Housekeeping and S&P

You can see a quick snippet of my contribution to the Bloomberg report on Ireland today here.


But for now, the main piece of news of the week so far is the S&P downgrade of Irish Banks.

The downgrade is the second in just 4 months - took Ireland's Banking Industry Country Risk Assessment from Group 1 (prior to December), to Group 2 in December and now to Group 3. We are now in the sick puppies crate with Portugal, Austria and Japan. The first (December 2008) downgrade was based on S&P's negative assessment of banks loan books exposures to housing and construction. The latest downgrade is based on an all-but-silly argument that Anglo Irish Bank loans scandal has undermined reputation of Irish Banking, as if a litany of bad loans did nothing of the sort, or as if unethical manipulation of the banks books via cross deposits between IL&P and Anglo did nothing of the sorts.

More importantly, S&P has also threatened a further downgrade due shortly - this time on the back of "significantly weaker long-term prospects for the Irish economy". Such a downgrade will place us in a banking ICU with Greece, Israel, the Czech Republic, Slovakia and Slovenia in the neighboring beds.

But the real unspoken issue remain unaddressed.

• The Irish taxpayers have guaranteed the banking system's liabilities, nationalized one of the big 3 banks and committed to injecting capital into other.
  
• Yet, the ability of the Exchequer to cover these commitments has been deteriorating at a speed that would make Einstein's theory of relativity go bonkers.
  
• In the mean time, not-too-often remembered smaller banks, building societies and credit unions are getting their closets opened up by scandal-seeking media. And rich pickings these parish-pump financial institutions present under the inspecting lens of public attention.
• All along, housing markets are still falling, commercial property is heading South like a flock of geese sensing a winter chill and the economy is shrinking like ceran wrap on a fireplace mantle.

So here is a question that S&P is trying to avoid so desperately and our Government is bent on denying with the trustworthiness and passion of the banker telling the markets "Our books are sound and we need no new capital": Given Irish Exchequer decision to blend public debt with banks' liabilities and capital exposures, why should Ireland's General Government bonds be rated AAA?


Rome or Reykjavik?
In the mean time, economic silliness (I am avoiding here a much stronger word) continues to grip the Government, as the latest statements by Minister for Finance (see here), attest.

“A lot of political pundits say the choice next time for Ireland will be Rome or Reykjavik,” Lenihan said on Bloomberg TV today. “Most people will vote for Rome."

Yes, Minister, we get the historical pun. But do you actually mean what you are saying?

Ireland is already in the company of Rome in many senses. Being a part of the APIIGS countries we are in a club of the sickliest countries in Europe (and OECD) alongside Italy. We have surpassed Italian levels of unemployment and, should we adopt Minister Lenihan's suggestion and chose Rome, we will be settling into a trend (long-term) growth rate of 0.5% annually over the next 30 odd years. But then again, we have already surpassed Italy as a more corrupt society (according to the World Bank) and as our economy shrinks by 7+% this year and 16% between 2008-2010, we are well on track to be the Mezzogiorno of the North Atlantic (minus weather, food, wine and beaches of Sicily). And, of course we are heading for the glorious 100%+ public debt to GDP ratio should Brian Cowen, have his way with the economy. So, Mr Lenihan, is Irish Government really bent on getting Ireland to join Rome? Is this what you will be telling the international investors?

In reality, what this comment illustrates is that Mr Lenihan is much better fit to be a Minister for Justice than a Minister for Finance, for even his European references set is so limited to the legalities of European treaties that he forgets that the brief he has is in finance!

But there was more to Lenihan's comments than Rome v Reykjavik blunder. “The ECB stands behind the entire Irish banking system, just as the Bank of England will stand behind the banks in the U.K.,” said Lenihan. “So there’s no default issue in relation to the banking system.”

Irony has it, I predicted after the last issue of Government bonds in February that in effect Ireland is already being rescued by the ECB. Now, we have a confirmation. Mr Lenihan's reckless actions on Irish banks have been preconditioned upon his belief that the ECB is going to back him up!

