This morning, there was further bad news about the eurozone economy, already plagued by the worst slump in living memory, and its performance diverging sharply from that of the US:
So what was the bad news? Well:
Business activity in the euro zone fell to a 16-month low in November, according to data released on Wednesday, confirming fears that the region's economy is faltering.
Then, the European Central Bank, the ECB, itself cut its growth outlook for the eurozone for 2015, from 1.6% to just 1% (so much for falling oil lifting economies..).
Nevertheless, despite a worsening outlook for an already anemic growth and prices flirting with deflation, the ECB lacks a disturbing sense of urgency, here is a summing up of ECB President Draghi's communique and press conference (from CNBC):
The European Central Bank (ECB) has "stepped up" its preparations for further asset purchases, central bank President Mario Draghi said at his regular news conference on Thursday. Draghi said ECB policymakers would review measures next year and that this could include changing the "size, pace and composition" of its asset-purchasing programs. "We don't need unanimity for QE (quantitative easing)," Draghi told reporters, in response to questions after his prepared speech.
While the increase of the ECB balance sheet to 2012 levels has now become a target, rather than an 'expectation,' a slight firming of the language, this is basically what we've heard for some time. Preparations ongoing. While we don't underestimate the intricacies of sovereign debt purchases, especially in the context of 18 member countries, we doubt that it does need this much "technical preparation."
And of course that is only language to hide the fact that there is no consensus within the ECB about the necessity of these policies, hence Draghi's insistence on the lack of a need for consensus. In fact, according to Die Welt, resistance to full blown sovereign bond buying is growing within the ECB.
Within the 6 member Executive Board, there is a balance between those in favor and those against. In the latter group we find, surprisingly, Frenchman Benoit Coeuré, apart from Sabine Lautenschläger and Yves Mersch. Of course, this tie isn't decisive, as the decision ultimately lies with the 24 member Governing Council (the 6 Executive Board members plus the 18 eurozone central bankers). Here, Draghi still has a solid majority.
But even under the 18 central bankers there is considerable resistance, from Germany, Finland and the Netherlands and probably a few others.
Proponents of a much more aggressive ECB argue that the slump in the eurozone is of such length and severity that basically everything has to be thrown at it in order to try to improve the economic situation, or even just to keep it from further sliding.
Most observers and academic studies show that QE has at least had some positive effects in the US, the UK, and Japan. Adversaries claim that it risks blowing up asset bubbles, relieves pressure from countries to pursue structural reforms, and could amount to outright debt monetization, something which is explicitly forbidden in the eurozone.
In the case of Japan, and to a lesser extent that of the UK, the main transmission mechanism has probably been via the foreign exchange market, the so-called 'currency war' argument. Some of the lifting has already been done with respect to the euro because of:
- The weakness in the eurozone economy
- The end of QE in the US and the prospects for rate hikes on the back of a strengthening US economy
- Draghi's mastery of the word, building expectations of further actions.
The curious thing is, the eurozone doesn't exactly lack competitiveness as it has a whopping trade surplus, although we believe this is more an expression of the deflationary bias working in the eurozone.
The latter is produced because all the adjustment is forced upon the deficit countries (which indeed have managed to drastically reduce, or even eliminate their trade deficits), while the surplus countries don't reflate and bask in some of the biggest surpluses in the world (Germany 7.5% of GDP, the Netherlands a rather bizarre 10% of GDP).
The eurozone as a whole isn't actually so open an economy, so while it would benefit from further falls in the euro, these falls have to be rather steep in order to create some traction.
Another positive effect of a falling euro would be that it rises import prices, and hence it helps warding off the deflationary threat. Some might be inclined to argue that this is partly countered by the steep fall in the oil price, but while this indeed reduces input costs for a good many industries, for consumers the impact is rather muted due to the steep excise taxes on gasoline.
Debt deflationary spiral
But meanwhile, inflation in the eurozone is at 0.3% and a considerable part of it is experiencing falling prices. Combined with low, or even negative growth this has set off a relentless debt-deflationary spiral where debt/GDP ratios rise on a stagnant denominator, and despite record low bond yields.
We warned about this a year ago and we're no closer to a solution. Indeed, investors are only willing to receive just 2% yield on 10 year Italian debt on the belief that it is fully backed by the ECB. One might want to recall that the same yield was above 6% before Draghi's "whatever it takes" promise.
But if the ECB is paralyzed because of German objections to launch QE in the eurozone and the economic situation doesn't improve, this belief might be put to the tests by the markets. If Italian yields start to creep up, it only further complicates Italy's plight to bring back its debt/GDP ratio, presently approaching 140%, under control and the creep could turn into a rout, forcing the hand of the ECB.
It seems a better idea to start buying bonds now, rather than wait for this to happen. QE isn't a miracle cure, but it's better than nothing.
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