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market throughout the four year old eurozone crisis on the one hand it regarded sovereign bond holders as greedy opportunists looking for german taxpayers to bail out their bad bets on the other hand those same traders were a useful tool to keep pressure on wayward governments particularly italy that were in dire need of economic reforms to spur growth in the view of many german critics there has been no serious effort by the italian government be it in the fading months of mario monti s premiership or during enrico letta s foreshortened tenure to undertake major economic reforms since ecb boss mario draghi first announced he would do whatever it takes to save the euro in july 2012 the bond buying progamme that the german constitutional court grumbled about last week known as outright monetary transactions was the product of that speech 18 months ago and has kept the crisis at bay ever since helping keep italian borrowing costs near pre crisis levels leaving aside the problem of mechanism how could mr draghi or anyone else have stirred up participants in the italian democratic party s primary election the potential synergy between the two developments the karlsruhe ruling and the new government in italy is more than evident the key part of the background here as wolfgang munchau has already pointed out is that the german court ruling effectively left omt which only ever had a virtual existence and was increasingly seen as an empty bluff since it was clear no one was going to accept the conditionality side deader than that infamous dead duck karlsruhe s objection to the existing bond buying programme was that it went beyond the ecbs mandate since directly financing government debt is prohibited under maastricht and the objective of omt was to help governments finance at an affordable price since break up risk which could have offered an alternative justification for omt is for the moment off the table omt lacks definitive legal justification and in practical terms the emperor visibly has no clothes it is just a question of how long the markets need to wake up to the fact under these circumstances as one argument would have it it is only a matter of time before market sentiment turns and peripheral spreads come back under pressure at which point omt would be tried tested and severely found wanting while i think this risk to peripheral spreads in the short run is probably overstated since at this point market participants are so bullish they are effectively immune to flashing red light warning signals letting italy simply drift does involve a high level of potential risk and certainly a higher level of risk than a prudent central banker might want to run so that part of it i buy mario draghi would be at least rooting for renzi even if he wasn t doing anything to actively make his wish come true but then enter the deflation threat the ecb is and not without justification see the above chart showing the movement in 5 year index linked forwards prepared by commerzbank s michael schubert concerned about the possibility that longer term inflation expectations could become anchored well below the 2 price stability level the maintenance of which the ecb does consider to be its mandate aggregated inflation across the 18 countries who constitute the monetary union has fallen and remained below 1 for an extended period of time now in several eu countries prices have actually started falling in others inflation has dropped to very low levels of 0 5 or below greek inflation is currently running at an annual rate of minus 1 4 and has been in negative territory for eleven months now see chart above worse still and again as wolfgang munchau points out there is a real risk that the periphery economies drag the german inflation rate down along with them germany s federal statistics office said last week that real wages after inflation fell in 2013 this was unexpected because other surveys suggested they had gone up what seems to have happened is profit related pay and other hard to measure components of wages came down last year for the eurozone german deflation is a nightmare if the periphery wants to become more competitive it needs lower inflation than germany but if germany too is deflating then either the competitive adjustment will not happen or the whole of the eurozone goes into deflation or more likely both insee the french statistics office announced that the annual rate of core inflation without volatile items and tax measures dropped sharply from 0 6 per cent in december to 0 1 per cent in january factory prices are another forward looking indicator according to data from eurostat the eu s statistical office they went down in the eurozone as a whole by a whopping 0 8 per cent annually in december as he says deflation in germany would become a true worst case scenario nightmare for euro area monetary policy so with the risk continuing to rise the bank will need to do something and some version of japan style bond purchases seems to be the most likely thing it will do lowering interest rates or more initiating more ltros simply wouldn t have a big enough impact which doesn t mean that both of these might not happen taken as part of a broader package this time the ft s david oakley explains at last after resisting for so long the european central bank looks closer to implementing its own version of quantitative easing to spark growth across the eurozone investors and strategists expect about 30 per cent of the bond buying will be in german bunds in a 400bn programme the ecb would then likely buy about 20 per cent in french oats 18 per cent in italian btps 12 per cent in spanish bonos with the rest being bought in the other much smaller debt markets the german constitutional court has asked the european court of justice to make a ruling on outright monetary transactions which mr draghi introduced as a backstop to the eurozone in the summer of 2012 although outright monetary transactions would involve buying government bonds it is not the same as qe as it would be introduced in the event of a run on one or more of the debt markets the ecb could successfully argue that qe which involves buying a range of bonds to lift inflation was within its remit as it is designed to bring about price stability so the initiation of some kind of bond purchases programme at the ecb is looking increasingly likely if such a programme is implemented it will differ from omt in the justification offered to try to attain the bank s inflation objective the fact that the bank will buy bonds from all countries according to their weight in euro area gdp and by the fact that there will be no conditionality attached naturally the fact that they will initiate such a programme doesn t necessarily mean it will work and achieve its objective as we can see in japan the effectiveness of the policy is questionable but then a central bank can hardly say deflation ahoy but there s nothing we can do about it whether or not it is possible to reflate economies which have entered some kind of enduring process of secular stagnation as larry summers obviously thinks you can or see here remains an open question as far as i m concerned if part of the problem is demographic as i explain here and here in the context of abenomics then it is hard to see how you can possible we need to start to learn to live with deflation and find ways of managing the impact on the financial sector as the ft s david pilling so