Here are two follow up questions to this statement:
1) If this is true, when did you negotiate with the ECB actual arrangements for emergency financing for Irish banks?
2) Do Germans and French know about this ECB commitment to Ireland?

Lenihan said nothing on this, other than claim that Ireland will be "in a position to fund ourselves as a state this year and the European Central Bank stands behind our banking system... So we’re a solvent state and we’re well able to do our business.” This is eerily reminiscent of Eugene Sheehy's infamous battle cry that AIB will not take any public money last Autumn. We know how that one turned out in the end...

Setting aside the arguments as to whether or not Mr Lenihan can actually finance our Exchequer deficit this year, can we please see the actual contract that commits the ECB to underpinning the Irish Government guarantees to the Irish banks and provide capital to these banks?

Eurozone: The High Cost of [Corporatist] Complacency

An interesting article from the Economists’ Voice (Éloi Laurent "Eurozone: The High Cost of Complacency", January 2009) argues that while the Euro is politically and economically attractive to a host of collapsing smaller economies, the Eurozone itself "is inert".

"How to make sense of this seeming contradiction?" asks Laurent. "It is tempting to blame America for Europe’s recession, but... Actually, if we view the last decade as a whole, we see that European passivity has cost it dearly and there lies the key to the Eurozone’s still unfulfilled promise."

Laurent's view of the Eurozone's failures reads like a description of what has happened in Ireland.

"...The ten years between 1999 and 2008 have been a golden era. There probably was not a better time in contemporary history to launch a monetary union and, learning by doing, to build efficient and resilient economic policy institutions to ensure its prosperity and sustainability. Yet, the decade was largely lost by Europeans in vain doctrinal debates and sterile blame game sessions. ...The reason [that technocratic debate] absorbs so much time and energy [of the European leadership] is that, absent a true democracy, economic doctrine has become over the years the justification of political power in Europe."

Laurent is only partially correct. Indeed, the technocratic economic doctrine debates have been a marker for European political landscape since 1999, but the debates became so central to the EU functioning because of the dogmatic pursuit of social consensus as the only benchmark for policy success. In other words, absent real democracy, the EU had to devise a deus ex machina replica of legitimizing democratic institutions. This is what social consensus - or corporatism, as it became known in Europe in the 1930s and 1940s - predicated upon.

The problem is that social consensus fails when ti comes to the need to formulate potentially unpopular and decisive policies. "With virtually the whole planet booming over the past decade, the Eurozone has, since its creation in 1999, displayed the worse performance in terms of growth and unemployment of the developed world, barely ahead of a depressed Japan."

What was the EU response to this crisis of insufficient growth? "One might conclude from [international comparisons] that the value added of the Euro is so far, at best, dubious and wonder why. But the European Commission did not, and recommended instead more of the same economic policies, stressing the importance of “budgetary surveillance” for the future and dismissing calls for improving economic cooperation and coordination among member states. [Thus] the ECB made in 2008 the exact same mistake as in 2001 by resisting a necessary cut in interest rates (actually, it increased interest rates in July 2008), waiting for the worst to be certain instead of trying to prevent it."

Laurent omits to mention the laughably naive EU Commission road maps and 'agendas' - the Lisbon I and Lisbon II frameworks for economic growth, the Barroso's Social Economy lunacy, and lastly the idea that geopolitical enlargement will resolve economic growth and political legitimacy deficits. For their claim that European Unification is predicated on a deeply historical rooting of European people, this Commission is failing a primary school lesson in history: the same strategies for legitimization have marked the Ottoman and Austro-Hungarian Empires, as well as a bag full of unsavory regimes in the early 20th century Europe.

But, getting back to the economy: few probably remember today the 1970s. Back then, it took European countries more than double the length of time it took the US to come out of the crises, despite the fact that Europe had at the time much lower dependency on imported oil than the US. Why? That European disease of not willing to take the necessary economic policy adjustments. The same sclerosis is present within the Eurozone today. "After the 2001 recession, [thanks to the Fed active intervention] it took a year for the US to go from negative to vigorous growth. In the Eurozone, it took five years to fully recover. As for fiscal policy, ...a true European stimulus is still nowhere in sight, even as the economic outcome worsens by the day."

