Tuesday, March 31, 2009

European Economic Sentiment Falls Again In March

Both the EU Economic Sentiment Indicator (ESI) covering the EU 27 and the eurozone only one declined again in March, though the pace of decline was slower than in the first two months of the year. The indicator fell by 0.6 points in the EU, and by 0.7 points in the euro area, to 60.3 and 64.6 respectively. As a result the indicators for both regions now stand at their lowest levels since the current series was launched in January 1985.

The EU Commission attribute the fall in the ESI to deteriorating sentiment in the industry and services sectors, which both fell by 2 points, and in both regions. In other sectors, the picture was more mixed. Consumer sentiment stabilised in the EU, but fell by 1 point in the euro area. Retail trade increased by 2 points in the EU and by 1 point in the euro area, reinforcing the rebound which started in February. Unfortunately this rebound in sentiment is only reflected in the sales numbers insofar as the rate of contraction (and only in some cases) is declining.

Construction sentiment remained stable at the February level in both regions. Among the largest Member States, Italy saw the most significant decline in sentiment (-4.5 points), while the fall has been more marginal in France and Poland (-1.0), Germany (-0.8) and the UK (-0.4). Economic sentiment recovered slightly in the Netherlands (1.3) and (amazingly) in Spain (0.8).

The financial services confidence indicator – not included in the ESI – improved by 1 point in the EU but deteriorated by 4 points in the euro area, reversing the previous month's gain. Compared to February, managers' expectation of demand for their services worsened in both areas – significantly in the euro area, but to a much lesser extent in the EU.

To a certain extent each country is a "world unto itself" and this can be seen in the shape of the respective index curves.

South Eastern Europe

The economic climate is now deteriorating all over Eastern Europe, but the crisis has set in rather later than in the West. In Romania, for example, the deterioration clearly starts after October.

Central Europe

In central Europe the decline has been a little more muted than elsewhere, as can be seen in the Polish case.

The fall in the Czech Republic has been rather steeper than in Poland, although interestingly both countries "steady up" a bit in February and March, and I wonder to what extent this is a by-product of the German stimulus package, since Germany is a major customer for exports in both cases.

Hungary is, of course, the worst case, and the decline has been unremmiting since late summer. The Hungarian index is now the lowest (32.7) in the entire EU 27.

The Baltics

The Baltic decline is much smoother than the others, for the simple reason that it started much earlier (spring 2007). The end point looks to be not that different though - even if it is unlikely that many will see GDP contractions which are so sharp as the double digit ones which are now looming in the Baltics.

The Eurozone In The East

The two euro area members in the East also have quite an interesting profile. The drop in Slovania is quite dramatic after October (just like Romania) even though the euro in theory gives more protection. This will make an interesting topic for research papers long after the present crisis is over.

Slovakia's drop is much more steady, so there doesn't seem to have been much of a "euro entry" boost, which may, or may not, be a good thing. In any event the decline in sentiment is striking, and gives more food for thought following Moody's recent warning on Slovak competitiveness.

Monday, March 30, 2009

Eurozone Retail Sales Contract For the Tenth Month In Succession

The Bloomberg Euro-Zone Retail Purchasing Managers' Index - based on a mid-month survey of more than 1,000 executives in the euro area retail sector - rose marginally in March - to 44.1, up from 42.3 in February to 44.1 in March. This was the smallest monthly drop in the value of sales in five months, but it was still a drop, and quite a significant one, since the neutral point between contraction and expansion is 50. Still first quarter retail sales have seen an average monthly decline which is smaller than in the fourth quarter of last year (an effect of all those stimulus programmes), however sales have now fallen for ten consecutive months.

The German Sales Contraction Accelerates

Retail sales in Germany, the zone's largest economy, dropped for a 10th month in March as unemployment rose and manufacturing industry continued to grapple with a slump in export orders. The retail PMI dropped to 44.4 from 45.4 in February.

