Predicting two more years of economic stagnation

José Manuel Barroso, President of the European Commission (in the centre), Olli Rehn, Vice-President of the EC in charge of Economic and Monetary Affairs and the Euro (on the left), and Michel Barnier, Member of the EC in charge of Internal Market and Services, gave a joint press conference on the blueprint for a deep and genuine Economic and Monetary Union (EMU). (EC Audiovisual Services).

José Manuel Barroso, President of the European Commission (in the centre), Olli Rehn, Vice-President of the EC in charge of Economic and Monetary Affairs and the Euro (on the left), and Michel Barnier, Member of the EC in charge of Internal Market and Services, gave a joint press conference on the blueprint for a deep and genuine Economic and Monetary Union (EMU). (EC Audiovisual Services).

Yesterday, as expected, the European Central Bank kept its basic interest rate unchanged at 0.25%. As usually, the decision was taken in the meeting of the bank’s Governing Council, the first of 2014. At this almost zero interest rate cost commercial banks get ample liquidity from the ECB and then lend this money to the private sector that is households and businesses, charging them with double-digit interest cost. Of course, large companies do not rely on banks for their financing and don’t pay such dear rates for their loans. It’s the consumers and the SMEs that pay the price.

In this respect, the President of ECB Mario Draghi revealed that the commercial banks of Eurozone showed lately “a preference for liquidity although it was below the peak of 8.7% observed in April 2013”. The truth is that Eurozone’s lenders borrowed a lot of cash from the ECB before the end of the year of course paying that near zero interest rate. Mysteriously, this money didn’t surface in the monetary market. Draghi explained that “The annual growth rate of loans to households stood at 0.3% in November, broadly unchanged since the beginning of 2013. The annual rate of change of loans to non-financial corporations was -3.1% in November, following -3.0% in October”. Then it’s a mystery what the major banks did with the money they took for free from the ECB. In short, the banks get the money from the ECB and use it for unknown purposes.

Cheap and abundant money for the banks

However, despite the fact that the banks do not lend the money they get from the ECB to the real economy to help it grow, Draghi confirmed that “the Governing Council strongly emphasises that it will maintain an accommodative stance of monetary policy for as long as necessary”. This means the ECB will keep supplying all and every Eurozone bank with unlimited quantities of liquid money covering fully all the relevant queries. It’s not only that. The ECB also promises to continue offering money to banks at almost zero interest rate. To this effect Draghi said that “Accordingly, we firmly reiterate our forward guidance that we continue to expect the key ECB interest rates to remain at present or lower levels for an extended period of time”.

Of course, the central bank is forced to act like this, given the sluggish state of the economy. “As previously stated, this expectation is based on an overall subdued outlook for inflation extending into the medium term, given the broad-based weakness of the economy and subdued monetary dynamics”. It’s a one way road for the ECB to continue pumping cheap money to the economy. The problem is that this can be done only through the banks, but the lenders keep denying offering this extra money to the loan market.

Predicting stagnation

In any case, the central bank will continue to follow the same monetary policy in the foreseeable future. As the President of ECB put it “Looking at 2014 and 2015, output is expected to recover at a slow pace, in particular owing to some improvement in domestic demand supported by the accommodative monetary policy stance”. Understandably, if ECB’s monetary policy stopped been fully accommodative, Eurozone economy would risk an abrupt return to recession. Obviously the ECB is obliged to continue supporting the barely growing or stagnant real economy by replenishing the coffers of the banks with zero cost and ample money supply. Under the present circumstances any other option may be catastrophic. It’s as if the banks hold the real economy as hostage.

The sluggish prospects of the real economy were confirmed yesterday by two announcements. In the first case the Commission revealed that the “Business Climate Indicator remained broadly unchanged in December”. On the second occasion, the Commission said that “the Economic Sentiment Indicator reached in December its long-term average (100.00) for the first time since July 2011”. In both cases the conclusion is that the Eurozone economy is rather stagnant. Unfortunately there is no indication that things will change during the next two years. Draghi accepted that, “in 2014 and 2015 the economy will recover at a low pace”. Mind you he didn’t say ‘will progress’ but rather choose the term ‘recover’. In short, a slow pace recovery is the best the Europeans can expect for the next years. Only the politicians talk about growth, but who believes them…

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