BlogSpot - May 12th, 2014

The ECB: all talk and no action, but wait until June!

EuroIntelligence looks at the latest data on the recovery and writes that they dispel the notion of a strong and vibrant economic recovery in the eurozone—with Germany industrial orders falling by 2.8 percent mom in March, and a 9 percent drop in orders from within the eurozone; an abrupt halt to the German construction boom; declining French industrial orders.

Inflation forecasts are getting worse. The OECD is projecting eurozone inflation to fall to 0.7% for this year, and 1.1% in 2014, after the Commission projected rates of 0.8% and 1.2% respective (hat-tip EuroIntelligence). Stephen Kinsella in the Irish Independent says deflation is already happening, with producer price indices.

As reported by Marc Chandler, on EconoMonitor, the ECB (the original statement with Q&A) decided to leave the monetary stance unchanged—on the back of firmly anchored inflation expectations. EuroIntelligence notes that Mario Draghi took the notion of a pre-commitment to a new level when he said that the GC is “comfortable with acting next time,” to coincide with the next staff macroeconomic forecasts. The ECB is looking not just at interest rates but also at other instruments to realign inflation expectations.

For Chandler, the lack of action to support the ECB’s narrative comes with a credibility cost. One issue is the need for consensus for policy action, and some creditor countries, led by Germany, being more worried about interest rates being too low for too long then about lowflation. This is happening against a context of a run-up in public debt, helped by a renewed decline in fiscal discipline, and moral hazard, according to Hans Werner Sinn (in Project Syndicate). Guntram Wolff (Bruegel) adds that finance ministers should act with the ECB on low inflation - cleaning up the European banking system, lowering household tax burden and increasing public investment will be key.

A number of analysts called for action from the ECB. The OECD’s advice is to cut both the refinancing and the deposit interest rates to a negative level, and keep them there until the end of 2015, and if unsuccessful, to contemplate non-conventional policies. Ashoka Mody, at Bruegel, even wrote that the ECB may have already waited too long and must undertake a long-delayed Quantitative Easing (QE) Program by buying US Treasuries—especially as despite its much weaker inflation outlook than in the US, the eurozone monetary policy is much tighter, and has been so since mid-2008. At end-January 2014, the shadow ECB policy rate was about -0.3 percent, about 2 percentage points above the US rate—the US economy continuing to, benefit from much greater monetary stimulus. And large differences exist in inflation rates across countries in the euro area—with countries that need the most economic stimulus getting the least. The current strategy of “internal devaluation,” lowering of wages does not work and increases deflation risks with no certainty of whether (or when) growth will resume.

Mario Draghi announced that the Governing Council is comfortable with taking action at its June meeting and a number of options are on the table:

Zsolt Darvas, Grégory Claeys, Silvia Merler and Guntram B. Wolff (Bruegel) criticize the ECB for not acting, yet. They review the available instruments—beyond ineffective conventional tools, the ECB therefore needs to start buying assets, i.e., they propose to buy €35bn per months of a portfolio of ESM/EFSF/EU/EIB bonds, corporate bonds, and ASB. Other tools, such as cutting rates further or designing a new very long term (e.g. 3 years or longer) refinancing operation would not be very effective.
Brunello Rosa, in Roubini, believes that an asset purchase program will be favored over changes in interest rates (including a shift to a negative deposit rate), as such a measure would have a larger impact on inflation and, indirectly, on the exchange rate. He stresses the importance for the ECB’s next move to live up to the market’s high expectations, driven by three main reasons: persistently low inflation, the strength of the currency and downside risks facing the eurozone.
FreeExchange also speculates about the potential action in June, and argues that QE may be only a last resort. The ECB could decide to lower the lending rate, as the OECD recommended, but this would be effective only if it also lowered the deposit rate, taking it into negative territory—following the example of the National Bank of Denmark.

Taking stock on the periphery: an odd recovery

The European Commission spring forecasts revised 2015 growth and inflation downwards by a notch from winter forecast (see EuroIntelligence). Signs of positive developments in the periphery are emerging: the Greek and Portuguese return to the markets, Portugal’s decision for a “clean exit” from its three-year rescue program (Jornal de Negocios and EuroIntelligence).

Yet analysts are cautioning against a very fragile recovery. Dan Steinbock in EconoMonitor warns of drastic social dislocation and divergence with the rest of the global economy, especially as the adverse impact of continued deleveraging is compounded by population aging. Ambitious structural reforms and inclusive growth are needed. A similar point is made by Guntram Wolff, in Bruegel, who sees the risk of permanent social fragmentation turning against support for European integration, open and global markets and the euro.

Greece: The OECD forecasts Greek GDP to contract 0.3% in 2014 and rebound 1.9% in 2015 (Macropolis). Greece is performing well on the fiscal front, with a general government primary cash surplus (Kathimerini)—but the state budget posted a primary deficit (Macropolis) and the stock of state arrears to the private sector rising.
Spain: The ECB and the Commission expect Spain to need additional austerity in 2015 and 2016, as reported by EuroIntelligence, based on the first post-programme surveillance visit.
Portugal: Diario Economico warns that it is too early to celebrate in Portugal and warns against complacency, calling for a political consensus similar to the one three years ago to ensure that the set of targets are realistic and possible.
Italy: Matteo Renzi has frozen all economic reform until after the elections, la Repubblica and other Italian media organisations report (hat-tip EuroIntelligence), after winning two victories over Senate reform and labor reforms. Federico Fubini points out the Commission’s pessimism on Italy, and questions whether focus on fiscal consolidation rather than economic reforms was wise.