German households are cutting spending as a deepening economic slump forces companies to eliminate jobs, pushing up unemployment. The fall comes despite the decision of German Chancellor Angela Merkel to spend about 82 billion euros in measures to stimulate growth, including tax breaks and incentives to buy new cars.

“Consumers were generally unwilling to spend, while evidence of shorter working hours at local companies reportedly curtailed their buying power,” Markit said in the statement. “The overall decline may have been greater were it not for government incentives to scrap old motor vehicles, which continued to support sales in the automobile sector.”

The Italian Sales Contraction Enters Its 25th Month

Italian retail sales contracted for a 25th month in March as the country's worst recession in more than 30 years prompts companies to cut jobs, in the process eating away at consumer demand. The index was up slightly at 41.9, from 38.2 in February.

Italy slipped into its fourth recession since 2001 last year, sending the unemployment rate to a two-year high. The government has adopted around 40 billion euros in stimulus measures, but is constrained from spending more due to the high level of prior government debt. As a result the OECD forecast the economy will likely contract by 4.2 percent this year.

French Sales Hold Up A Little Better

France also saw a moderation in the rate of sales decline, with the pace easing from February's record but remaining steep. Month-on-month the index rose from 42.6 to 45.7, rounding off a first quarter that has seen the weakest sales performance in the history of the French survey. French retailers have reported falling sales in five of the past six months.

Italy's Economic Contraction Accelerates

There is no doubt about it: Italy's economic situation has worsened considerably during the current quarter. Only last week the OECD forecast that Italy's gross domestic product is likely to fall by 4.2 percent in 2009. This follows hot on the heals of an earlier statement where the OECD said the situation in Italy this year and next was "much worse" than it had previously thought, and that Italy would not come out of its recession until "sometime" in 2010 at the earliest. According to the earlier forecast the OECD expected GDP to fall this year by one percent and then by a further 0.8 percent in 2010.

The Bank of Italy has also changed its forecast, and now suggest that GDP this year will fall by 2.6 percent. In January (the last time they revised their Italy forecast), the IMF forecast a fall of 2.1 percent. This is almost certain to be revised downwards in the April World Economic Outlook forecast review. Only today the Italian employers’ lobby Confindustria cut its forecast for 2009 GDP , saying the economy will contract by 3.5 percent while public debt will climb to 112.5 percent of GDP.

And these forecasts are not drawn like rabbits out of a hat, since evidence of the deterioration in Italy's economic performance is now to be found everywhere, but perhaps nowhere is it clearer than in the most recent exports and industrial output numbers. Italian exports plummeted 26 percent in January from a year ago, the biggest drop since records began in 1991. With the drop in exports leaving the country with a trade deficit of 3.6 billion euros.

Meanwhile Italian industrial output fell for a fifth month as what is now the country's worst recession in more than 30 years forced companies to keep cutting output and jobs. Production dropped a seasonally adjusted 0.2 percent from December, when it fell a revised 3.9 percent. From a year earlier, adjusted production fell 16.7 percent, the biggest decline since records began in January 1991.

As we can see from the revised output index, after remaining pretty much stationary from early 2007, production really started to slump in May 2008, and hasn't looked back since.

Italy's manufacturing PMI fell again in February to 35.0 from January's 36.1, and was only marginally above November's series record low of 34.9.

Italian business confidence fell to a record low in March as concern that the fourth recession in seven years will damp orders more than offset lower oil prices and borrowing costs. The Isae Institute’s business confidence index dropped to 59.8, the lowest since the index was created in 1986, from a revised 63.2 in February.

Italian executives also reported having more problems getting credit in February, when the report showed that 40.2 percent of those surveyed said the credit situation worsened, up from 33.5 percent in January. The new orders sub component also fell, to minus 65 from minus 58 in January, the lowest since 1991. And manufacturers’ expectations for production over the next three months fell to minus 24 from minus 20.

