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To Be, Or Not To Be, More Centrist? That Is The (Second Referendum) Question

by: Adam Whitehead

Centrism crosses the Channel to Britain with a ticket from George Soros.

The ECB’s current priority is the level of interest rates post normalization.

Germany is trying to tighten fiscal and monetary policy at a time when the Eurozone economy is decelerating.

Eurozone economic growth and inflation have softened in Q1/2018.

The ECB is becoming temporarily more patient about maintaining QE; which may become a more permanent attitude with further softness in Q2/2018.

As France and Germany provide competing visions for the Eurozone of the future, Britain the old enemy in the west and Russia the new enemy from the east frame related new visions of their own. George Soros appears to have a position on this combined new vision and some skin in the game also.

(Source: Seeking Alpha)

For readers, who also love a good spy thriller, the saga surrounding the attempts to keep Britain within the EU is turning out to be a gripping yarn. A previous article noted that Europe, France and the UK were realigning; in a configuration that would enable Britain to re-join the EU without ever appearing to have left it. Since then events have moved on rapidly, with the EU (ex-Austria) coming out in support of Britain in the bizarre case of the poisoned Russian spy. Since then also, a slip of the tongue by Foreign Secretary Johnson has put the matter of the poisoned spy into the realms of Britain's infamous (non-existent) WMD dossier from the days of New Labour.

(Source: The Independent)

The plot now thickens, with the news that a George Soros discovered entrepreneur is creating a new British centrist party that is solidly pro-EU. This new party allegedly has links to Blair & Son, so the New Labour WMD simile is apposite.

(Source: The Guardian)

The party will cannibalize not only the LibDems but also the centrists from Labour and the Conservatives. All that is required now, is for some big names from said incumbents to defect and climb the slippery pole Coningsby style. There should be no shortage of takers, since Labour is currently being framed by the popular media as the party of Islamic Fundamentalism and the Conservatives as the new Far Right.

(Source: Bloomberg)

This plot has now been stirred with the new news from YouGov that Briton's support a second referendum on the negotiated Brexit deal. If they don't like the deal, Britain will remain in the EU by default. This ignores the fact that Brexiteers who vote against the deal, because it is too soft on the EU, will have the unintended consequence of forcing Britain to remain. It should be noted that Prime Minister May is softening her position on EU migrants, so the Brexiteers are highly likely to vote against the eventual deal. Belatedly highly risk averse British business, that has become accustomed to cheap continental labor without having to pay the social costs for the native labor it makes unemployed, has joined the bandwagon. Speaking for this collective confederacy of the risk averse, the Confederation of British Industry (CBI) recently opined that the opportunities presented, by breaking free from European Union regulations, are vastly outweighed by the cost of losing access to Europe's single market.

Confluent, with this risk averse industrial trend, Theresa May's government is alleged to be going soft on its initial plan to exit the EU customs union to seek free trade opportunities. Going it alone is all too much trouble, when presented with a continuation of business as usual. Brexiteers who vote against the riskless status quo, will then have the effect of maintaining it!

(Source: Bloomberg)

The EU has reciprocated with alacrity, in order to nudge Britain back into a closer flexible relationship; so close and flexible as to make Brexit irrelevant in practical detail during the immediate post-Brexit phase. Brexit itself is thus headed towards being a meaningless formality to tick the democracy box for Britain; whilst to all intents and purposes it remains economically, politically and fiscally joined at the hip to the EU, until such time as the two estranged lovers decide to get formally married again.

(Source: The Independent)

For those who see more causality in all of these sequential events, than the gallimaufry presented daily in the popular press, the unavoidable conclusion is that Britain will remain or at least re-join after leaving the EU. In fact Britain never really left. Those with an imagination will see startling parallels between President Macron's En Marche movement and what is currently being undertaken by stealth in the Perfidious Albion with the creation of a new Centrist party.

Brexit risk to both the EU and British economy should therefore be lowered. Indeed, the previous report noted that Brexit ostensibly is a catalyst, for Europe to reform its economy to prevent the abuse of wealth transfers from rich to poor nations without corresponding changes in the recipients' economic and political behavior. The EU and hence the Eurozone by default could yet come out of the other end of the Brexit tunnel unified and reformed! In the meantime, as the saga continues, the ECB is unlikely to threaten the possibility for the best case outcome with tighter monetary policy.

The last report noted that the ECB's current priority is to build consensus on the trajectory of interest rates following the end of QE later this year. A politico-economic bloc within the Eurozone, eponymously named the Northern 8, was also identified and discussed in the previous report. This group is averse to all plans for deeper Eurozone integration, which involve them sharing their own tax bases with nations outside this bloc who have not reformed either their fiscal methods or banking sectors during the post-Crisis economic recovery. The Northern 8 evidently is represented at the ECB level also. Speaking recently, would-be ECB President Jens Weidmann reiterated this bloc's credentials. These credentials also include a more aggressive trajectory for interest rates when the ECB ends QE.

