For once, the European
Central Bank has been doing the right thing. Regularly blamed for not doing
enough, or being too late with policy solutions, the ECB’s monetary super-stimulus
is finally paying dividends. Euro zone growth is outpacing its Group of Seven
partners and the bloc’s unemployment rate has fallen dramatically.
Understandably it is building hopes for sustainable recovery ahead.
Things are clearly looking up
after years of economic poor health and crisis in Europe. Thanks to the first
quarter’s 0.6 per cent GDP gain, the euro zone economy grew at its fastest pace
in five years, driven by unlikely stars such as France and Spain. Critically
the euro zone economy has risen above its pre-crisis peak, with growth surging
past the US and UK.
Sadly, the euro zone’s
success could easily prove to be its undoing. The more euro zone growth gets
onto a stronger footing, the more it strengthens the case for Germany’s hawkish
central bank (the Bundesbank) to put a future block on open-ended ECB easing.
Unfortunately, the recovery still needs more careful nurturing to deal with major
economic headwinds coming the euro zone’s way.
External risks and internal
frictions still pose serious pitfalls for the economy. Slowing global growth, entrenched
deflation pressures and deepening financial market uncertainty pose enough
potential to derail the euro zone’s nascent recovery. The euro zone also needs
to chart its way through dangerous political waters. Threatened exits by
Britain and Greece out of the European Union could pose deeply troubling shocks
to the euro zone economy up ahead.
While the recovery in growth
is clearly welcomed, it is raising concerns in Germany that the ECB is going
over the top with too much stimulus. Negative interest rates and vast infusions
of QE money might have put the euro zone back on track to recovery, but German
policymakers are worried that too lax policy will open up the floodgates to
overheating and inflation risks down the line. The economy may be getting too
much of a good thing.
Upcoming ECB policy meetings
could see some brutal confrontation between the monetary hawks and doves. The Bundesbank
are likely to press for more monetary stability with no new easing, possibly even
calling for a policy taper at some stage soon. In its view, ECB policies have
already made enough positive inroads. The banks are lending more and consumer
demand is picking up thanks to easier access to cheap credit and stronger labour
markets.
The Bundesbank’s key concern
is that the euro zone has become over-dependent on the flow of easy money and
the dilemma is what happens when the taps are finally shut off. Consumers,
businesses and financial markets must be weaned off the steroids of
super-stimulus before it is too late and the euro zone follows Japan into a
similar zombie land of economic stagnation, perpetual deflation and ineffectual
policymaking.
ECB doves remain adamant the
central bank’s monetary accelerator must stay firmly rammed to the floor. The
pro-easing camp believes the euro zone is bogged down by fiscal austerity, high
debt, weak bank profits, high unemployment and too much excess capacity in the
economy. While ECB President Mario Draghi might have met his pledge to do
‘whatever it takes’ to secure recovery, the argument now is about ‘how much
more will it take’ to secure sustainable prosperity longer term.
Right now the omens are not
encouraging. Last month the euro zone slipped back into deflation again, the
euro zone’s all-important economic sentiment indicator has started to flat-line,
while German business sentiment indicators are looking more lacklustre. If Germany,
the euro zone’s biggest growth driver, loses much more momentum, the chances of
the ECB hitting its modest 1.5 per cent growth target this year will be
compromised.
As a result, ECB policy is
heading towards potential deadlock. The monetary policy meeting in June could
prove to be a critical High Noon for rate policy intentions with neither side
looking likely to back down. It could end up in a dangerous stalemate.
Any sign of a policy stall is
unlikely to go down well with the markets. The US Federal Reserve and the Bank
of England are both in ‘wait and see’ mode, while the Bank of Japan is keeping
its powder dry in case of emergency. If the ECB looks in any doubt on future
easing, it could catapult global risk appetite and world equity markets into a very
nasty tail-spin.
Article appeared in the South China Morning Post 10th May 2016
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