cogently put it recently in the japanese context monetary policy can t print babies and one day or another as our workforces accelerate their decline it may be hard to sustain positive growth maybe there are some realities looming out there that we are just not ready or able to accept yet but going back to renzi the initiation of sovereign bond purchasing type qe will surely mark the beginning of a japanese turn in ecb policy it may start with just 400 billion but it could then grow and grow especially if the structural weakness in domestic demand continues to exert a downward pressure on prices even despite the money printing so just who might benefit from this well you don t have to be excessively astute to see that italy would be prime candidate the country currently has a gross government debt to gdp ratio of around 135 small when compared to japan s level of nearly 245 but still it is large and rising especially if italy continues to push on its fiscal deficit limits and they will need to do this since there are no signs that the country s economy like its japanese equivalent can grow any faster than it did before the global crisis without ongoing fiscal stimulus pushing the debt upward much beyond the current level without being forced into some kind of debt restructuring would seem to be be virtually impossible unless unless the ecb start to buy the bonds so could matteo renzi who doesn t seem especially worried by the size of italy s public debt levels be just the man for the job the key to the new win win strategy would lie in the renzi s aim getting agreement to increase the country s fiscal deficit rather than as previously lowering the bond spread in exchange for structural reforms basically any ecb italian bond purchasing would ease pressure on renzi in the short term mario would have renzi s back provided he complied with the reforms and if he didn t well then more than likely he would simply go the way of enrico letta and to those would argue that all of this goes beyond what the german public have come to expect from euro area policy i would suggest that all of what is about to happen was already evident when mario draghi used the famous whatever it takes phrase he meant what he said as i argued in october 2012 in a post entitled taking a man at his word the heart of the issue is that mario draghi has vowed to do enough and enough seems to have no limits so what could the ecb do if we really put our imagination to work on the issue well like ray dalio argues they could print money lots of it even to the point of doing it helicopter style those people who think the ecb is already printing money which they aren t necessarily doing when they increase their balance sheet ain t seen nothing yet that s what the it will be enough promise means none of this is in the mandate yet naturally it isn t but it could be and it would be much easier to put more in the mandate than it would be to keep going to the german parliament to ask for more money so it could and most probably will happen when you re crossing that rope bridge and it starts to creak and sway then you just have no alternative but to continue moving towards the other side we have all seen far too many movies about what happens to the people who try to turn back posted by edward hugh at 8 38 am no comments friday august 10 2012 is the italian elephant about to break loose again market nervousness about italy has been growing in recent weeks with the moody s credit downgrade of the country being only one of the reasons a bailout is clearly in the offing with the only real questions being how and when while the situation inside his country appears to be deteriorating mario monti has been doing the rounds of european capitals in an attempt to drum up support while in helsinki he raised an eyebrow or two when he warned that without a serious plan to bring down interest rates disaffection with the euro in his country could easily grow to dangerous proportions crying wolf or a piece of insider information probably a bit of both italy is in a deepening recession which has now lasted for over a year monti himself has ruled out the possibility that he could continue in office after next spring s general elections while at the same time silvio berlusconi is constantly hinting that he would not be averse to accepting prime ministerial office again should his country need him all of which makes me ask myself just over a year after my is italy not spain the real elephant in the euro room post whether in fact the currently chained beast is not about to break its tethers and go for a crockery breaking rumble round the euro living room what follows is a summary of a revised version of a presentation i gave in cortona last autumn i have put the presentation online here low growth and high debt a highly combustible cocktail just as i highlighted in the case of portugal in my recent post italy s problem is long term growth this is not a passing phenomenon but one which has been getting steadily worse over decades italy has lost growth at a pace of about one percent a year over the last four decades if the pattern continues italy gdp will drop over this decade and continue to do so for as far ahead as the eye can see to give us an idea of what this means italian gdp at the end of june was at the same level it first reached in the second quarter of 2003 if the current recession continues as forecast by the italian government during this year by december we will be below the gdp level of december 2000 which is another way of saying that it will be below the level first attained some 12 years earlier if the recession is slightly deeper that the current government forecast and continues throughout 2013 certainly not an excluded scenario we might even arrive at levels first seen in the late 1990s in the meantime the country s population will have risen from 57 million to 61 million hence gdp per capita will have fallen substantially this is not a situation either to be taken lightly or one which it will be easy to turn around there are a variety of reasons for this sharp drop in growth momentum some of the reasons are undoubtedly as i will argue demographic others are associated with the loss of international competitiveness experienced by the italian economy since entering the european monetary union once clear indication of the extent to which the deteriorating growth outlook is associated with cometitiveness loss is to be seen in the correlation between worsening growth performance and the deteriorating current account balance double dip recession italy first fell into recession at the end of 2007 some months before the other euro area countries and didn t come out of it again till the start of 2010 so the economy contracted for two full years gdp fell by 1 2 in 2008 and by 5 5 in 2009 after an 18 month recovery the economy again fell into a second double dip recession around the middle of 2011 after a surge in borrowing costs forced the government to apply stringent austerity cuts in an attempt to recover investor confidence in the three months up to june gdp contracted for a fourth straight quarter falling by 0 7 percent over the previous quarter we don t have the detailed breakdown from the statistics office yet but it seems clear the contraction was again led by sharp falls in consumption and investment as concerns about the fiscal outlook and the euro area crisis depressed confidence and tightened 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