Retail Sales Fall

Italian retail sales contracted for the 24th consecutive month in February as the credit crunch tightened its grip on spending, and consumers put off purchases of cars and home appliances.

Services Decline Confirms Accelerating Contraction

Italian service sector activity sank in February to its weakest level on record, the latest sign of a deepening recession in the euro zone's third largest economy, the latest Markit/ADACI PMI survey and the Index, spanning companies from hotels to insurance brokers, fell to 37.9 from 41.1 in January to hit the lowest level since the survey began in January 1998.

GDP Growth In Long Term Decline

Italian fourth quarter GDP fell a downwardly revised 1.9% from the previous quarter, the largest drop since 1980, compared with a downwardly revised 0.7% contraction in the third quarter of 2008 according to data published by the Italian statistics office Istat last week.

On a year on year basis GDP fell a downwardly revised 2.9%, also the sharpest drop since 1980.

Business investments fell by 6.9% during the quarter, consumer spending fell 0.6%, while exports plummeted 7.4%. As can be seen from the chart below, given the endemic weak state of Italian household consumption, GDP growth tends to follow export growth.

Although, of course, household consumption has now been falling back sharply since early 2007.

2008 data for Italian GDP has now also been published, and again the drop of 1,0% has not been seen since 1975.

Italy's economy will shrink by around 2.6 percent this year, a member of the Bank of Italy's executive board said on Wednesday, cutting the central bank's previous forecast of a 2.0 percent contraction made in January.

Since January, Italian economic data has been consistently bad, with business confidence and purchasing managers' indexes plumbing new record lows. The government pencilled in a forecast of -2.0 percent in its Stability Programme issued in February, but many analysts have cut their forecasts even lower than the BOI. Intesa San Paolo, Italy's largest bank, has a forecast of -2.9 percent.

While Italy’s unemployment rate rose in the fourth quarter to the highest in more than two years as the recession deepened, prompting companies to reduce production and jobs. Joblessness increased to a seasonally adjusted 6.9 percent from 6.7 in the previous quarter, the Rome-based national statistics office said today. The number of unemployed rose to 1.73 million in the third quarter, when 1.69 million people were out of work.

Little Room To Manouevre As The Credit Crunch Tightens

For some time now Italy’s government has been abandoning its optimistic rhetoric and adoptinmg a more sombre assessment of the economy. Giulio Tremonti, the finance minister, recently told a conference that 2009 would be “even more difficult” than last year, with two leading newspapers quoting him as saying Italy faced a “horrible year”.

Tremonti said the government would look next week at providing more to help the growing numbers of unemployed, on top of €8bn it says has already been set aside for extra benefits.

Italian consumer confidence fell for the first time in three months in March, with the Isae Institute’s consumer confidence index dropping to 99.8 from a revised 104 in February.

Growing evidence suggests that the crisis is really hitting the Italian economy in a kind of back-to-front fashion, with the slump in the real economy (and especially the economic crisis in the East of Europe) threatening to drive Italian banks into more and more difficulty. The finance minister is under growing pressure from other cabinet members to increase government spending further, but understandably, Tremonti keeps pointing to Italy’s huge public debt as a major impediment to any serious stimulus plan. So it is simply a question of grin and bear it.

Tremonti admitted at a recent meeting with banks, companies and unions that Italy had seen a greater credit market conditions tightening in recent months than most other eurozone economies. On the other hand he pointed to the fact that Italian banks had shown a “strong interest” in taking up the government-backed bond offer (which only totals €12bn) at the same time as he rejected criticism that the 8.5 per cent interest rate they carry was too high.

Intesa Sanpaolo, which is Italy’s biggest bank by market value, has announced that it will apply for 4 billion euros worth of the bonds after it posted a 1.23 billion-euro fourth-quarter loss on writedowns. This makes Intesa the third Italian lender to take advantage of the country’s bank aid package, following similar decisions by Banco Popolare and UniCredit.

