BlogSpot - January 12th, 2015
After disappointed optimism in 2014, starting 2015 in confusion
A disappointing 2014—marked by the return of geopolitics (and their negative economic effects) and by worse than expected economic performance, according to Guntram Wolff (Bruegel). Albero Gallo (at RBS) analyzes the poor eurozone performance in 2014 as the result of the boomerang effect of Russian sanctions on exports, but also of the continued lack of coordination and delay in the implementation of fiscal and monetary easing policies. Erik Nielsen (UniCredit) writes that markets started the year as confused and volatile as ever due to increased fears of damaging deflation, new questions on the effectiveness of sovereign QE, and Greek politics.
In RealTime Brussels, Stephen Fiddler reminds us that 2014 changed the political landscape in EU institutions, with a new leadership at the European Union and at the North Atlantic Treaty Organization, a new European Commission and a new European Parliament (see this graphic). Their list of most-reads is an interesting list of key issues in the past year, with Greece toping the chart (as in 2010, 2011, 2012 and 2013).
The economic drivers for 2015
For the Guardian, 2015 has two possible track, one towards self-sustaining vigorous recovery and the other track leading back towards recession—with a financial crisis in the emerging markets (is Russia a special case or will it trigger deep volatility?), a hard landing in China (with a global impact through the global value chain and through more deflation), new eurozone struggle associated with Greece, deflation à la Japan.
Goldman Sachs makes a list of key events for 2015 in Europe (with a useful calendar table), starting with Lithuania joining the Euro on January 1. Morgan Stanley worries that markets may be too complacent on Europe, and that a reversal of opinions will be costly, despite projecting a renewed recovery in the euro area, with upside risks from a further fall in oil prices. Key drivers for 2015 include (as identified by RBS with a special focus on financial markets):
1. The ECB will deploy more stimulus to fight low inflation and support growth. For Paul Krugman (NYT), when looking at risks for the global economy in 2015, there is one downside which is already a certainty: the euro area has entered a Japan-style deflationary trap. Looking at the implied market forecast, the picture is grim: German 5-year bonds offer a yield of zero, an implicit firm forecast that Europe will be in a liquidity trap for the foreseeable future, and the reflection that investors see little profitable investment opportunities and expect close to 0 inflation over the next five years. The ECB needs to both increase its balance sheet size (e.g. with covered bonds) and to reactivate the credit transmission channel (e.g. with ABS). It could support investment by buying bonds from the EIB, the EU or from a new SPV, and could add corporate credit to boost its balance sheet further.
Monetary policy risks are substantial. For Morgan Stanley, there are policy risks, with the controversial decision on QE (and its design), and associated legal cases (from the ECJ and the German Constitutional Court) amidst institutional changes at the ECB (policy decisions every six weeks rather than every four, together with published accounts of policy meetings). The degree of divergence is expected to be high between monetary policymakers in the Euro area, the UK, Sweden, Norway and Switzerland.
2. Political risk will come back to the Eurozone, with persistently high unemployment, declining inflation and elections in Greece (February), Finland (April), the UK (May), Portugal (September), Spain (December). Morgan Stanley sees risks of potential political backlash against bail-outs on both sides, in a context of key elections in Europe. Starting with Greece, the periphery will enter more turbulent times politically. For Goldman Sachs, this string of political and institutional events is set to shape the "policy mix" identified by Mr. Draghi as so critical to restoring macroeconomic stability: national and/or regional elections (notably in Greece and Spain, with considerable uncertainty with risks of policy discontinuity); draft budgetary plans and fiscal financing packages will continue to be scrutinized in area-wide meetings of ministers.
The electoral landscape plays a critical role in the speed and efficacy with which structural reforms can be passed and implemented—notably the labor market reforms in Italy, the implementation of the program in Greece.
3. European banks remain weak and in need of more capital. Lending activity won’t restart quickly.
4. The US-Europe gap in growth will continue to widen.
What new year resolutions for 2015?
As expected, resolutions diverge:
Balancing the demand and supply sides—Guntram Wolff (Bruegel) looks at new year’s resolutions for Europe in 2015, and suggests policies to reduce conflicts in neighboring countries (see Steven Blockmans’ review for CEPS), and to increase growth and jobs. To grow, investment is key, and increasing private-sector confidence and predictability of policy is central. To bridge differences of views, acknowledging both significant structural problems and significant demand-side problems is also central. Bolder initiatives on all fronts are required.
Focusing on the demand side—for Joe Stiglitz (Project Syndicate), Europe’s policymakers remain convinced that structural reform must be their top priority, but the problems were apparent in the years before the crisis and were not stopping growth then. What Europe needs more than structural reform within member countries is reform of the structure of the eurozone itself, and a reversal of austerity policies. This is urgent given the alarming growth of extreme nationalist parties.
The need for political impetus—Alberto Gallo (RBS) writes that 2015 is a “make or break” year for Europe. Mario Draghi sent a clear message (Project Syndicate): there is no monetary union that can last without more fiscal and political cohesion. Yet Gallo finds that governments are refocusing on national issues, rather than worrying about EU investment, and the ECB looks increasingly left alone with its QE program (Bloomberg).
Whatever it takes—for 2015, the balance of risks points to the downside for Europe. As explained in RBS 2015 Outlook: The Waterworld Recovery, their view is that QE will not go very far beyond markets—with few grounds for growth. The real impact of QE will depend on fiscal support and reforms, including the promise of an investment plan. Without credible fiscal action, QE will only boost financial assets, leaving unemployment high, growth and inflation weak. Time is running out, and political risk is around the corner with Greek elections in February and others to follow.
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