Taking real policy decisions and implementing new policies is something that is clearly not en vogue in Brussels. "Facts speak for themselves in this regard: the financial and banking crisis started to receive an adequate response after an improvised meeting of head of states and governments of the Eurozone last October, a standing body that does not even exist in
European treaties. As [Jean-Paul] Fitoussi observed: “the structure of power is such in Europe that those institutions who have the instruments to react have not the legitimacy to do so while those which have the legitimacy no longer have the instruments. Hence the passivity of European policy reaction.”

This is a sweeping (and absolutely apt) description of the entire political illegitimacy of the current EU power structures. But it is also an apt description of the Irish governance disease.

Just as an unelected and unaccountable EU Commission (and its Directorates) has no capacity to legitimize its rule, except via an elitist consensus bought by providing a guarantee of access to the feeding troughs of Brussels, so the elected European Parliament has no capacity to exercise its democratic mandate. Just as an unelected and unaccountable Social Partnership in Ireland has no capacity to rule except by bribing its way through all and any changes in economic environment, the elected Dail has been reduced to a nearly irrelevant student debating society. In both cases, corporatism has won and society has lost.

In 1934, Eoin O'Duffy - an Irish corporatist - stated: "We must lead the people always; nationally, socially and economically. We must clear up the economic mess and right the glaring social injustices of to-day by the corporative organization of Irish life; but before everything we must give a national lead to our people... The first essential is national unity. We can only have that when the Corporative system is accepted."

Am I the only one who sees clear parallels between this historical statement and our Government's (and EU's) active suppression of any dissent and the pursuit of a social-consensus model of policy formulation?

What if interest rates rise?

Just to stake some forward looking ground - here is a quick thought.

While we are preoccupied with the current crises, one has to wonder what the future might hold. Consider the following scenario.

Mid-2010 and German economy recovers slightly ahead of the rest of the Eurozone. Why? Because Germany is more exposed to global growth and thus will respond to renewed global demand for investment and consumer goods; and because German consumption has been suppressed since the mid 1990s, creating a significant domestic demand overhang. The ECB's response will be to immediately raise interest rates.

Of course, prior to German recovery, Manufacturing Purchasing Indices and other leading indicators will be flashing red for some time, prompting an earlier rise in interest rates in early 2010. So, say, Eurozone enters 2010 with 0.5-0.75% rate, goes to 1.0-1.25% by June 2010 and jumps to 2.0-2.25% by the end of 2010.

What happens then? Ireland, will by now have much higher taxes (three-tier rates structure of 25%, 48% and 52%), much lower standard deductions and standard rate ceiling, with higher PRSI and pensions tax relief at a standard rate. This will mean that before ECB rates hikes, our mortgages burden will be on par with those that prevailed at the onset of the crisis, but against a backdrop of lower disposable income. Now, as interest rates revert to rising, the burden of debt will start climbing up against decimated household incomes. Homeowners, with savings exhausted during the 2009-2010 downturn will be feeling more heat than they do today. Foreclosures will rise and personal insolvencies will go sky high. Consumption will remain suppressed, but this time, there will be no boost in savings. Ireland Inc might suffer a complete fall-out of the growth re-start.

An example
Here are some numbers. Assume we take a family with Q1 2008 after-tax income of €100 and a mortgage burden of €35 (35% of the after-tax income). By Q1 2009, due to falling interest rates, this family's mortgage costs will have fallen 26% (roughly 10% per each 1% fall in ECB rates). At the same time, the family income has declined to €91 due to increased taxation (Budget 2009) and recession. In Q1 2009, family mortgage burden was €26 or 28.5% of the disposable income.

Now, assume we are in Q4 2009 and recession continues and Mr Lenihan has stuck to his promises and raided the family income to 25-48-52% tax rates outlined above). The family after-tax disposable income now stands at €82, while the ECB has lowered the rate to 0.75% from current 1.50%. The family is now paying €24 in mortgage which constitutes a mortgage burden of 29.25% of the family income.

