Youth unemployment could prolong eurozone crisis, Christine Lagarde says

IMF chief warns against prematurely declaring an end to the economic crisis, saying joblessness puts future growth at stake

Christine Lagarde, the managing director of the International Monetary Fund, has warned that long-term prospects for eurozone growth look bleak unless politicians act urgently to stoke domestic demand and tackle youth unemployment.

After months of relative calm in financial markets, and with Ireland due to end its painful bailout programme and its reliance on the IMF this weekend, some European politicians have declared the worst to be over for the 17-member single currency zone.

But speaking at the European Economic and Social Committee in Brussels, Lagarde warned against prematurely declaring an end to the economic crisis.

"Can a crisis really be over when 12% of the labour force is without a job? When unemployment among the youth is in very high double digits, reaching more than 50% in Greece and Spain? And when there is no sign that it is becoming easier for people to pay down their debts?"

She warned that high youth unemployment could jeopardise the economy's ability to grow in the future, by creating a generation of young people without the skills to take their place in the jobs market. "What is at stake is Europe's potential for growth in the future," she said.

"Unemployment at a young age means a lack of on-the-job training, depreciating skills, and possible withdrawal from the labour market. Experience tells us that long spells of unemployment lead to a less productive workforce down the road."

Lagarde called for a raft of reforms, including fixing the battered banking sector to "jump-start growth", and warned that with monetary policy all but exhausted, and interest rates already close to zero, governments might yet need to resort to a new fiscal stimulus if recovery fails to take hold.

"In the event growth is low for a protracted period of time and monetary policy options are depleted, fiscal policy will need to provide more support to domestic demand," she said.

In a veiled criticism of Germany, which has tended to rely on an export-led growth model, Lagarde suggested that boosting Europe's growth potential will require stoking demand at home too.

"Most of the demand for European goods and services comes from abroad, not from within, leaving the economy at the mercy of the ups and downs of global trade. European demand for European products remains lacklustre."

After European Central Bank president Mario Draghi unexpectedly announced a cut in interest rates last month to stave off deflation, Lagarde called for the ECB to "keep interest rates low and convince investors that it will do so for as long as is necessary".

The IMF would also like to see a series of labour market reforms, including making it easier for skilled employees to cross Europe's borders in search of work; cutting employment regulation; and shifting the burden of taxation from income on to consumption, in the hope of boosting future job prospects.

"There can be no letting up on reforms until growth has recovered sufficiently to arrest the rise in unemployment and debt," Lagarde said.

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Why central bankers' composure is pure theatre

Federal Reserve, European Central Bank and Bank of England know extricating from stimulus policies is fraught with danger

Central bankers like to project a sense of serenity. The markets may be traumatised and the politicians may be panicking, but nothing fazes the technocrats in charge of our money. They are headmasterly figures: slightly detached but with their fingers on the pulse.

That's the image. In reality, the central bankers are in a funk about the health of their nations' economies and the challenge of extricating their institutions from the stimulus policies that have been responsible for what has, so far, been a tepid global recovery.

Why else would the Federal Reserve have bottled a decision on gradually winding down its bond-buying programme? Why else would the European Central Bank have surprised the markets with a cut in borrowing costs last week? Why else would the Bank of England feel the need to reassure the public that the 0.5% bank rate that has been in force since early 2009 would remain in place until unemployment came down to 7%, barring some unforeseen inflationary shock?

Mark Carney will face the press this week for the first time since he outlined Threadneedle Street's forward guidance in August and the governor will have the job of explaining why unemployment is now expected to come down faster than the Bank predicted three months ago.

On the face of it, this is an easy gig. Carney could stand up and say it is a jolly good thing the economy is doing better than expected and, therefore, interest rates can start to return to more normal levels a little earlier than planned. This, though, is the UK, and here there are really only three economic moods: periods when there is concern that the economy is not growing, periods when the worry is that it is growing too fast, and periods when a combination of steady growth and low inflation is considered too good to last.

For now, the UK appears to have moved from fretting about a triple-dip recession to fears about overheating without any intervening Goldilocks period. Accordingly, the financial markets will be focused in coming months on barometers of excess demand: the housing market, the trade figures, earnings and consumer spending.

Carney will have a period of grace before the markets start to demand action. In part that's because those indicators speaking of problems to come – the housing market and the trade balance – are flashing amber rather than red. In part, though, it is because problems are more acute elsewhere.

For the Fed, it is a question of when to taper, not whether. It wants to continue supporting what is a historically modest recovery with low interest rates and quantitative easing, but thinks the amount of new money creation each month should be reduced.

But it wants to do this without causing chaos either domestically or in the broader global economy. When the Fed chairman, Ben Bernanke, floated the idea of a gradual taper to bond-buying back in May, financial markets threw a fit. The laws of supply and demand have meant that bond prices have risen as central banks have bought more and more of them. The interest rate on a bond goes down as the price goes up, and these interest rates (bond yields) affect how much it costs firms and households to borrow over long periods.

