Portugal

Greece has announced that it will not pay the IMF the €300 million due to the Fund on June 5.  Instead, it will “bundle” the payments due to the Fund over the course of June into one payment of about €1.7 billion that it will make at the end of the month.  This contradicts earlier pledges that it would not resort to bundling.  The only country ever to have done so is Zambia, three decades ago. While the dramatic move suggests that Athens is seriously contemplating outright default, we think such a move, at this point, borders on insanity.  This is because the gap between the parties over the main issue between them, the size of the primary budget surplus (the excess of revenues over expenditures, excluding interest payments) Greece will have to achieve in the coming years is now very small relative to what it was a year ago - as shown in the figure above.  In contrast, the cost of a Greek default is likely to be a complete cut-off in ECB liquidity support that will crush the Greek banking system and, also likely, force the country out of the Eurozone. Then again, Greece has always had an affinity for tragedies.   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Relentlessly falling inflation is bad news for Eurozone banks.  It increases the real (inflation-adjusted) value of borrower debt and the real cost of servicing that debt.  It causes loan defaults, and therefore bank loan losses, to rise. So with Eurozone inflation, currently at a near-record low of 0.4%, clearly at risk of heading into deflationary territory, what did the ECB say was the “adverse scenario” for this year?  Inflation of 1% – more than twice its current level.  This is indefensible; the ECB’s dire scenario for this year is actually much cheerier than the IMF’s baseline forecast, which pegs inflation at 0.5%.  The country-by-country comparison is shown in the graphic above. Disturbingly, at no point through the end of 2016 is the ECB even willing to contemplate the possibility of inflation being less than it already was in September: 0.3%.  This is a serious failure on the part of the central bank, which this month assumes supervisory responsibility for Eurozone banks.  It suggests that the ECB is more concerned with the reputational costs of acknowledging the possibility of deflation than with testing accurately the ability of banks to withstand it.  As the private sector is not privy to the proprietary bank data that would allow such a proper test, the ECB’s failure to address deflation risks raises the critical unanswerable question of how many of the seven banks that barely passed should actually have failed. Buiter: Four Rescue Measures for Stagnant Eurozone Evans-Pritchard: ECB Stress Tests Vastly Understate Risk of Deflation and Leverage Legrain: Yet Another Eurozone Bank Whitewash Financial Times: Bank Stress Tests Fail to Tackle Deflation Spectre Steil and Walker: Restoring Financial Stability in the Eurozone   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Back in April, we showed that the eurozone countries most in need of lower corporate borrowing rates benefited only marginally from ECB rate cuts. Today’s Geo-Graphic shows that little has changed in this regard; the financial crisis has clearly done serious and lasting damage to the monetary transmission mechanism in Europe – particularly as it affects Greece, Portugal, Spain, and Italy. In April we also showed that the GDP-weighted inflation rate of the countries where the monetary transmission mechanism was working normally – Austria, Finland, France, Germany, and the Netherlands – was 1.8%, right near the ECB’s target of just-below 2%. Thus, the countries that most needed lower borrowing rates needed much more than an ECB rate cut to boost business lending, whereas those where business lending was responsive to ECB rate cuts were not clearly in need of one – at least according to the ECB’s inflation criterion. Inflation in the strong countries, however, has declined significantly since then – it now stands at a GDP-weighted 1.5%. This means that a rate cut at the ECB’s November 7 governing council meeting should be a no-brainer. Sadly, our Geo-Graphic suggests it will also be a no-gainer; the ECB will have to take far more aggressive action to prod business lending in the worst-hit crisis states. Financial Times: ECB Weighs Up Options Amid Concerns Over Falling Prices Bloomberg News: Draghi Weighs Whether Rate Cuts Too Valuable as ECB Meets Wall Street Journal: A Call to Arms for the ECB The Economist: Waiting for the Cut   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Recent developments in Portugal provide yet another example of the growing political strength of anti-austerity forces in Europe.