Has winter returned to the Eurozone?
The European first-quarter GDP numbers released last week disappointed the majority of economists and investors. Consensus was expecting a 1.6% annualized growth rate, but barely half that was achieved. More importantly, the last quarter of 2013 showed the six largest Eurozone economies posting growth simultaneously for the first time since the Great Recession of 2008/9, but this could not be confirmed in the latest release.
Germany as a juggernaut posted a solid annualized 2.4%. Spain and Belgium each managed 1.6% annualized growth, at least good numbers in line with expectations. Joy ended there.
France stagnated at 0.0% growth. Italy receded again, at 0.4% annualized. The worst-performing large Eurozone economy was that of the Netherlands, showing annualized decline of 5.6%. This alone shaved the overall Eurozone growth rate by annualized 0.4%.
Much of this dismal Dutch number was attributable to the mild winter in Europe. It depressed gas prices and thus the value added of the energy sector in the Netherlands. Hence, in Europe as in the US, the polar vortex is an excuse for first-quarter setbacks. But unlike in the US, some of those setbacks (France and Italy) are due to more than the weather.
This has gone on for the last seven months, i.e. since sub-1% inflation surprised market participants last October in the Eurozone. The Eurozone is slowly sliding into a low growth, low price-pressure (the word deflation remains taboo) environment. The European Central Bank (ECB) so far has stood on the sidelines trying – like many economists – to collect all the “special factors” (weather, energy, food discounters’ war in Germany, etc.), which would prevent calling a trend a trend.
But this has ended. During the last ECB press conference two weeks ago, Mario Draghi made a U-turn. The main communication channel of the ECB so far has been a form of forward guidance with no strings attached (“whatever it takes,” “using unconventional instruments within the ECB’s mandate”). Now, Draghi almost pre-committed by even acknowledging that his predecessor Jean-Claude Trichet’s “We never pre-commit!” finished a long time ago.
So what might happen at the next ECB meeting scheduled for 5 June? It seems a done deal that main interest rates will be cut. The ECB’s deposit rate might even drop below 0%.
Market participants are nearly unanimous, and therefore a rate cut as such is in my view already “priced in.” So if the ECB really wants to have an impact on the euro, on inflation expectations and thereby on the still ailing Eurozone economy, it will need to do more.
Opinions of market participants diverge here. Some say the ECB could even launch a fully-fledged quantitative easing (QE) program by buying the debt of Eurozone governments. There are good reasons to doubt this. First, a European QE would be legally touchy, given that the European constitutional court has so far given no ruling.
Second, there are technical issues. While to be most effective QE would target specific countries in need, the German constitutional court has stated that this would favor some Eurozone countries over others.
Finally, we should bear in mind that the interest rates of the European periphery’s government bonds are far lower now than six months ago (in some cases at record lows), so reducing them further does not seem effective.
What could be more effective would be to address the specific problem of still declining loan and credit activity of the Eurozone’s small and medium-sized enterprises. ECB measures to entice European financial intermediaries to loosen their credit conditions therefore seem more plausible alternatives to QE.
Whatever the ECB’s ultimate decision, it should in my view avoid complacency or procrastination. The Eurozone recovery is far too fragile for that.