Sharon Bowles (ALDE, UK), chair of the Committee on Economic and Monetary Affairs of the European Parliament welcomes ECB’s Vice-President Vitor Constancio in the EU’s legislative, for the presentation of the ECB’s annual report. (European Parliament photographic library).
It is probably the first time in the annals of the European Central Bank that its president and vice president went so close as to almost announce the next interest rate reduction. Yesterday ECB’s Vice-President Vitor Constancio, presented the central bank’s Annual Report for 2012 to the Committee on Economic and Monetary Affairs of the European Parliament. While answering questions by MEPs, if the bank is ready to cut its basic interest rates in order to help the real economy, he said that the ECB, “stands ready to act in any way it could, especially if the situation deteriorates”.
However this precondition for an ECB’s interest rate reduction set by Constancio, “if the situation deteriorates”, has obviously materialised over the few past weeks, when it became clear that economic activity in Eurozone is to further recede this year. All economic analysts agree that Eurozone’s recovery is not to come in the second half of 2013 but rather some time in 2014. In reality this bleaker prospects for Eurozone is now common ground.
This was also evident in IMF’s World Economic Outlook, which was published last weekend, where it is clearly stated that “In the euro area…in many economies activity will be held back by continued fiscal adjustment, competitiveness problems, and balance sheet weaknesses. Furthermore, new political and financial risks that could put a damper on the recovery have come to the fore. Accordingly, real GDP is projected to contract relative to 2012, by about ¼ percent of GDP”.
The ECB will cut its rates
If this is not enough for a disbeliever to accept that Eurozone’s economic prospects deteriorated and as a result the ECB is about to cut its rates, there is more from the most competent source, the president of ECB, Mario Draghi himself. The president of the ECB on 4 April 2013, in his introductory statement to the traditional press conference after the monthly meeting of the governing council, appeared clearly negative for the prospects of Eurozone this year. While presenting ECB’s economic analysis he said, “economic outlook for the euro area remains subject to downside risks. The risks include the possibility of even weaker than expected domestic demand and slow or insufficient implementation of structural reforms in the euro area. These factors have the potential to dampen the improvement in confidence and thereby delay the recovery”.
A few minutes later in that press conference, Draghi, while answering a reporter’s question about interest rate cuts, he almost replied positively. He said, “Our monetary policy will remain accommodative – do not forget that the EONIA, the very short-term interest rate, is standing at about 7 basis points, or at 6 basis points now, which is almost zero. But having said that, we will assess all incoming data and stand ready to act”. At that time all economic analysts translated it as an announcement of rate cuts. Given that those incoming data are now in position, the entire financial world is convinced that the ECB is ready to cut its basic interest early next month, during the next meeting of its governing council.
In view of that all the European stock exchanges had a party over the last two days, and markets always know best. All first year students of economics know that when the interest rates fall, stock prices rise. The reason is very simply that any reduction in the cost of central bank’s money helps all commercial banks increase their profits. As a result their stocks will become dearer, simply because the central banks will inject to them cheaper money. On top of that there is the possibility that a part or all of this reduction of the cost of money will pass on to the real economy, making credits. In theory this will help the real economy grow, produce and sell more and consequently public companies will gain more. But how real this last theory is?
What good will that do?
In Eurozone financial markets remain so fragmented that a reduction of ECB’s interest rates by ¼ percentage unit will mean nothing at all, say for the Greek banks and the country’s economy as a whole. The same is true for a large number of euro area peripheral member states. In the most important of them, like Italy, Spain, Greece, Ireland and Portugal any discussion for growth is out-of-place. All of them keep losing large parts of their GDP, and their bleak prospects are invariably not fading away even for 2014.
Even in core countries like Germany, France and the Netherlands the growth problems will not be alleviated in any way by an interest rate cut by ECB of the order of ¼ percentage unit. Their problem remains the falling internal demand, as a result of the fiscal consolidation and the large cuts of government spending. Germany has been heavily criticised for that in the recent spring conference of the IMF and the World Bank.
All in all it’s like the ECB to be ready for an interest rate cut just because it will have no impact at all on the real economy. It is as if Eurozone’s decision makers have firmly concluded that the region needs an internal devaluation period, in order to become more competitive internationally. At the end it will be only the major commercial banks in core countries, to benefit from this ECB’s interest rate cut.
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