Notes From Underground: Two banks, no waiting

The Bank of England and the European Central Bank both grace us with their wisdom tomorrow. We certainly expect no change on policy from either institution. The BOE is basking in the glow of a depreciating currency and for the moment, the British debt markets are relatively quiet and rather well behaved considering the weakness of the currency. So we say carry on boys and depreciate your way to prosperity. The ECB would probably like to raise rates just to rile the world, but the PIIGS prevent the Northern Europeans from flexing their schadenfreude. So we will see an unchanged verdict and Trichet will do his dance at the news conference and feed the frenzy of the financial media.

We will stress ad nauseam that the European situation is totally a political story waiting for a political resolution. The economics have been played out and nothing but politics matters. Frauline Merkel needs to put an end to the dance and flex her political advantage to put Axel Weber into the ECB presidency and declare victory.

Berlin reported that average wages in Germany fell for the first time in modern history as the recession took hold. Wages in the manufacturing sector were hit the hardest. This is what makes the situation for the peripherals so difficult. German labor costs are so competitive that it will take severe contraction in wage rates in the PIIGS to stop the bleeding. There is just no way out.

The downward pressure on wages is what makes any economic resolution so dire, for wage contraction is ultimately a credit event starting a negative feedback loop. The only alternative would be a surge in German inflation to ease the burden on the other Europeans but as today’s wage news showed, that appears to be a non-starter. Now we await Friday’s unemployment report and we will have more to write about that tomorrow as we will see more data and hopefully get a better feel on the consensus.

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