Speculation about a Fed taper pushed up bond yields, which in turn made mortgages more expensive in the US. That put the dampers on the recovery in the housing market.

The same laws of demand and supply meant that electronically printing trillions of dollars has driven down the value of the US currency. It has also created a massive pool of funds looking for places around the world where returns were high. This was not in the west, where both growth and interest rates were low, but the emerging world, where growth was strong and borrowing costs much higher.

Even the threat of a Fed taper was enough to put this process into reverse. Money came flooding back out of emerging markets, putting pressure on their currencies as growth rates were slowing.

Europe has a different problem. Relief during the summer that the eurozone was at last coming out of an 18-month double-dip recession pushed up the value of the single currency. But a stronger currency means lower inflation because the cost of imported goods falls.

Inflation in the 17-nation bloc as a whole stands at 0.7%, well below the ECB's target of close to but just less than 2%. In those countries worst affected by the sovereign debt crisis it is already negative.

Deflation is not always a bad thing. In fact, if you are a saver it is a good thing because your money goes further. For debtors, though, a period of falling prices means that your debt burden increases. If interest rates are rising, then you can quickly find yourself in a situation where your debt is increasingly unpayable even if your income is going up at the same time.

What applies to individuals applies to countries also. Greece is already in a situation where it will require another bailout to make its debts sustainable and it wouldn't take much to push some other countries on the eurozone's periphery – Italy and Spain most notably – over the edge.

Economists at Fathom financial consultants have modelled what would happen to eurozone debt sustainability given plausible (if relatively generous) assumptions for budget deficits, growth rates and inflation. They found that if primary government budget balances (excluding debt interest payments) and growth rates were set at their long-term average, debt sustainability hinges on what happens to inflation.

At an inflation rate of 2%, the level of debt to national output (the debt to GDP ratio) declines for every country in the eurozone, including Greece. At 1%, and assuming a Fed taper leads to an increase in long-term interest rates of 1.5 percentage points in the next two years, debt becomes unsustainable for the peripheral eurozone countries. At zero inflation, even without a taper, debt sustainability is a problem for the core of the currency zone as well.

This threat explains many things. It explains why ECB head Mario Draghi moved so quickly to cut ECB interest rates last week. It explains why there is a lot of nervousness about the upcoming asset quality review of Europe's banks, since they are awash with eurozone bonds. It explains why the Americans, who know a taper is coming, are openly frustrated with Germany's failure both to reflate and to press ahead with banking union. And it explains why the sang-froid of central bankers is strictly for show.

Article Source : http://www.guardian.co.uk
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Eurozone unemployment stuck until 2015, warns European commission

Commission warns jobless total will remain at record 12.2% in 2014, as growth forecast drops to 1.1%

The European commission is warning that it is too early to claim victory in the euro area's fight against recession after its latest forecasts showed it would be 2015 before weak growth generated a fall in the jobless total.

Although the 17-nation single currency zone started to expand in the summer after a six-quarter double-dip recession, Brussels said there will be a lag before the pickup in activity leads to a fall in unemployment.

The commission trimmed its growth forecast for the euro area in 2014 from 1.2% to 1.1% and said unemployment will remain stuck at a record 12.2% next year. It added that there were encouraging signs that the recovery would continue but said the legacy of Europe's debt crisis would continue to act as a brake on growth.

Only in 2015, when growth is expected to increase to 1.7%, does the commission see a dent being made in the jobless total, with unemployment predicted to drop to 11.8%.

Olli Rehn, the commission's vice-president for economic and monetary affairs and the euro, said: "There are increasing signs that the European economy has reached a turning point. The fiscal consolidation and structural reforms undertaken in Europe have created the basis for recovery.

"But it is too early to declare victory: unemployment remains at unacceptably high levels. That's why we must continue working to modernise the European economy, for sustainable growth and job creation."

The commission, publishing forecasts three times a year for the eurozone and the EU, stresses that the return to solid growth in the countries that belong to the monetary union is set to be gradual, with big differences in economic performance across member states. Financial markets believe the combination of sluggish growth, high unemployment and the threat of deflation will prompt the European Central Bank into fresh efforts to boost activity.

Of the bigger euro area countries, only Germany is forecast to grow by more than 1% in 2014. Spain is expected to expand by 0.5%, Italy by 0.7% and France by 0.9%.

By contrast, the commission said the outlook for the UK – which has exceeded expectations in 2013 – was "quite bright". Growth of 2.2% is pencilled in for 2014, rising to 2.4% in 2015.

Article Source : http://www.guardian.co.uk
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Central bankers face fight to keep bond markets calm

Carney & Bernanke have to project gloom that satisfies markets without deterring businesses investing and consumers spending

For the next few weeks and months, Europe's central bankers will be arming themselves for yet another battle with the bond markets. After a brief period of calm following the Spanish debt crisis last year, interrupted only briefly by Cyprus flirting with bankruptcy, the bond markets are tense, poised for a seismic economic jolt.