At the same time the credit crunch is evidently producing some sort of housing crisis and the sale of residential properties dropped 15 percent last year, according to OMISE, a government agency that specializes in collecting data on real estate. Property specialists Nomisma forecast house prices will fall 8.5 percent in the second half of 2009, and for a country which has not seen much of a housing boom, this drop is significant. Italian Prime Minister Silvio Berlusconi has announced a housing plan designed to make it easier for property owners to carry out home modernisation. According to Il Sole, Italians will be able to add as much as 20 percent of the current size of their homes without planning formalities. This is obviously rather controversial, and Bank of Italy Governor Mario Draghi was himself pretty non commital in his testimony before a parliamentary commission last week, resticting himself to saying that the “plan could act as a stimulus, although the short-term effect on economic growth is uncertain.”

Moody's Cuts Slovakia's Outlook

Now here's an interesting story. Slovakia has just joined the eurozone, a status most of the rest of the EU's East European members would badly like to attain. But just to remind us that joining the zone, while offering considerable support and protection in times of trouble, is no panacea, Moody's Investors Service have last Friday cut their outlook on Slovakia’s government bonds rating (to stable from positive, implying their is no likelihood of an upgrade in the near future, a possibility which was implicit in the earlier positive outlook).

Moody's justify their decision on the grounds that future investment in Slovakia is at risk due to a combination of factors: the recession in the euro-region, the country’s dependence on the car industry and its falling competitiveness compared with other eastern European nations, many of whose currencies have fallen sharply during the crisis. In fact the Slovak Finance Ministry forecast only last Friday that foreign direct investment into Slovakia will be much lower this year than originally expected - with the Minister stating he expected a decline in FDI to 0.6 percent of gross domestic product in 2009, compared with a 2.7 percent forecast before the economic and financial crisis hit the country.

The worrying thing for me about all this, is not the immediate short term pressure which Slovakia will undoubtedly be under due to the regional crisis, but rather the loss of competitiveness issue, becuase it is ringing bells in my head about what previously happened in the case of Portugal (see my lengthy post on this here). The danger is that eurozone membership gets to be seen as a target you strive to achieve, and then relax into once it has been attained. The Southern Europe experience generally is not encouraging in this regard, and as they are finding out now, the hardest work begins after adopting the euro, since there is no currency left to devalue should loss of competitiveness prove severe.

So I really do wish Jean Claude Trichet would exercise some of that famous "vigilance" on what to do about this issue too, since the long term future of the currency zone undoubtedly depends on getting this one right.

In fact investors are already positioning themselves for a future weakening in the country's creditworthiness. Slovak five-year credit default swaps have been falling back recently, after hitting an all time high of 133.1 earlier in the month, according to CMA Datavision prices. (A basis point on a credit-default swap contract protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year).

But the spread on Slovak government bonds has also been rising (see chart below), and the spread with the 10 year government bond vis a vis the German equivalent was 136.7 on Friday. The chart presents a pretty preoccupying picture, since while bond spreads have all been under pressure since the onset of last October's crisis, it is unusual to see investors perceiving credit risk rising in a country which has only just joined the "gold-digger" club. And Friday's warning shot from Moody's needs to be understood in this context.

The country has seen a huge increase in its car manufacturing capacity in recent years, fueling double-digit economic growth in the quarters before the financial crisis, but amid waning western European demand for Slovak-made cars - including brands Volkswagen, Audi and Peugeot - the country now faces a stalling economy and rising unemployment. Slovak unemployment data for February showed the jobless rate reaching its highest level in more than two years, rising to 9.7% from 9% in January.

Over 75% of the country's EUR332 million stimulus has now been spent, largely giving tax breaks to low-wage earners to encourage them to reenter the work force, and with a fiscal deficit ceiling of 3% of GDP to defend, spending cuts rather than stimulus cannot be ruled out, since VAT returns are falling fast.

