected to leave interest rates on hold. Cough, cough, cough.

Industrial Orders Down In June

One indication that the contraction may well carry through into the third quarter was provided by the news this morning thatGerman factory orders fell for the seventh straight month in June. Orders, adjusted for seasonal swings and inflation, declined 2.9 percent from May, the Economy Ministry in Berlin said today. That's the biggest drop since July 2007. Orders were down 6.1 percent from a year earlier.

Now this news is important, since it will be reflected in the July and August industrial production numbers. Foreign sales dropped 5.1 percent, while domestic orders fell 0.6 percent in June. Orders from the euro area declined 7.7 percent and demand from outside the region fell 3.1 percent. That is, the position is clear, economic problems in Spain and Italy are slowly but surely dragging German export growth down, and when Germany has no export growth then recession is guaranteed.

The euro area, which takes just over 40 percent of Germany's exports, probably contracted 0.5 percent in the second quarter, according to the latest estimate from economists at the French bank Societe Generale.

Monday, August 04, 2008

Storm Clouds Continue To Darken Over Spain

August is going to be a long month for Spain. All those people lying on the beaches reading such depressing news day after day. We have three more gloomy inputs since last Friday.

Dire Manufacturing PMI in Spain in July

Spain's manufacturing economy shrank in July at the fastest rate ever seen in any European Union survey of the sector conducted by Markit, the research organisation said on Friday. The Purchasing Managers Index for Spain slipped to its lowest level since the survey began in February 1998, Markit said. The Markit Research Manufacturing PMI index contracted for the eighth consecutive month to 39.2, down from 40.6 in June. Any PMI figure below 50.0 shows contraction while figures over 50.0 show growth.

Eurostat figures show that May unemployment in Spain was the highest in the 27-member bloc after Slovakia, and the government said it expected it to rise to 12.5 percent by the end of 2009. The Markit figures indicate a continued rise in unemployment to the end of the year, with the index's employment rating falling to 38.8 from 39.3. Staffing levels contracted for the 11th month running and the rate of decline has accelerated in each month so far in 2008, the survey showed

Spain's Consumer Confidence Hits Another Historic Low In July

Spanish consumer confidence fell to a new historic low of 46.3 in July from the previous record low of 51.7 hit in June, according to the Official Credit Institute (ICO) this morning. A reading of less than 100 indicates pessimism about the economy exceeds optimism. The index started in September 2004.

The index has only risen in one month (February, just before the elections) in the last 15.

All the sub components were also down.

To help us understand how all this works, and what such a reading might imply, PNB Paribas have kindly prepared a nice chart which overlays consumer confidence (with a 3 month lag) over consumer spending. If this chart continues to give a reasonable representation, then we may expect consumer spending in October to be dropping in much the same way as consumer confidence has just fallen in July.

Spanish consumers may find yet another reason to get pessimistic in a survey of European housing published by ratings agency Standard and Poor's last Wednesday. According to S&P's estimates UK house prices are set to fall by a quarter in total but could find a floor next spring, unlike in Spain, which is set for a longer housing correction.

S&P said the average cost of a house would revert to about 4.4 times average annual earnings - near back to where it was in 2000 - if prices fell by 25 percent overall. S&P said such a drop implied another 17 percent fall for UK house prices, with a trough occurring in April or May 2009, given the market's current rate of decline. The market is down by almost 10 percent since August 2007.

Spain was also likely to see 25 percent peak-to-trough drop in house prices, according to S&P's, but a cocktail of higher interest rates, excess housing supply, and a darker economic climate meant it would take longer to get there, S&P's said.

Standard & Poor’s, also estimated that there are 1 million homes currently looking for a buyer, 500,000 of them newly built. One developer’s association recently forecast as many as 750,000 newly built homes on the market by the end of 2008.

Spain's Unemployment Rises Again In July

Registered unemployment in Spain, where construction firms added more than a million jobs this decade, increased for the fourth consecutive month in July. Unemplployment has only fallen now in one month (February, just before the elections) in the last eleven. The number of people claiming unemployment benefits rose 1.5 percent, or 36,492, from the previous month to 2.43 million, according to the Spanish Labor Ministry. From a year earlier, the number of claimants increased by 23 percent, or 456,578.

