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Beyond Ratings Weekly Digest

Your briefing on augmented financial risk analysis

N°130 ▪ 25th January 2018



Executive Board of the European Central Bank: European you said?

Over the next two years, the European Central Bank (ECB) will see some new faces in its Executive Board, with four of the six Executive Board members’ expiring in this period. The date of October 31, 2019 will certainly mark the culmination of the metamorphosis of the European institution based in Frankfurt, with the end of ECB head Mario Draghi’s mandate reaching its end. Although, as the current governor of the Bundesbank (Buba) Jens Weidmann states, “a central banker is not a politician”, , some personalities have already started to run for vacancies, including that of (super) Mario Draghi.

The chronicle of departures of the four members of the Executive Board is as follows:

– Vitor Constãncio, Vice-president, will leave on May 31, 2018;

– Peter Praet, Member of the Executive Board, will leave on May 31, 2019;

– Mario Draghi, President, will leave on October 31, 2019;

– Benoît Cœuré, Member of the Executive Board, will leave on December 31, 2019.

If the nationality of the successor to the Italian Mario Draghi should have little importance, the fact remains that several different European capitals have started to push their pawns. The first one to leave the ECB Executive Board is the Portuguese Vitor Constãncio; Spain is banking on its Minister of Economy, Luis de Guindos, to replace the institution’s current Number 2. This first appointment is expected to take place officially in March. If Southern Europe (the doves) remains at the vice-presidency of the ECB, the presidency could probably pass into the hands of Northern Europe (the hawks). Jens Weidmann serves as a favourite in the race to succeed Mario Draghi. While observers like to label him as a hawk, he spends a lot of time tempering the words of some of his German collaborators, making him perhaps a hawk among hawks… Other names, such as that of the current governor of the Bank of Ireland Philip Lane, have also been mentioned. While his economic background and reputation are his first assets to run for the ECB’s presidency, some see him more in place of the current chief economist Peter Praet or Benoît Cœuré, who will leave in 2019.

At the same time, the name of the French François Villeroy de Galhau, the current governor of the Banque de France, comes up often when we talk about Mario Draghi’s successor. While his profile fits perfectly with the position, he has one major handicap in this campaign: his nationality. Indeed, a Frenchman has already held this position just before Mario Draghi while it is not yet the case of the Germans. Some would see him in another role: that of Finance Minister of the Eurozone, an important position that could emerge if the European Union is moving quickly in the construction of a European government.

At the end of the day, the new faces and especially the nationalities of these new faces are highly strategic and political. Indeed, if Madrid pushes de Guindos’ candidature to the vice-presidency, Mario Draghi’s place would have a great chance of being occupied by a German and it is currently the candidacy of Jens Weidmann that seems to make consensus. This is why the nationality of the future Number 2 of the institution is a strong signal as for the choice of the nationality of the future Number 1… Indeed, while the ECB starts its turn towards the normalization of its monetary policy, to put a hawk in the presidency of the institution based in Frankfurt and a dove to the vice-presidency would  more rapidly bridge the monetary policy gap between the United States and the Eurozone at a time when we are no longer talking about recovery but economic expansion within the monetary union. When globalization is weighing on structural low inflation across the world, it seems highly likely that a financial crisis – if there is a financial crisis – is to become quickly systemic. The ECB would then lack some room for manoeuvre on monetary policy to absorb this type of shock while on the other side of the Atlantic, the balance sheet of the Federal Reserve is already declining.

To be continued…

Julien Moussavi, Head of Economic research



Sovereign Risk

Is the euro too strong? A part of the answer could be in the 5Y5Y inflation swap forward spread between the United States and the Eurozone

On Wednesday January 24th, the EUR/USD parity was almost 1.24 during the trading day, bringing the EUR appreciation to almost 20% in just over a year. The EUR jump raises the prospect that the ECB Governing Council will reinstate language in its statement warning that volatility is a source of uncertainty that requires monitoring. This wording was last used in September 2017 after a 14% appreciation since the start of the year — and prompted the European common currency to weaken over the next two months.

EUR/USD parity vs 5Y5Y inflation swap forward spread between the U.S. and the Eurozone

According to the above chart, it seems that the EUR/USD parity is relatively well anticorrelated to the 5Y5Y inflation swap forward spread between the United States and the Eurozone. As a reminder, these series are measures of expected average inflation over the five-year period that begins five years from reported date. On the above chart, we compute the difference between the United States and the Eurozone series. Over a period of about 10 years, the anticorrelation between the EUR/USD parity and the above computed 5Y5Y inflation swap forward spread is c. -52%. However, it seems that this anticorrelation fades over the recent period. Moreover, a consensus seems to emerge on the pain threshold, i.e., the point at which appreciation begins to weigh on the real economy. This pain threshold is 1.25 and according to economists at ABN Amro, the recent EUR strength will reduce the ECB’s core inflation projections by around 0.1-0.2 percentage point. This could postpone the start of the ECB’s normalisation cycle.

All in all, if the first ECB meeting of 2018 pays attention to the EUR volatility and strength, the EUR/USD parity could quickly return to 1.20. However, the Eurozone economic expansion should remain a bullish factor on the single currency.

Sources: Beyond Ratings, Datastream



Productivity, working time and paradise

Productivity and working time

Across OECD countries and partners, there appears to be a strong relationship between working time and worker productivity. This reflects the fact that the more a worker is efficient the less he or she needs to work to create the same level of wealth and, in case of stable breakdown between labour and capital, a constant revenue. Nevertheless, two countries fall out of this pattern: Luxembourg and Ireland. For Ireland, the gap can be partially explained by the share of labour income in GDP that is low compared to the OECD average (35,2 % vs an average close to 50%). Moreover, productivity distance to standards for Ireland and Luxembourg questions the materiality of their GDPs and/or their local reality. In other words, would this be a way to identify tax heavens?

Sources: Beyond Ratings, OECD, ILO


Carbon/Climate Change

The European Commission and air pollution: should we take action?

Relationship between air pollution and government expenditure on pollution abatement, 2015.)

The European Commission has recently announced a ministerial summit on January 30. in Brussels with nine countries, including France, Germany and the United Kingdom, subject to infringement procedures for non-compliance with air quality standards. These countries are among the 23 that exceed the EU emission limits for nitrogen dioxide or particulate matter (PM10), pollutants particularly related to road traffic and are dangerous for health. The Commission has decided to convene in Brussels with the Environment Ministers of the nine Member States – including the Czech Republic, Spain, Italy, Hungary, Romania and Slovakia – against which it intends to seize the Court of Justice of the European Union (CJEU). Continuous rise of air pollution could thus quickly become a concern for European public debts sustainability. In a situation of low fertility rate, induced excess mortality by air pollution (more than 400,000 citizens die prematurely every year in the EU because of poor air quality, which also causes respiratory and cardiovascular diseases, according to the Commission) could also undermine European potential output growth in the future.

Source: World Bank, IMF, Beyond Ratings





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