So while Slovakia's total public debt only equals around 30% of GDP, pressure on the spread could increase if the country is forced to increase its borrowing. Slovakia only expects to need EUR 5 billion in borrowing this year, and EUR 2.5 billion has already been secured in the first few months of the year.

Strong Economic Slowdown Underway

The Slovak economy slowed further in the fourth quarter of last year with real GDP growing by 2.5 percent year on year. Whole year GDP for 2008 was 6.4 percent with total GDP reaching €67.33 billion. Economic growth had been 6.6 percent in the third quarter, and while there is no official data for seasonally adjusted quarter on quarter growth, I estimate the economy may well have contracted by around 1.5%.

Part of the problem is the drop in export demand for Slovakia's car driven economy, and the country posted a trade deficit in January, as drop in demand was made worse by the suspension of gas deliveries from Russia. Exports slumped 29.9 percent on the year in January, the fourth consecutive monthly decline, and the biggest drop at least since 2006 when the statistics office began compiling data under the current methodology. Imports were down 22.4 percent.

The trade deficit totalled 279.5 million euros ($361 million), following a revised deficit of 341.6 million euros in December. Slovakia posted a trade surplus of 42.3 million euros in January 2008.

The drop in the demand for exports has obviously hit industrial production which decreased by 27 % year-on-year in January reach the biggest drop since the statistics office began compiling data in 1999. Manufacturing output fell 32,7 %.

Construction output was also down sharply in January, falling by 25.6% year on year, although seasonal factors can obviously be playing a part here.

Slovak retail sales fell by 3.3% year on year and totalled €1.3bn in January 2009. The largest contributing factor to this overall decrease was from the category of ‘other household goods in specialised shops’ retail which dropped by 24%. In addition sales of fuels ‘in specialised shops’ retail (15.6%) and the category of ‘retail sales realised not in stores’ (4.8%) experienced significant drops. Retail sales of electronics fell sharply (42.5%), and drops were also witnessed in the categories of: ‘food in specialised shops’ (15.8%); recreation and entertainment (12.7%); other goods in specialised shops retail (5.9%); and retail in non-specialised shops (4.5%).

Worry Now, So As Not To Pay The Price Later

In the short term the Moody's decsion really doesn't mean that much, since Slovakia only had 28.6% (of GDP) in gross debt in 2008, but it is the mid and longer term dynamic we need to think about. Slovakia is about to issue a 2-year zero-coupon bond for an unspecified amount today, but the government debt agency is unlikely to have problems. However, as we have already seen in the cases of Ireland, Greece, Portugal and Spain, simply becoming a member of the eurozone is not a guarantee of anything in economic performance terms (although it does provide almost automatic protection from short term balance of payments crises). So it is important that Slovakia takes the appropriate measures to restore competitiveness now, otherwise we could see the horrifying spectacle of the eurozone's newest member steadily moving over to stand alongside countries like Greece, hovering around near the exit door, struggling desperately to avoid being rocketed out.

Sunday, March 29, 2009

And So It Begins, The Bank Of Spain "Intervenes" In A Spanish Savings Bank

Well , we didn't have to wait too long. Only last Friday I wrote the following:

Two Spanish regional savings banks have already reached a preliminary merger deal - Unicaja, based in Spain’s southern Andalucia region, and the smaller Caja Castilla La Mancha (CCM), located in the central-southern province of the same name - following talks which were carefully brokered by the Bank of Spain. Clearly this merger willl need to be followed by a capital injection from Spain’s Deposit Guarantee Fund to help them clean up the “troubled assets” which will naturally be found in the combined accounts of the new bank which emerges.

Today we learn that the merger is off. It is off for the simple reason that Caja Castilla La Mancha is about to cease to be an independent, autonomous entity. It has been "intervened" by the Bank of Spain. This is the first, it will not, of course, be the last.