Home sales and mortgage lending slumped by more than a third in the year to June. Jobless claims among construction workers grew 5.4 percent in July over June. Unemployment in service industries was up 0.8 percent on the month.

Caja Castilla-La Mancha Exposed To Failing Builders

OK, this is not big beer, since La Caja Castilla-La Mancha is not itself big beer, and the sums of money involved are pretty small, but it is indicative of what is to come.

The Spanish newspaper El Economista are reporting this morning - citing unnamed sources - that Spanish savings bank Caja Castilla-La Mancha has a 40 million euros ($62.3 million) loan with two property companies that are seeking to be put into administration. The companies, Masdevalia and One Properties, are owned by businessman Juan Antonia Roca and are involved in promoting two leisure complexes in Murcia, in southeast Spain.
For the unlisted savings bank, the outstanding loan represents almost double its EBITDA (earnings before interest, tax, depreciation and amortisation) reported in the first half of the year, the paper said. The property companies have asked to be put into administration because they are unable to meet a debt repayment of some 80 million euros in total, El Economista said.

The latest Spanish unemployment figures show a national rise of 23.17% in the number of unemployed, but in regions heavily dependent on residential construction, like Murcia (which is the community where unemployment has risen the fastest), the rise has been far more dramatic, with unemployment up 51.88%. And it is of course in Murcia that Masdevalia and One Properties have been building.

And just to cap it all today, we learn that Euribor (12 months) – the interest rate normally used to calculate mortgage payments in Spain – rose to 5.361% in June, the highest level since the Euro was introduced. Euribor has now risen for 5 consecutive months, and is now 18.2% higher than it was a year ago. Compared to June 2004, when it dropped to its historic low of 2.103%, Euribor is now 156% higher, which is to say it is more than one and a half times greater. The latest rise in Euribor will push up mortgage repayments on variable, annually-resetting mortgages taken out last year by close to 900 Euros per year.

Friday, August 01, 2008

Are Migrants In Spain Now Working Twenty Hours A Day Just To Keep Their Homes?

Well, this is a claim Bloomberg are making today (they just don't seem to want to let up on Spain over at Bloomberg right now), and they have a video interview to back it up:

Immigrants like Fanny Palacios, drawn by Spain's once-booming construction and service industries, helped sustain the decade- long surge in house prices by scrimping and sometimes lying to qualify for mortgages. Now those last on the property ladder are losing the lives they built as the global credit shortage pushes interest rates higher. The single mother of two from Ecuador worked 12-hour night shifts caring for an elderly woman on top of her day job at a nursing home to meet her bank's deadline for 3,000 euros ($4,720) in mortgage arrears. "This is desperation," says Palacios, 30. "I have to pay whatever it takes. I won't let them take my home."

This is a typical TV interview, and is just as superficial as might be expected, and it is also obviously a case of the interviewee giving the interviewer what they wanted to hear, namely that there are a lot of migrants in Spain now struggling to pay their mortgages in situations which make default likely (you know, it's another part of their Spain IS Sub-Prime picture).

Possibly "Fanny" is exaggerating, but not necessarily by that much. A lot of migrants have bought flats, often with a view to renting to other migrants (who may themselves now be leaving). The locutorios in Barcelona are now full of "room to let" stickers, but there are ever fewer takers, as a whole business model steadily crumbles.

The Raval district of Barcelona, home to the largest Pakistani migrant population in Continental Europe ( ie outside the UK, possibly 10,000 strong), who have bought property extensively, is, according to the July survey of consultants Aguirre Newman, the district in Barcelona which has seen the sharpest declines in prices - 12% - over the last 12 months.

Also, I visited, with my colleague La Dona Arruinada, the Fondo district of Barelona recently, and here are some of the photos we took.

