Two stories that would be reassuring if they were entirely convincing, and one from a parallel universe ..... Italian banks, post-Brexit cheer and Irish GDP.

Wednesday 13th July 2016

Two stories that would be reassuring if they were entirely convincing, and one from a parallel universe ..... Italian banks, post-Brexit cheer and Irish GDP.

1. ref:- "Merkel soothes fears over Italian banks", The Financial Times, International section

If you were thinking that the small problem facing Italian banks  --  that of 360 billion euros worth of bad loans  --  might just escalate into Europe's next crisis, you might be able to rest a bit easier. At least you might if you take Angela Merkel's latest comments on the subject at face value. Doing well to sound an upbeat note at a very difficult time for the European project, Mrs Merkel played down fears that the impasse between Rome and Brussels on how to rescue Italy's struggling banks might develop into something with truly dire ramifications. Instead, she expressed confidence that the issue could be "resolved well", prompting speculation that Germany might be prepared to give a little in response to Italian demands.

Yesterday's rally in Italian bank shares was evidence that plenty were prepared to buy into the more optimistic tone, but for all the soothing words it's still not clear just how such a fundamental obstacle will be overcome. At its most simple, the dilemma revolves around Italy's desire to offer assistance from the state to the banking system, and EU rules that state that investors in financial institutions (bondholders etc) must take the hit before it starts to cost taxpayers  --  the so-called "bail-in" option. If the rules are watered down in some way, it's not likely to do the EU's credibility any good just at a time when it can least afford further damage.

If Mrs Merkel adopts a more accommodating position towards Italy, she may meet with some serious opposition, not least within her own government. You can always rely on Finance Minister Wolfgang Schauble to give it to you straight. He is adamant that Italy should stick to the rules with respect to its banking problems, and not seek special treatment ..... and just in case anyone was tempted to bring up the old "rich North -v- poor South" accusation again, he also warned Germany's own troubled banking sector against seeking something similar.

2. ref:- "Risk-on mood propels US stocks to highs as sovereign bond prices fall", The Financial Times, Global Overview, Markets and Investing.

Just a glance at the FT's daily market round-up and you'd be forgiven for thinking "Was it all just a bad dream ?". An exaggeration for sure, but  the less pessimistic tone seemed to reflect a more balanced perspective on events even if some asset values continue to push the boundaries. US stocks made record highs again on confidence in the economy, hopes of central bank help elsewhere (Japan/Europe/UK), and a calming of post-Brexit anxiety. This last factor was ushered in by the quick and COMPARATIVELY painless accession of Theresa May as Conservative leader and PM, and saw Sterling sharply higher towards US$ 1.33 .

The generally calmer mood brought on a Risk-on mindset , one in which investors would once again contemplate riskier assets as opposed to the "safety first" strategies of a Risk-off environment. This played a big part in stock market gains and saw the traditional safe havens like government bonds and gold marked lower. This year's favourite port-in-a-storm, the Jap Yen, was particularly under the cosh and is still suffering from expectations of likely monetary easing in Japan.

If the atmosphere really has changed from one of panic to something more pragmatic, for the most part that should be welcomed. But remember, it doesn't take a whole lot to bring such swings in sentiment and it certainly wouldn't take much to send it back the other way.

 3. ref:- "Ireland's 26% GDP growth met with bafflement", The Financial Times, International section

This is an absolute beauty of its type, and will go down as a classic example of how plain statistics can sometimes give a false impression (just slightly!).  Officially, Ireland's GDP grew by 26.3% in 2015 .... yes, really. It was previously estimated that the data would show growth of 7.8%, and that seemed toppy enough even allowing for the distortions of how Ireland collates its figures.

We can put the official (and quite remarkable) number down to corporate "inversions", whereby companies move their assets and/or domicile to Ireland to take advantage of the extremely low 12.5% rate of corporation tax. They do the same thing with intellectual property. Consequently, the data has very little relevance to what is actually going on in the real economy, particularly in the politically sensitive field of job creation. Inflated figures like these may allow politicians to talk about economic recovery, but if the man or woman in the street can only see the recovery in official data releases and not in reality, it tends to play badly at the ballot box ..... which is exactly what happened in February.

Irish data has long been volatile due to the nature of the economy  --  small, open and dominated by foreign direct investment. They are constantly subject to sizeable revisions which is already a huge frustration for investors and frankly the new figures may be one step too far, credibility-wise. Numbers like these may be good for a laugh in the bars of Dublin and beyond but can only be damaging for Ireland in the greater scheme of things.

For 2016 and beyond, many were speculating on how the Brexit vote might adversely affect growth in Ireland, whose economy is so closely linked to that of the UK. It's pretty safe to assume that from a starting point of 26.3% it will come in lower, but how much of the fall will relate to the real economy ? That's really the point about these meaningless numbers .... they're distorted and consequently dangerous.

And one more thing ..... Q1 GDP fell 2.1%. If Q2 should do something similar, then technically Ireland will be in recession. From 26% growth ?? Maybe you've got to laugh, after all.....