According to Noticias Cuatro:
The governing council of the Bank of Spain has taken the decision to intervene in the operation of the Caja after carrying out an analysis of its financial position, thus taking as read that the negotiations which might have lead to its merger with the Andalucian 'Unicaja' have not been able to reach a successful conclusion.

The "intevention in Caja Castilla La Mancha will mean in the first place that the Bank of Spain will now manage the Caja directly via the management commission it is about to establish. Sources at the central bank have given an assurance that all the banks clients' savings are guaranteed. The Bank of Spain will now negotiate with the government urgent measures to guarantee the liquidity of the Caja, and its normal functioning.

In the second place, the Bank of Spain will be responsible for making an immediate detailed evaluation of all the Caja's assets and liabilities. In addition the central bank intervention implies the immediate replacement of the entire previous bank Administrative Council.

The last time the Bank of Spain intervened in a Spanish bank was in 1993, when the central bank too over control of Banesto. The necessary decisions will be taken in the next few hours since all other potential solutions have been discarded, including the assimilation of the Caja with Caja Madrid.

The Spanish newspaper El Pais reports that the Spanish cabinet (the Consejo de Ministros) are holding an extraordinary meeting at 18:00 this afternoon to discuss a proposed Decree Law to inject capital into the bank.

According to Finanzas.com, the "hole" in Caja Castilla La Mancha could be something in the order of 3 billion euros. This money could be paid from the bank funded Deposit Guarantee Fund (FGD), however, and as I said on Friday:

the (FGD) insurance fund holds only 7.2 billion euros in bank contributions, and since this is orders of magnitude less than the size of the problem it is obvious the government will end up having to putting money into the recapitalisation process, and especially into the Savings Bank sector, since the Spanish press has been reporting that 20 of Spain's 45 savings banks are now considering mergers. And it is obviously only a matter of time before one of the mid-sized Spanish banks like Popular, Sabadell or Banesto joins the consolidation process.

So it is not clear at this point how the capital injection process will be financed, nor is it completely clear what will happen to those deposits of over 100,000 euros, the maximum presently guaranteed under the FGD insurance system.

Friday, March 27, 2009

Two Graphs That Tell It All On Spain

First, the one year Euribor reference rate, which has been falling since the ECB started lowering interest rates in the autumn of last year.

And secondly the chart showing the average rate of interest charged by Spanish banks on new mortgages, which as we can see, has been rising steadily since December 2007.

The average interest rate charged by Spanish banks for new mortgages in January 2009 was 5.64%, meaning that the average cost of a new mortgage had gone up by 10.2% over January 2008 (when the rate was 5.1%), and by 1.1% when compared with December 2008. Meanwhile the Euribor reference rate looks set to close this month at all time record lows of 1.91%. In January - the last month for which we have data on mortgage lending - the Euribor rate was 2.27%.

The reasons lying behind this upward movement in Spanish mortgages are twofold. On the one hand the Spanish banks are having increasing difficulty raising finance due to their perceived risk level, and on the other they themselves have have been forced to raise the risk premium they charge to clients due to the rising levels of non performing mortgages they have on their books.

Basically what this means is that the ECB policy isn't working in Spain, and that despite the massive quantities of liquidity provided, the monetary conditions continue to tighten, and doubly so give that the real value of the rates charged (ie the inflation adjusted value) keeps rising automatically as inflation falls.

Mortgage lending in Spain more than halved in January while the number of homes started in the fourth quarter dropped an annualy 62 percent. The 51.7 percent year on year fall in mortgage lending for urban dwellings was the steepest in 12 straight months of decline.

House sales fell in January by 38.6 percent, figures published earlier this month showed, and Housing Ministry data showed the foundations of only 40,737 homes were laid in the fourth quarter - 62 percent fewer than in the fourth quarter of 2007, and 27 percent down on the preceding quarter. During 2008 as a whole, Spanish builders started 360,044 homes - a 41.5 percent fall on 2008. On the other hand 633,228 homes were completed last year, reflecting the optimist which prevailed in 2006/07 when the buildings were started at the height of the boom in 2006-07.

