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Talk of ECB action grows amid Europe growth worry

First Published Aug 25 2014 09:19AM      Last Updated Aug 25 2014 09:19 am

Frankfurt, Germany • Worries about the economy are rippling through Europe.

Downbeat data have pushed the European Central Bank closer to more drastic action to keep the hesitant recovery from stalling completely.

Meanwhile, open feuding in the French government about how to break out of economic stagnation saw President Francois Hollande dissolve the cabinet and order Prime Minister Manuel Valls to form a new team.

Stock markets rose on hopes that the ECB will intervene with new stimulus measures, expectations fed by comments late Friday by bank President Mario Draghi.

Draghi warned that low inflation — a sign of economic weakness — could be getting worse. Draghi also underlined the sense of urgency by telling European governments to make a more coordinated effort to boost growth through tax cuts and a new joint investment program.



Predictions that more ECB help will be needed were reinforced Monday by a drop in Germany’s closely-watched Ifo business confidence index. It fell to 106.3 points in August, from 108 in July and below market analysts’ expectations for a dip to 107.

The downbeat signal from the largest of the 18 economies that use the euro follows drops in other surveys of business activity. The euro currency union showed disappointing zero growth in the second quarter after four quarters of weak recovery from a crisis over too much government debt.

The recent data, coupled with turmoil in Ukraine and the Middle East, has shaken confidence in the ECB’s outlook that modest growth will continue. The ECB launched a raft of measures in June, including a cut in its benchmark interest rate to a record low of 0.15 percent and an offer of cheap loans to banks that are willing to lend to businesses. Officials have said they want to wait to see how those steps work.

But signs are growing that the ECB and its president, Mario Draghi, may not have that luxury.

"The continued fall of the Ifo is really problematic for the rest of the euro area, which is barely growing," Commerzbank’s chief economist, Joerg Kraemer, wrote in a research note. "The ECB’s optimistic economic outlook is crumbling."

Draghi has said that if weak inflation — now only 0.4 percent — shows signs of worsening, the bank could launch large-scale purchases of financial assets, known as quantitative easing, or QE. He said Friday at a U.S. Federal Reserve conference in Jackson Hole, Wyoming, that money market interest rates now show inflation expectations have "exhibited significant declines at all horizons."

He added that the bank would "acknowledge these developments" and use "all the available instruments" to keep prices stable.

Economist Kraemer said the comments mean that "the probability of broad-based bond purchases (QE) is rising." The ECB’s governing council next meets Sept. 4.

Stock markets in eurozone countries rallied on Monday on the prospect of more stimulus, with the benchmark German and French indexes up over 1.4 percent.

In quantitative easing, a central bank creates new money and uses it to buy financial assets such as bonds. That pumps newly created money into the financial system. It can in theory increase the amount banks can lend, push up the prices of stocks and other assets, drive down interest rates, and increase inflation. The U.S. Federal Reserve, Bank of Japan and Bank of England have all used quantitative easing. But there are legal, political and practical hurdles to doing it in a multi-country currency union and so far the ECB has held off.

Draghi also urged European governments to move past their recent focus on austerity and do more to boost growth with tax cuts — offset by spending cuts to remain within the strict European Union limits on government deficits. He called on them to push ahead with longer-term reforms such as better worker education and more flexible rules on hiring and firing. He also endorsed a plan to set up a 300 billion-euro program for public-private investment proposed by Jean-Claude Juncker, the incoming president of the EU’s executive commission.

France’s Socialist President Hollande has struggled to push through pro-growth measures. France, the No. 2 economy in the eurozone, has had no growth this year and his approval ratings are in the teens.

Hollande’s promises to cut taxes and make it easier for businesses to open and operate have stalled, in large part because of the divisions among his Socialist party. Prime Minister Valls resigned after left-wing Economy Minister Arnaud Montebourg criticized austerity and called for "a major change in our economic policy."

 

 

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