This aggressive rise in interest rates fits perfectly with Germany's "Black Zero" fiscal policy. The new German Finance Minister Olaf Scholz mendaciously used the expected rise in interest rates as the latest excuse for fiscal austerity. Scholz sees normal interest rates in the Eurozone between 3 and 4 percent. Such levels will raise the interest cost of German debt, which will push it into deficit. Scholz sees avoidance of this accounting deficit as justification for cutting fiscal spending in order to get back to the "Black Zero" baseline. Germany is thus calling for a combined fiscal and monetary policy tightening in its own economy. The headwind from this tightening will then knock on to Germany's Eurozone trade partners. As will be seen later, this structural deceleration in the Eurozone's driver economy, may be coming at a time when growth is already decelerating.

The Northern 8 are also doing their best to derail Emmanuel Macron's ambitious deadline to have deeper fiscal and banking union by the summer. Dutch Finance Minister Wopke Hoekstra threw a further spanner into the works recently, when he opined that substance is much better than speed in relation to this matter. The Northern 8 want to see firm rules on budget limits, that cannot be bent by Southern Europe, before they will proceed further towards deeper fiscal integration.

The Northern 8 are also advancing their own agenda to deal with the non-performing loan (NPL) problem. Current febrile attempts to resolve the matter, thus far have only amounted to some prescriptive guidelines for loans that turn sour now and in the future. The Northern 8 would like some tighter guidelines and rules to cover historical loans, that have been sour for some time already. Such a move would put this group directly into conflict with Southern Europe, where most of these loans are to be found.

The non-performing loan saga should now be placed into the context of the softening economic backdrop. Eurozone bankers and their captive politicians have been able to push back against the ECB's proscribed methodology for dealing with NPL's with great success. So successful has this pushback been, that the ECB's own top banking regulator Danielle Nouy recently opined that the central bank's rules and regulations may soon be "made redundant".

ECB Governing Council member Ardo Hansson, a de facto member of this Northern 8, has penciled in his dot-plot of the first interest rate hike by mid-2019. Mid-2019, would also seem to fit Jens Weidmann's view. In addition, Hansson sees the ECB falling behind the curve; if it does not gradually withdraw the QE stimulus before inflation reaches target. Hansson's colleague Vitas Vasiliauskas positively reinforced this message, by then opining that the market was correct to be discounting this higher interest rate trajectory outcome.

Governing Council member Ewald Nowotny also showed himself to be sympathetic towards the Northern 8 movement with his latest comments. Like Hansson, he sees a risk of falling behind the curve; and would therefore like to get ahead of it now with guidance about ending the current phase of QE as summer ends. For Nowotny, the matter is a delicate balance between slowly evolving inflation versus a growing asset bubble underpinned by QE and low interest rates. His views on interest rates, then drew a swift rebuttal from the ECB itself, which opined that "Governor Nowotny's views are his own. They do not represent the view of the Governing Council."

Nowotny had committed the heresy of suggesting that interest rates could rise before the balance sheet is wound down. Chief Economist Peter Praet and Mario Draghi have so far framed the exit from QE as being balance sheet normalization first, followed by interest rate hikes later. If Nowotny was probing to see any possible change, their answer was unequivocally no change. By inadvertently probing however, he did reveal that the ECB's priority is now the level of interest rates when QE ends. The views of the Northern 8 seem resolutely out of sync with the incoming economic data; and should therefore be seen as ideologically rather than economically driven.

There is therefore a growing risk that a Northern 8 driven ECB, with its own representative as President, comes into being as Mario Draghi retires and economic conditions soften. Governing Council member Jozef Makuch outlined this risk, with his latest comment that the lack of a convincing inflation trend still warrants caution in guidance.

Governing Council member Erkki Liikanen was even more overt with his warning about a sudden tighter monetary policy agenda. In his opinion, it is not advisable to begin exiting monetary stimulus until inflation expectations are well anchored and then rising above 2%. He even embraced the new thinking on inflation targeting being promoted within the Federal Reserve.

In Liikanen's view, the ECB's 2% inflation target is also symmetric like the Fed's and not a ceiling. By inference therefore, he will tolerate inflation overshooting target through a gradual removal of stimulus, that would be seen as falling behind the curve by the strictest members of the Northern 8. Liikanen's commentary should be scrutinized closely, because it is alleged that he will be the next ECB President. His view can be seen as an interesting development of Mario Draghi's current Dovish attitude towards the normalization process.

Liikanen's view resonates with those from Southern Europe, where the normalization is looked upon with trepidation. ECB Governing Council member Luis Maria Linde, who requires a well thought out gradual and well communicated process, to be designed and agreed upon by all, articulated the Spanish view. The Bank of Italy has also stated that the normalization can be done painlessly, only "as long as it is done in a context of robust growth and in a gradual way" and also requires "that monetary policy remain expansionary for a long time."