Spain has a supply overhang estimated at almost any number you like over 1 million unsold homes (the minimum estimate, and no one really knows), or more than three times the number of new households created each year in Spain.

The number of mortgages offered has crashed as banks restrict credit given forecasts non-performing loans will reach around 9 percent next year, while unemployment is now likely to rise above 4.5 million by years end, up from the current 3.5 million.

As I indicated in this post yesterday, we are moving from a situation where people the banks were afraid to lend, to one where people become increasingly afraid to borrow (since they don’t know when they will lose their jobs, or even their homes), with Spain's citizens becoming more and more reluctant to take on additional debt due to fears they could be caught in the next round of job losses.

As a result January mortgage lending falling to 6.47 billion euros, while the rate of new bank lending to households dropped to 3.9% year on year.

Spanish debt defaults leapt 197 percent in 2008, with construction and property firms accounting for 4 of every 10 failures. The number of firms and individuals that filed for administration rose to 2,902, the highest level on record, according to Spain's National Statistics Institute. Also bad loans at Spanish banks rose by 15.3 percent in January, the sharpest monthly increase since property developer Martinsa Fadesa filed for administration in July. Bad loans rose more than 9 billion euros to 68.18 billion in January compared with an average monthly rise in the last six months of around 5 billion euros.

The non-performing loans (NPL) ratio for all institutions was at 3.8 percent in January, up from 3.3 percent in December, with rates among savings banks the highest at 4.45 percent compared with 3.79 percent a month earlier. Commercial banks had an NPL ratio of 3.17 percent, up from 2.81 percent. In fact Spain's financial institutions have seen NPLs more than quadruple in the last 12 months from 16.23 billion euros in January 2008.

Spain's savings banks, responsible for about half the country's loans and the most exposed to the property market downturn, could see NPLs rise to 9 percent by 2010, according to the saving banks association.

What To Do With The Bad Banks?

As a result of all this a high profile and pretty public row (unusual in Spain) has broken out over what to do with the broken banks.

The Spanish Economy Minister Pedro Solbes has said the government is prepared to recapitalise healthy banks but suggested that those with serious solvency problems should seek a merger rather than look for state aid.

"In cases where banks have acted correctly in relation to solvency and the health of their accounts...logically they could receive support," Solbes said in a speech to an economic conference in Madrid. "Banks that are unable to remain solvent and clean up their accounts should cease to be players in the financial system so they don't generate distortions in the public sector."

What Solbes has in mind is that the troubled banks should turn to Spain's privately-funded Deposit Guarantee Fund (FGD) should they need capital injections to make tie-ups viable. However, the insurance fund holds only 7.2 billion euros in bank contributions, and since this is orders of magnitude less than the size of the problem it is obvious the government will end up having to putting money into the recapitalisation process, and especially into the Savings Bank sector, since the Spanish press has been reporting that 20 of Spain's 45 savings banks are now considering mergers. And it is obviously only a matter of time before one of the mid-sized Spanish banks like Popular, Sabadell or Banesto joins the consolidation process.

Clearly many of those most directly involved in the banking industry are laothe to accept the Solbes formula, since wuite simply they cannot afford it. And this was made pretty clear by Francisco Gonzalez, chairman of Spain's second largest bank BBVA, when he pointed out last week that nationalisation of the bad banks was the only realistic way forward.

"When a bank shows signs of extreme weakness the authorities should take control of it, which implies removing the directors and reducing or eliminating share capital in the institution," Gonzalez said at a conference in Madrid.Governments should then appoint a new team to separate toxic assets from healthy ones and quarantine them in publicly controlled funds, the chairman said, advocating a level of state intervention not yet seen in Spain. "Then the bank would be privatised again through a transparent sale to private companies," he said, without making specific reference to Spanish banks.