We go to Q1 2010 next. Recession and Mr Lenihan keep on robbing the family of income, so its after-tax take home pay is now €79.5. But due to advance leading indicators flashing recovery for Germany, the ECB tightens the rates a notch to 1.0%. Family mortgage burden jumps to 31% as the twin blades of higher taxes and interest rates inflict two simultaneous cuts to household's spending power.

On to Q4 2010. Things are going swimmingly in Berlin, so the ECB races with rates increases. We have three scenarios:

Scenario 1: relative stagnation in Ireland - so our income remains at €79, while German expansion drives rates to 1.75%. Irish family's mortgage burden jumps to 33.4% of the disposable income.

Scenario 2: recession in Ireland continues, with income falling to €76, while more mild German expansion drives the ECB to raise rates to 1.5%. Irish family's mortgage burden jumps to 34%.

Scenario 3: recovery shines upon Ireland and our income rises to €80, while rapid growth in Germany drives rates up to 2.25%. Our family's mortgage repayment burden is now at 36% of the disposable after-tax income.

Conclusion
May be Alan Ahearne, in his new capacity, can tell Minister Lenihan this much? Or anyone from a myriad of our vociferous social-democratic economists, begging the Government today to raise taxes. Little hope. His (and their) policy advice to date has been pretty much in line with the Government's efforts to demolish private sector workers in order to save public sector jobs. Then again, neither Ahearne, no Lenihan will be losing much sleep over ordinary families who will be unable to stay afloat in this WunderWorld of richly rewarded public sector and impoverished private sector workers that they are creating.

Recession? Raise taxes. Public finance busting at the seams? Raise taxes. Unemployment? Raise taxes. Public sector inefficiencies? Raise taxes. Exports plunging? Raise taxes. Banks falling off the cliff? Raise taxes. And always blame the outside world for any trouble we might land ourselves into. Classic economic problems with uniquely Irish responses.

"Pints!"

Market View: Lenihan's Cod Oil Sales Trip?

Weekly round up
We are in a thaw though don’t bet on this being a sign of global warming. The markets have shown some (to some not surprising) bounce in the latest (bear) rally. Across the world and here in Ireland. But the winter isn’t over, yet.

First where it all started from: the US. Some encouraging news:

• The U.S. trade deficit narrowed by 9.7% in January to $36bn, the lowest monthly gap since October 2002. This marks a sixth consecutive decline in the trade deficit, the first case of such extended contraction since the new data collection started in 1992. Oil and petroleum products deficit fell to $14.7bn in January, the lowest since September 2004. Trade deficit with China widened to $20.57bn relative to $20.31bn in the same month last year. Lower prices for inputs and commodities helped. In exports, main decreases were in the areas of capital goods and industrial goods – reflective of the global investment slowdown. Ditto in the area of imports (except that capital goods imports were down less than exports, suggesting companies continue to travel down the cost curve. Details here).
• US University of Michigan/Reuters consumer sentiment index notched up in March to 56.6 from 56.3 one month ago. While this beats analysts’ expectations (55.0), the improvement is hardly significant to signal any improvement in consumer spending and borrowing going forward. This is despite March being the first month of Obama’s massive stimulus plan – not exactly a ringing endorsement (for more on this see here)
  

So the last week came to be a somewhat bullish one with flat US Treasuries, low single-digit gains in commodities and a rally in stocks (up ca 10-14%) with commercial real estate-leading markets, like REITs. Up over 20%.
US Dollar has lost some ground on the Euro, further underlying markets desire to see continued strengthening of the US trade balance. In this beggar-thy-neighbour climate, good news for US is bad news for exports-driven Ireland.