As you can see, Fondo is a district which grew during the strong waves of internal Spanish migration in the 60s and 70s. The main Spanish population remaining are now old (Los Abuelos), and the younger generations have sold and moved, to sattelite towns like Olesa de Montserrat, and those who have bought in their place are either migrants or those who rent to migrants.

The photos were taken on a Wednesday morning, and these Chinese construction workers evidently don't have a full order book at the moment.

So basically, I would say that the Bloomberg video is very much to the point, and one of my big queries is what is going to happen to the Ecuadorian and Columbian communities here, given that the men are mainly about to lose their jobs, while the women will largely continued to be needed, in jobs with low pay and long hours, but there will be work for them caring for Spain's rapidly growing elderly population.

Dire Manufacturing PMI in Spain in July

Meantime the conditions in Spain's real economy continue to deteriorate. Spain's manufacturing economy shrank in July at the fastest rate ever seen in any European Union survey of the sector conducted by Markit, the research organisation said on Friday. The Purchasing Managers Index for Spain slipped to its lowest level since the survey began in February 1998, Markit said. The Markit Research Manufacturing PMI index contracted for the eighth consecutive month to 39.2, down from 40.6 in June. Any PMI figure below 50.0 shows contraction while figures over 50.0 show growth.

Eurostat figures show that May unemployment in Spain was the highest in the 27-member bloc after Slovakia, and the government said it expected it to rise to 12.5 percent by the end of 2009. The Markit figures indicate a continued rise in unemployment to the end of the year, with the index's employment rating falling to 38.8 from 39.3. Staffing levels contracted for the 11th month running and the rate of decline has accelerated in each month so far in 2008, the survey showed.

Spain's Inflation Hits A 12 Year High In July

Rising energy costs pushed Spain's EU harmonised inflation to a record 5.3 percent in July, higher than expected, according to the flash estimate from the IME yesterday.The data preceded overall euro zone consumer price data out this morning and which showed inflation in the 15-member currency bloc rose to a record 4.1 percent in July from 4 percent in June.

Spanish consumer price growth, among the highest in the 15-member currency bloc, rose to 5.3 percent from 5.1 percent in June.

It is now quite probable that Spanish inflation has peaked, and could even ease back slightly in August before falling considerably between now and year-end as the severe economic slowdown bites and generally lower oil prices arrive.

Gas Natural Rating Watch Placed On Negative By Fitch

Fitch Ratings has today placed Gas Natural SDG's (Gas Natural) Long-term Issuer Default rating of 'A' and Short-term IDR of 'F1' on Rating Watch Negative (RWN). Gas Natural Finance BV's senior unsecured rating (issues under its EMTN programme are guaranteed by Gas Natural) of 'A+' and the 'F1' rating for its Euro commercial paper programme are also placed on RWN.

The background to this is that Spanish utility Gas Natural have announced they are borrowing 17 billion euros in a syndicated loan provided by ten banks that were mandated yesterday to finance the acquisition of rival Union Fenosa. Barclays, BNP Paribas, Caja Madrid, Citigroup, ING, La Caixa, Royal Bank of Scotland, Santander, Societe Generale and UBS are to lead the loan backing the purchase.

Spanish utility Gas Natural agreed to buy a 45 percent stake in rival Union Fenosa from the debt-ridden builder ACS in a deal worth.

This sale enables ACS (Actividades de Construccion y Servicios SA) to cut debt after booking a net financial gain of 2.73 billion euros ($4.26 billion) from the sale of its stake in Union Fenosa SA. In other words my impression is that simply no one here now has any spare money. Gas Natural helps out ex-Real Madrid president Florentino Perez and his property company, and for their kindness they themselves are put on RWN by Fitch.

The background to all this is that, as can be seen from the chart below, the indebtedness (or leverage) of Spanish corporates (including non-construction corporates) is even greater than the indebtedness of Spanish households, and is way above the average for the other eurozone countries.

Also, according to INE data yesterday, Bankruptcies were up in Q2 by 172% when compared with Q2 2007. On and on we go then, until, of course, the day comes when we don't.