Two Spanish regional savings banks have already reached a preliminary merger deal - Unicaja, based in Spain's southern Andalucia region, and the smaller Caja Castilla La Mancha (CCM), located in the central-southern province of the same name - following talks which were carefully brokered by the Bank of Spain. Clearly this merger willl need to be followed by a capital injection from Spain's Deposit Guarantee Fund to help them clean up the "troubled assets" which will naturally be found in the combined accounts of the new bank which emerges. Many other such regional caja "weddings" are obviously soon to follow. But the big question is, where will all the financing come from? It is pretty clear that the problem which is building up is bigger than Spain can handle alone, and finance (not loans) from the European Union will be needed, with centrally backed EU Bonds being the most likely mechanism with which to fund the injection.

The Euro-Zone March PMI Holds Near February's Record-Low

The Euro-Zone composite Purchasing Managers Index (PMI) rose slightly in March (to 37.6) from the record low of 36.2 registered in February. The PMI reading for manufacturing rose to 34.0 (from 33.6) while the services component was up to 40.1 (from 38.9). (You need to bear in mind that 50 is the neutral point (marking the boundary between expansion and contraction) on these indexes, and any reading below 40 means a very significant rate of contraction).

Bottom, I See No Bottom, Only A Mirky Deep Below

So it now seems virtually certain that the Q1 Eurozone GDP contraction will be far worse than the Q4 2008 one. Taking into account that the eurozone contracted by 0.2% in Q3 2008, and by 1.5% in Q4, then, in my humble opinion, the data we are seeing for this quarter are entirely consistent with a 2% quarterly contraction (or an annualised 8% rate of contraction) or more. As I said last month, not quite Japan territory yet, but certainly not far behind. And for those who simply don't believe the PMIs can tell you so much, here is Markit's own chart, showing the strong underlying relationship between movements in GDP and the *flash* composite PMI. Pretty impressive I would say.

Economic activity in Germany seems to have continued to contract at virtually the same rate in March as in February, as the services PMI was 41.7 (up from 41.3, the sixth straight month of contraction) while manufacturing PMI increased to 32.4 from 32.1. And we are at the height of the stimulus package here. Downside risk for the German economy for the second half of this year now looks very strong indeed. That Commerzbank 7% annual contraction forecast is looking more and more credible.

The German economy's heavy dependence on exports means it has suffered very badly as the global financial crisis has reduced demand for its industrial goods, and March's manufacturing reading came in well below that of France, which was 36.3 (up from 34.8 in February) . The East European connection means it is doubtful that we will see any sort of recovery in German manufacturing industry in 2009, since the economies in the East are now contracting at almost lightening speed.

French private sector activity declined at a generally slower pace in March than in the previous month, but firms reported they were cutting jobs at a record rate, casting doubt over the outlook for the coming months. The Markit/CDAF composite PMI - which combines data from services and manufacturing firms - rose to 39.6 in March, from the record low of 36.7 registered in February. The headline service sector measure was at 42.9 compared with February's 40.2 reading.

Markit's chief economist Chris Williamson, commenting on the results, remained cautious about reading too much into the modest rise. "It throws up little in the way of an improvement in terms of concrete measurements... We could still go anywhere from here," he said, adding that hopes of a rebound in the second quarter would depend on consumer spending.

German consumer confidence declined for the first time in seven months going into April, as workers worried about keeping their jobs in the face of the worst recession since World War II. GfK AG’s forward looking confidence index for April, based on a survey of about 2,000 people, declined to 2.4, the Nuremberg-based market- research company said in a statement yesterday.

As Chris Williamson emphasised "There could be some easing of the pace of decline in the second quarter, that's the general expectation.............But there's still scope for things to go wrong if consumer spending plummets and if exports are hit harder by the euro's strength."