Financials
JP Morgan and Morgan Stanley (first chart below) illustrate the rally for the financials. Most of the sector gains were probably due to rising levels of speculative news flow. If this is a signal of a renewed focus on balance sheet health, expect the rally to turn into a deep correction. Bank of America (BAC) – up some 85% during the week – is a case in point. There is no fundamentally new development, yet this week’s statements about improving outlook on profitability pushed the stock to the top of the financial shares (Citibank (C), Wells Fargo (WFC) etc) performance rankings. The second chart below illustrates, while highlighting the relatively poor performance of non-financials.

Irish Markets
Pretty much the same picture holds for Irish markets. Two of the three remaining banks led the positive momentum with few features of note:

1. Volumes were relatively weak (running at ca ½ of the 52-weeks daily averages);
2. IL&P underperformed (with the markets having little faith in the bank side of the insurer, as in the past);
3. Overall ISEQ posted a lacklustre performance for the week, signaling that the main concerns about Irish economy’s fundamentals are still there.
   

These are illustrated below and show continued theme of volatility around a relatively flat broad markets trend - something I predicted a month ago.
The above concerns, of course are to continue next week as well.

Ireland Inc Sales Pitch
It is now being rumored that Mr Lenihan is going on that 'road trip' to showcase Ireland to UK (and other international) investors. Here is a list of problems that I would put to him at such a sales meeting. All of these basically ask the same question - why would any investor expose herself to Ireland today.

1. Fiscal position: all the indications are that Minister Lenihan will opt for a ‘soft’ solution – raising taxes and refusing to inflict real cuts on the public sector. Thus, ‘savings’ on the current expenditure side will be pushed into 2011 or later as the Minister ‘cuts’ numbers through natural attrition. Taxes will hammer the economy today. Only an insanely naïve person can be convinced by such a strategy.
   
2. Corporate credit: debts problems continue to plague Irish companies, with more roll-overs and re-negotiations of the covenants. This will be compounded in weeks ahead by an accumulation of arrears to contractors and suppliers. Mini-Budget will spell a war of attrition between smaller services providers and larger contracting companies as the former struggle to extract payments in the environment where Messrs Lenihan and Cowen sneaking deeper into peoples' (and thus companies') pockets.
3. Corporate outlook: PE ratios are still too high for Ireland Inc, implying that there is more room for downgrades. In the US, there is more clarity as to the 2010 PE ratios supported by the markets, with a range in 15-20 perceived to be the top during the recovery part of the cycle (whenever this happens). So the expected downgrading room that is still remaining in, say S&P500 is -150 points or ca 20%. In Ireland, the same figures imply probably a range of sustainable 2010-2011 PE ratios of ca 10 (again assuming that we see some recovery starting in 2010 and companies actually living up to the idea of proper disclosure of losses and impairments – something that few of them have done to date). So the bottom line is that we can see ISEQ travelling all the way to 1,470-1,500 before hitting a sustainable U-turn, while IFin might be tumbling down to 200-215.
4. Earnings and demand are going to continue falling in months to come. Although much of this is already built into expectations, the actual numbers are not yet visible through the fog of corporate denial. Banks still lead in terms of balance sheets opacity and the Government is doing nothing less than destroying in a wholesale fashion private workers’ ability to stay afloat on mortgages repayment and consumption. Dividend yields are now poised to continue downward well into 2010 (optimistically) or even past 2011 (pessimistically). So any bottoming-out of the market will coincide with an on-set of an inverted J-styled recovery – we are not getting back to 4-5% long term growth trend once we come out of this recession. A poultry 2% would be a miracle and a Belgian-style 1.2-1.5% GDP growth over the long run is a more likely scenario.
5. Global growth for Ireland Inc is not going to be a magic bullet. The Government has wasted all chances of reforming the least productive sectors in this downturn and is hell-bent on protecting our excessively high cost base. This means we are unlikely to benefit from any serious global growth upturn.
6. Increased global reliance on Governments interventions is going to hurt Irish exports in the long run as national Governments will tend to reduce incentives for outsourcing, leading many MNCs to gradually unwind transfer pricing activities here in Ireland. There is absolutely no chance our Enterprise Ireland-sponsored companies are going to be able to take up the slack.
7. No recovery in Ireland will be possible until house prices and commercial real estate values stabilize and start improving. High debt, diminishing ability to repay existent loans (courtesy of Government raiding households finances to pay for waste in the public sector and a growing army of consultants – e.g Alan Ahearne & Co) all mean that there is no prospect for a return in house values growth until, possibly, well after 2013. Absent such a recovery, there will be no sustained rallies in other asset classes.
8. Finally, there is a psychological shift that is underway when it comes to Irish public perceptions of asset markets. This shift is now counter-positing a 40-50% decline in house prices against a 90% decline in most popular equity categories and a wipe-out of investors in nationalized (and potentially yet to be nationalized) banks. The return of a growth cycle is unlikely to trigger significant movement of households’ cash into Irish stocks. This will be further compounded by the aversion to leveraging and continued credit rationing (induced via new banking regulations and investor hysteresis).
   