It would be easy to assume that there is a strong conflict over the path of monetary policy within the ECB Governing Council, but this is too simplistic. The risk from an overzealous normalization is currently small, since the Northern 8 still understand that monetary policy will still be accommodative for considerable time after QE ends. They are simply itching not to ease further. ECB Governing Council member Klaas Knot neatly articulated their position recently. In his view, the move to end QE is a global imperative that the ECB must sign up for; even though it will leave a significant stimulus in place when it ends, by reinvesting all the proceeds of the previous and current phases of bond buying.

(Source: Seeking Alpha)

The previous report also noted significant deceleration in the economic data in early 2018 and the ECB staffer's "scary" predictions for softer growth and inflation ahead.

(Source: Econoday)

The latest money supply data also suggests that the Eurozone banks are not supporting the private credit creation process. Consumer sentiment has also reversed from the year end euphoria of 2017, that never continued into 2018. In this softening economic environment, prospects for significantly higher interest rates and even the end of the QE process itself will be questioned.

Perhaps in view of this softness, ECB Governing Council member Erkki Liikanen reminded market observers that the central bank remains data dependent, despite the fact that it has dropped its commitment to ease again from the last guidance statement. Further softness may therefore see this commitment reinserted.

The non-performing loan saga should now be placed into the context of the softening economic backdrop. Eurozone bankers and their captive politicians have been able to push back against the ECB's prescribed methodology for dealing with NPL's with great success. So successful has this pushback been, that the ECB's own top banking regulator Danielle Nouy recently opined that the central bank's rules and regulations may soon be "made redundant".

The Eurozone is therefore heading into an economic slowdown; with banks that have not tidied up their balance sheets, nor raised enough capital to deal with another recession. The credit data already shows that the banks are pulling in their horns, in light of the deteriorating economic fundamentals and their own ugly balance sheets. These banks are therefore nudging the ECB to continue to "do whatever it takes" to keep credit flowing, even though it has not even exited its last version of this sobriquet.

(Source: Seeking Alpha)

The last report noted America's strong leverage over Germany in trade negotiations. This leverage has immediately been applied with success, to the German auto sector; with Angela Merkel canvassing opinion amongst German auto companies in order to apply pressure at the EU level to grant American car exports concessions.

ECB Executive Board Member Benoit Coeure accepted the dubious privilege of officially introducing the potential global trade war into the ECB's policy making process. Framing the trade war as an assault on the established global economic order, he then clearly articulated the effects of tariffs on monetary policy thus: "The first is the effects higher tariffs would have on growth and inflation in the near to medium term…The second main implication is the possible impact on long-run potential output growth, and how that may influence the conduct of monetary policy".

It should be noted that Coeure also explained that his colleagues on the Governing Council are already preparing to remain highly accommodative, even when they eventually end QE, before the headwinds of a trade war are factored into their planning. Coeure told CNBC's Steve Sedgwick, at the sidelines of the European House Ambrosetti Forum, that "I (Coeure) think there's a very broad agreement in the Governing Council of the ECB that a high degree of monetary accommodation will remain needed...because the economy, and in particular the inflation in the euro zone, is not yet where we want to see it". The ECB was already lagging the Fed, who was dragging its feet on normalizing. Recent developments on the data and trade front will have dragged on both central banks, with a disproportionately stronger drag on the ECB.

Coeure's prescient remarks were timed to herald the release of the ECB's annual report to the European Parliament. In the report ECB President Mario Draghi Chief Economist Peter Praet and Vice President Vitor Constancio did their best to take the steam out of the worrying Q1/2018 economic data and emerging trade war threats. All three averred that, despite the continued lack of inflation, the Eurozone economy has enough momentum to weather the storm; so that there is no current need to change the strategy for the gradual normalization telegraphed by the Governing Council at the beginning of the year.

Governing Council member Ardo Hansson sought to frame the recent economic and inflation weakness as transient. In consequence, he believes that the ECB should be a little more patient in maintaining its current QE phase. Should the softness endure into Q2, patience may then morph into questioning the scheduled timetable for exiting QE. This is by no means a call for further easing, it is however ostensibly an easing outcome by nature of averting the beginning of the normalization.

According to the minutes: "The view was put forward that the Governing Council's criteria for a sustained adjustment in the path of inflation could be assessed as close to being satisfied over a medium-time horizon," but then, "however, the broadly agreed conclusion was that the evidence for a sustained rise in inflation toward levels consistent with the Governing Council's inflation aim was still not sufficient." The softer economic data and trade war rhetoric since then, will have reinforced the Governing Council's patient posturing.

The growing euphoria surrounding the win-win Brexit prenup under construction, will have given the ECB confidence. The devil is however in the detail and nothing has been officially drafted or signed yet, so the ECB will retain its patience until confirmed otherwise.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.