More QE in a difficult political economy context
Draghi’s “Whatever it takes” in action
The ECB is hinting at more stimulus as rising downside risks are weighing on inflation and the economic outlook. The deteriorating inflation outlook (see Erik Nielsen from Unicredit) is caused by two sets of factors: (i) Eurozone financial conditions tightening as the trade-weighted euro appreciated and equities slipped through Q2 and Q3; and (ii) the negative contributions from the external environment (uncertainty about a Fed lift-off this year, and EMs struggling). Inflation is back in negative territory in September.
During the last ECB meeting, Mario Draghi announced that rates were left unchanged (widely expected) but signaled that further monetary policy easing is coming in December (for example Barclays Capital), through two mutually reinforcing moves (Deutsche Bank):
Additional QE—The ECB will carry on the asset purchase programs (APP) until September 2016 and afterwards if necessary, with a monthly average purchase of €60bn per month (Warning Signals). The APP remains flexible in terms of adjusted size, duration and composition. This announcement triggered strong reactions: big intraday moves (FT), boosted stock markets (The Guardian) and a large decrease in two-year German and Italian yields (Bloomberg), reaching a record low. Nevertheless, a vigorous debate among economists remains about QE’s effectiveness (VoxEU).
A deposit rate further in negative territory—Deutsche Bank expects a minor cut, but also a signal that the lower bound has not been reached to avoid disappointing markets.
Alberto Gallo (RBS Silver Bullet) adds (i) that positive upside surprises are to be expected in December, and (ii) that further ECB easing is likely to push the Fed’s lift-off further into 2016. For Goldman Sachs, additional measures (e.g., a step-up in the monthly pace of asset purchases; a change in the composition of those purchases; and/or a cut in the rate on the ECB’s deposit facility) will depend on: (1) whether a more pronounced slowdown in Euro area activity emerges; and (2) developments in the Euro exchange rate (which, in turn, remain heavily influenced by the direction of US monetary policy).
Despite a stream of downbeat data from Germany, the ECB’s Bank Lending Survey, showing that banks are easing lending standards on loans to firms should bolster confidence among some ECB policy makers that its program is working. Others are calling for a more expansionary fiscal policy to complement the ECB’s efforts to raise inflation and output. Erik Nielsen (Unicredit) questions the (future) long-term impact of the policy moves in December, because of the unfortunate policy mix and their likely choice of tools.
The end of German Hegemony?
Germany, the EU’s largest economy, faces challenges to its dominant position in the region according to Daniel Gros (Project Syndicate):
First, it enjoys only sluggish growth (Eurostat) despite nearly full employment. This reveals a slow productivity growth (Project Syndicate). Declining demography is a key headwind, resulting in a scarcity of highly skilled workers. While the large influx of refugees could partially tackle this problem, this new workforce may lack needed skills, limiting the impact on productivity. And, amid rising tension over migration in Germany, the country’s biggest trade union IG Metall warned of downward pressures on wages from migrant inflows. The Volkswagen scandal (Warning Signals) could affect the confidence in the German model (ZEWIndex), though the effect is expected to be limited according to Dalia Marin (Bruegel).
Second, German economic performance is vulnerable to external shocks. In a context of slowdown in emerging countries, Germans exports will lose impetus—especially as China, its fourth largest trade partner (Statistisches Bundesamt), rebalances its growth towards more consumption (Bloomberg). This amplies the negative effect of the economic sanctions imposed on Russia for German industrial exporters as highlighted by Richard Werner and Vladimir Yakunin (Project Syndicate).
My spending is your income, your spending is my income—Paul Krugman writes (again) that deflationary policies associated with fiscal consolidation and large trade surpluses, when generalized, lead to decline in income and worsen debt problems. Simon Wren-Lewis (Mainly Macro) asks whether good German economic outcomes might be the result of a “beggar my neighbor” policy within the euro area—i.e., reaching a solid competitive advantage thanks to a low nominal wage growth, leading to lower production costs and prices, thus displacing goods produced in other euro area countries. Advocating for spending cuts or tax increases just as recoveries begin may be costly for Germany’s legitimacy.
Towards a political divergence process in the EU?
Politics and fiscal considerations. With an annual inflation rate at -0.1% (see our previous BlogSpot Warning Signals), public deleveraging is becoming costlier in the euro area. After several years of efforts, tensions are arising between several countries (Portugal, Spain, Italy and Greece) and Brussels (EuroIntelligence) as the European Semester is in full swing:
Portugal—With legislative elections producing no majority, Coelho (leading in the ballot) made concessions on budgetary discipline and budget deficit rules (Bloomberg). The Stability and Growth Pact takes the backstage, potentially leading to conflicts with the European Commission.
Spain—Spain’s budget also risks missing deficit targets, with government forecasts for 2016 (2.8 percent) diverging from the European Commission (3.5 percent) (Natixis). In addition, the structural deficit should increase in 2015 and 2016. The government is unlikely to change its budget before the legislative elections in December. A Portugal-type scenario might occur.
Italy— A 2.6 percent deficit is forecasted for 2015, yet Italy challenges the EU to accept a budget including large tax-cuts (€35bn over three years) and measures to boost consumer spending, instead of fiscal tightening (FT).
Greece—With debt unsustainable (IMF) the government presented additional tax and pension reforms to parliament amid growing concerns that these measures will prolong the country’s six-year recession (LSE and Bruno Biais’s “debt overhang” narrative), reinforcing calls for debt relief. Discussion about the debt relief will be contentious.
The refugee crisis—The costs associated with the refugee crisis interact with deficit targets, and some countries call for exclusion from European fiscal targets (EuroIntelligence). While EU governments reached an agreement on how to deal with refugees and asylum seekers, the implementation of relocation remains difficult. Receiving countries have stretched capacities (Institut Delors), especially at times of budget austerity (EPC). Cooperation with transit countries (Turkey, the Balkans and African countries) is key. Leaders reached a provisional agreement with Turkey and agreed to revitalize a contentious Turkey's EU accession process (Reuters), at President Erdogan’s request.
Which long-term perspectives? Questions about EU membership are affecting regional dynamics, e.g., British exit and Turkey’s accession. Europe is nevertheless in the lead on many areas. For example, the EU is pressing for a global and legally binding international treaty that can prevent global warming from reaching dangerous levels (Bruegel).