So the conclusion is a simple one – Irish equities recovery is nowhere near becoming a reality. Expect further turbulence on a generally downward trajectory in weeks ahead, followed by a potential spike of misplaced short-term optimism in the wake of the mini-Budget. Once the investors work through the forthcoming Government decisions, it will be down again for ISE.

New Credit Markets Acrobats: Brian, Brian & Mary

The media is now ‘seriously’ talking about the Government setting up a ‘shamrock’ SFEF-styled bond (named after Societe de Financement de l'Economie Francaise guaranteed bonds issued by the French) for Ireland (see here).

The bonds peddlers – primary and secondary alike – have been enthused. The idea is that an already nearly-insolvent state will issue strong-guarantee senior, cash-redeemable only bonds covered by Ireland’s AAA rating for a large volume issuance, blah-blah-blah…

In reality there are serious and insurmountable problems with the idea of Ireland Inc issuing a SFEF to be disbursed across Irish banks in order to aid their capitalization and re-start lending.

First problem is that this state can hardly convince the markets to buy its own bonds, let alone a stand-alone, ring-fenced ‘aid’ bonds. The General Government Guarantee for such bond will either have to take priority over the Government guarantees on its own direct debt in order to fly, or it will have to take a second seat to these in order to flop.

In the former case, you can throw away any hope of top tier ratings for Government bonds out of the window, and assign risk weightings to public debt on par or even in excess of those currently allocated to our banks. Hmmm… an appetizing prospect.

In the latter case, the SFEF will be subordinate to the Government Banks Guarantee Scheme (GBGS) – a measure that had spectacularly failed to deliver for the banks and for the Exchequer. Even more to the point here, Ireland’s €440bn bank guarantee scheme has in effect converted Irish banks debts and deposits into a SFEF-styled vehicle already. According to both the European Commission and the ECB – this was a bad deal for the country credit position.

In February 2009, the Commission said the GBGS could have a “potential negative impact on the long-term sustainability of public finances”. The ECB’s assessment of such schemes across the EU also reads like a wholesale condemnation of the overly-optimistic packages, with Irish GBGS being a front-runner for the title of the most reckless of all. “…Together with weakening fiscal positions in the wake of the economic crisis, the bank rescue packages seem to have contributed to a sharp widening of intra-euro area government bond spreads, in particular for member countries with weaker fiscal positions. Looking ahead, it is important that governments return to sound fiscal positions as soon as possible in order to maintain the public’s trust in the sustainability of public finances”.

Expanding the scope of GBGS to cover not only the existent debt and deposits, but also the future lending (under the SFEF), while pushing the Guarantees quality even below the already low stuff that the original Scheme delivered is not an appetizing prospect, either.

Now, another problem with SFEF is that it is restricted by the EU rules to a 2-3 year maturity window (with only a small portion allowed to be issued with a 4-5 year horizon). This means that any SFEF written in 2009 will mature in 2011-2012. The Government latest bond placement shows that from now on, we are likely to see most of the standard new Government debt hitting the 2012 maturity date (for 2009 issues) and 2013 date (for 2010 issues). There is absolutely not a snowball’s chance in Hell that we can frontload so much debt (once our own Exchequer borrowing requirements are factored in) into the economy for 2011-2013 horizon.

