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Economy in Brief

Euro Area: Pre-Brexit Snap Shot of Financial Conditions
by Robert Brusca  June 27, 2016

Brexit came as a shock and now we must monitor all relevant trends to see what will be affected in the post-Brexit period. We also get a look at how trends were performing as we were gliding into the pre-Brexit vote period. The answer for the EMU area financial conditions is that things were not that rosy. Obviously interest rates have been low in the wake of the easy money policies and the proliferation of negative rates around the world. But after what seemed to be a `pop' and some positive reaction to the ECB's initial stimulus programs, both money and credit flows are coming off peak. The new policies are not gaining traction.

Money growth in the EMU has decelerated from 12-month to six-month to three-month from a growth rate of 5.1% to 4.4% to 4.1% on sequence. On that same timeline, private credit has slipped from the anemic growth rate of 0.5% over 12-month to 0.1% over six-month and to -0.1% over three-month. These are not the kinds of reassuring metrics the ECB had hoped to see.

No Supplementary U.K. budget

Today Britain's Chancellor of the Exchequer, George Osborne, has said that there is no immediate need for a supplementary budget and that authorities can handle the market turbulence. Sterling is lower still on the day. Market reverberations continue to be transmitted from the U.K. and onto other markets. And U.K. money growth has been faltering.

Money and real credit trends elsewhere

As we noted, EMU money growth is slightly weaker. EMU credit to residents is steady but weak, while private credit is contracting mildly. Japan's M2-plus CDs is picking up and doing even better in real terms. U.S. real money balance growth shows some slight slowing. Real credit growth in the EMU shows a pullback.

Models vs. people

The monetary side of things looks moribund or worse. And with negative rates in play, central banks already appear to have done `all they can do.' There is, of course, a controversy about negative rates. The problems stem from a parallax view from models vs. the view from people. Models take the numbers at face value and grind out results. They look at incentives and process them through believed economic channels and spit out results: Voila! But people look at the same circumstances and many recoil in horror. Many view the presence of negative rates as an affront and as a threat- for one a threat to their savings. They wonder what's next. It has already been the case that most bank deposits earn nothing or next to nothing in interest. If negative rates progress, people fear having to pay banks for the safe storage of their currency.

In Japan...

In Japan, these fears already are in play. The Bank of Japan did not prepare its markets for its negative rate gambit. As a result, the policy was not explained and the public took it very badly when it was announced. There has been a run on safes in Japan so much so that there is a shortage. And demand for currency has ballooned. Why risk a bank fee when for a small fixed cost you can buy insurance from negative rate changes by purchasing a home safe? Japan has long had a culture that leaned more on currency usage in any case. Maybe that is why it has taken this policy tact to heart. This is a clear example of why central banks need to explain programs before they are installed; surprise programs often bring surprise results.

`Knock on' effects: not simply knocked-off as many worried

In the wake of Brexit, many things are still on process. An early poll in Scotland finds that the Scots are worried about their treatment in the EU but do not want another referendum on U.K. membership. That is one bullet potentially dodged. Another is that in the Spanish election, Brexit seems to have scared the mainstream more than it galvanized the opposition. Rajoy's PP party gained seats (a bit, but not enough for control -so the deadlock continues). Unidos Podemos did not do as well has some has thought. I guess `United We Can' is not the same as `We Want To' (Podemos pero no queremos! PPNQ!). Spain will continue to struggle, but it is less in the grasp of a Brexit scenario than what seemed possible just a few days ago despite Podemos' past gains. Has the Spanish tide turned once the people saw the reality of the U.K. result and market reactions? There are more elections slated for Italy next month that will tell us more about the possible contagion of the Brexit vote.

The road ahead

Stock markets are still somewhat wobbly today and oil is weaker. Economists have cut estimates for growth in the wake of the Brexit vote; most have trimmed them around the edges, but some have offered scenarios of deeper growth losses. We will have to give the U.K. and Europe more time for each side to regain its cool in the wake of some of the hot-headed comments we have seen in the immediate post-Brexit period. The U.K. and Europe still have many strong commercial ties that both sides will want to keep. The U.K. has always been at a bit of an arm's length with Europe having stayed out of the euro-currency mechanism. Any hasty cutting or putative treatment of the U.K. will swing with a double-edged blade. And as we can see from the metrics below, Europe needs all the positive momentum it can muster. Cutting the rope from which the EU and the U.K. both are grasping for support seems like folly. But politics often is folly.

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