Mario Draghi, President of the European Central Bank, Michael Noonan, Minister for Finance of Ireland, Pierre Moscovici, Minister of Economy, Finance and Foreign Trade of France, Olli Rehn, European Commissioner in charge of Economic and Monetary Affairs (European Council – Council of the European Union, TV-Newsroom).
Last Wednesday, one day ahead of the regular monthly meeting of European Central Bank’s Governing Council, Eurostat, the EU statistical service, published a Press release on Eurozone’s near zero economic growth. The relevant passage of that text went like this, “Seasonally adjusted GDP rose by 0.2% in the euro area (EA18) and by 0.3% in the EU28 during the first quarter of 2014, compared with the previous quarter, according to second estimates published by Eurostat, the statistical office of the European Union. In the fourth quarter of 2013, GDP grew by 0.3% in the euro area and by 0.4% in the EU28 “.
It was pretty clear that growth in the euro area economy remained not only quite anemic but it was steadily heading towards the negative part of the graph. Understandably, all the members of ECB’s Governing Council had access to this information before converging to Frankfurt to participate in last Thursday’s gathering. They also knew that “In April 2014, compared with March 2014, industrial producer prices fell by 0.1% in both the euro area and the EU28, according to estimates from Eurostat “. Last Tuesday, this most reliable statistical authority had also produced a Press release announcing a new fall of the overall inflation rate in May to 0.5% according to the standard flash estimate procedure.
Extraordinary measures for growth
In conclusion, it was completely evident then that Eurozone was heading, if not towards a deflation and recession dual precipice, to at least a very lengthy stagnation trap. In reality, this dreadful prospect must have been apparent to the members of the ECB’s Governing Council, even from their May meeting at the beginning of the previous month. On that occasion, the European Sting observed (on 12 May) that “Draghi, the ECB’s President said the ECB governors will unanimously agree in June, in taking extraordinary monetary measures aimed at bringing inflation back in line with the target, set at ‘below but close to 2%’. By applying extraordinary monetary measures the ECB will also try to arrest the rise of the euro vis-à-vis the other major currencies, thus helping exports and hindering the rise of imports, in order to support growth”.
As a matter of fact, last week, on Thursday 5 June, the Governors of euro area’s central bank unanimously decided to reduce the basic interest rate of the bank to 0.15% from 0.25%, and introduce for the first time a penalty of -0.1% on idle money deposits parked by commercial banks with the ECB. Draghi also announced extraordinary monetary measures in order to support the liquidity of the financial system and thus help the granting of bank loans to the real economy. He stopped short only from announcing quantitative easing, that is straightforward new money printing.
No quantitative easing
The extraordinary measures include a series of targeted longer-term refinancing operations (TLTROs) aimed at improving bank lending to the euro area private sector. Banks will be refinanced on their loan balances, excluding loans to households for house purchase. The ECB will also “intensify preparatory work related to outright purchases of asset-backed securities (ABS)”. Those two instruments (TLTROs and purchase of ABSs) are obviously targeted to refinance the commercial banks by replenishing their liquidity, so as they can start a new cycle of lending to the real sector.
In detail, under the TLTROs commercial banks will be entitled to a borrowing allowance from the ECB equal to 7% of the total amount of their loans to the euro area non-financial private sector, excluding loans to households for house purchase, outstanding on 30 April 2014. All TLTROs will mature in September 2018. The other line of commercial bank refinancing will be through ECB purchases of securitized high quality loans accorded to real economy agents, aimed also at facilitating new credit flows to the economy.
Betting on growth
Those extraordinary monetary measures are meant to support growth. The problem is however, if they will prove enough to drag the Eurozone out of stagnation. For one thing, the reduction of ECB’s basic interest rate from 0.25% to 0.15% may look unimportant, but it is introduced in a world financial environment of upwards bound interest rates in all the other major currencies. The recent fall of the euro/dollar parity is an indication of the repercussions of this step. The other monetary measures taken last week by the ECB are thought to work towards the same direction, yet their full effect will be seen over the next months, probably well into 2015.
The European Sting has anticipated those extraordinary measures early in the morning of Thursday 5 June, in an article entitled “Falling inflation urges ECB to introduce growth measures today”. The urgent character and the pressing need for those measures were evident many months now. Nonetheless, the German government expressed doubts despite the fact that the country’s central bank, the prestigious Bundesbank, agreed. The German Federal Minister for Finance Wolfgang Schauble said that interest rates must increase in the medium term.
Given its institutional constrains the ECB did what it could, to help Eurozone grow again. It can do more if needed. Quantitative easing remains stored in its arsenal. If the impact of the reduction of the interest rate will prove weak to revive Europe’s economy then the TLTROs and the purchase of ABS could take the lead by acquiring important dimensions. If that also proves insufficient to restore growth and arrest the rally of the euro, quantitative easing will be decided for sure.
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