In my view, the Government is completely missing the point by pursuing this idiotically frantic search for new cash to throw at the problem of banks balance sheets. As I have proposed in this blog before (here) and in numerous articles in the press, the solution to the problem of stalled lending must begin at the coal face of the credit demand and supply imbalances. These are driven as much by a lack of funding as by a lack of demand for funding. The problem is therefore a twin collapse in fundamentals and it requires address both sides of equation simultaneously.

Side 1: collapsed supply of funding is driven by deterioration in banks balance sheets. Solution: help banks to unload bad loans off the books by doing equity-for-loans swaps under the capitalization scheme.

Side 2: collapsed demand for funding is driven by the excessive leverage of the households and corporates. Solution: take their bad loans and restructure them via a combination of a partial write-down (to the amount equal to the recapitalization funding given to the banks) and restructuring.

This is, really, the only way we can get out of this mess!

Deflation is cemented, but Government rip-off continues

The above table, courtesy of Ulster Bank's economics team, is revealing.

CPI is now anchored firmly in the deflation zone at -1.7% for February - a record rate of deflation since Q1 1960 (when CPI fell 2%). Prices actually fell 0.4% last month, but because in February 2008 prices grew by 1.2%, the overall difference amounted to -1.7%. So don't be surprised if you are not feeling that easing on your household budget (other than house payments), yet.

The HICP harmonised measure (ex mortgage rates) fell to +0.1%, the lowest in history (since 1997). This implies that CPI fall off was dominated by the ECB-driven declines in the cost of mortgage finance. The average mortgage cost declined 8% in February and is now down 26% on a year ago. This is certainly helping many households to stay afloat, given rapid deterioration in after-tax disposable personal incomes and rising unemployment.

Now, do the math - if the ECB rate-cuts cycle is to run out of steam by H2 2009, as expected at ca 0.75-1% level, total savings on average mortgage will amount to a total of 33% off their peak. Assuming an average mortgage burden of 30% of the household budget at the peak, this will shift overall mortgage burden to ca 22% of the budget. Assuming income tax, VAT and other housholds-related measures stay on course laid out in Budget 2009, mini-Budget will result in a fall in the household disposable income of 3-5%. Add in expected fall in earned income (due to slowdown and rising unemployment) and we have a recession-induced 13-19% decline in the disposable income. Thus, the average mortgage burden for the household will rise back to 26% at the bottom of the ECB rates-cut cycle, virtually canceling any positive effects of the ECB rates cuts on households' balance sheets.

Another feature of the figures above is the collapse in prices in the clothing and footware sector - normally the sales end in February (between 2002-2008, February saw the first monthly increases in prices in this category for the year, averaging some 12%). This year, the increase was only 7.5% - lowest since 2000.Overall, in January we recorded the steepest drop off in prices in this category in the Eurozone.

But as always, it was in the Government controlled/regulated sectors where price changes were out of sync with the rest of economy. Health insurance costs were up 21%, house insurance was up 17%. Education was up 5.5% in February after a 5.6% increase in January, health was up 4.8% in February after an increase of 5.8% in January. Government-sponsored rip-off of consumers is still alive and kicking. (Note: of course, house insurance is not directly priced by the state, although it is a part of the regulated sector. Possible causes for the rise in house insurance in recent months might include inclement weather payouts and, more importantly, insurers using all means possible to strengthen their capital reserves positions. The latter is a function of regulation and markets assessment of inherent risks. Both, in turn, are functions of the public sector actions/inactions, although indirectly).

While private sector prices were down 0.1% in the last 12 months, Government-controlled prices were up and the rate of increases is accelerating. In 12 months to January 2009: Gas prices were up 20%. Health insurance +19%, Electricity +17%, Bus and Rail transport +13% & +9% respectively, Hospital services +7-9% (out-patient v in-patient). Total Government-controlled inflation +14% for regulated services in year to February 2009.

Overall, I expect the CPI to average -3% for 2009 as a whole.