The situation is complicated, undemocratic you might say, as the world's largest pension funds and sovereign wealth funds vie with each other to maximise their returns safe in the knowledge that only a few people at the heart of the financial system have a clue what they are doing.

One month they pile into sovereign bonds, the next they turn to stock markets. Driven by fear and greed, they swim the international money markets like sharks scenting a profitable kill.

Mark Carney, the Bank of England's new governor, was being sniffed by the markets for a sign of weakness or indecision within hours of his arrival last week.

Four days into his five-year tenure and he took the plunge into giving forward guidance to the markets. The guidance said: "There will be no shocks. We intend to maintain ultra low interest rates for some time", or words to that effect. Mario Draghi, his counterpart at the European Central Bank, took the same step just 90 minutes later, promising an "extended period" of record-low rates.

The problem faced by both men is that much of the bond markets is focused on the US where some major investors believe an end to ultra low rates is inevitable sooner rather than later.

Already, some of the biggest investment funds that populate the bond markets are wrestling with the prospect of the Federal Reserve not only pushing up interest rates within a couple of years, but also bringing its $1 trillion (£670bn) a year bond buying programme to a halt before next summer. After years of feeding on cheap dollars, the party might be over.

And if the US pulls back, there could be negative effects to inflation, commodity prices and the real economy.

The Fed's QE spree, which is set at $85bn a month, makes it one of the biggest bond buyers on the planet. Mostly, it buys US government bonds and in so doing effectively underwrites the Obama administration's growing debt pile.

Until a couple of months ago the only worry among bond investors was how the Fed's purchases pushed up the price of the remaining bonds left for sale. A higher demand for US Treasuries sent returns, known as the yield, spiralling down and encouraged many investors, often against their better judgment, to put their funds into US, UK and European stock markets.

Bank of England's news governor, Mark Carney, like his counterparts at the Federal Reserve and the European Central Bank, has a tough balancing act to master. The huge recovery in the FTSE 100 during the first half of this year can partly be attributed to a share-buying frenzy with money previously locked up in the bond market.

Such was the rise in the stock market that Fed boss Ben Bernanke has now hinted he might start to slow QE. Not switch it off, just slow the pace of growth.

Pimco, one of the biggest bond fund managers, promptly experienced a huge outflow. Its boss, Bill Gross, wrote last week, seemingly with his head in his hands, that panicky investors were blinded by the smoke from recent battles to the long term outcome of the war.

He pointed to the Fed's high tolerance of inflation. Just as the Bank of England has allowed inflation to yo-yo and peak at 5%, so the Fed is happy for its core inflation rate of around 1% to increase to beyond its 2% target, something Gross said would make inflation irrelevant as a guide to behaviour for many years. Then he talked about the likelihood of a dramatic fall in unemployment to the 6.5% level Bernanke has targeted. This target, he believes is also many years away.

"Fed [0.25% interest rate] will not increase until at least mid-2015 and even then subject to a consistently strong economy that produces 2%+ inflation. I wonder if we can get there in this decade to tell you the truth," he said.

Far from endorsing the Fed, he is even gloomier, saying that short bursts of goods news on the housing market or car buying belie the problems all western economies face of growing health and care costs, competition from Asia that drives down wages and a constant technological drive that is de-skilling important white-collar industries from architecture to the media.

"The Fed, we would argue, is too cyclically oriented, focusing substantially on housing prices and car sales. And speaking of housing, since mortgage rates have risen by 1½% in the last six months and the average monthly check for a new home buyer is up by 20–25% as well, then as I tweeted several weeks ago, 'Mr Chairman are you serious?'" Growth will be negatively influenced, Gross added.

Carney faces a similar problem to Bernanke. He needs to convince the bond markets that a decent run of car sales and a booming housing market in the south east of England does not make for a surging economy. And yet he won't want to sound so gloomy that he deters businesses from investing and consumers from spending.

There are many economists, mostly on the monetarist wing, who believe the underlying state of the economy is sound, and with the good times are so close we need to calm things down with higher rates.

So every time Carney sounds even modestly upbeat he will find himself stinging his audience with a bit of gloom.

Can he maintain this balancing act? As we have seen in the last few weeks, Bernanke only needed to allow the corners of his mouth to lift a little, to allow a slight smile, and the bond markets took flight.

The answer must be that central bankers can maintain their balance if they just keep recycling the same message every month for the next few years. Fund managers will, no doubt, read too much into one speech versus another and send demand rocketing, or the reverse, only for the status quo to reassert itself, which is great if you are a mortgage holder or have high debts. Low interest rates for longer is your saviour.

But the bond markets never lose. They will turn away and seek returns elsewhere, sniffing weakness in developing world countries or obscure stock markets. These investments could turn into nasty bubbles and crash, which means people – governments and small investors – getting hurt.

Article Source : http://www.guardian.co.uk

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