When the European Central Bank announced the end of quantitative easing in December, it was conveying a very clear message to markets and governments alike: we are approaching the end of expansionary monetary policies, so get ready for what’s coming.
That much was clear from the press release the ECB put out at the time, hinting that interest rates could start rising as soon as September 2019.
However, more recently the bank’s Governing Council seems to have backed down in its plan to tighten monetary policy. In light of the worsening economic outlook, the Eurozone’s monetary authority has made clear that it will keep interest rates at their current levels at least until the end of this year. Added to that, a new series of long-term refinancing operations starting in September will be carried out in order to give a boost to bank lending.
Are there good reasons to postpone the normalisation of monetary policy? Maybe. Several bodies have recently warned about the possibility of an economic slowdown in the Eurozone. In fact, the ECB itself has slashed growth forecasts for this year from 1.7 to 1.1 per cent. Similarly, the European Commission estimates that Germany, the so-called locomotive of Europe, will grow by only 1.1 per cent, 40 per cent lower than its previous estimate.
The Economic Sentiment Indicator (ESI), which measures consumers’ and businesses’ confidence in the economy, has been falling since 2017, and investment growth is expected to slow down in 2019.
So what is hampering economic growth in the Euro area?
Brexit is one of the reasons. There is no doubt that the UK’s withdrawal from the European Union will have a negative impact on the performance of the Eurozone’s economy, especially if hard Brexiteers win the battle and secure a No Deal exit. That would mean new tariff and non-tariff barriers on both sides of the English Channel, which would affect exporters. Without doubt that impact would be more serious for the UK, whose main trading partner is the EU.
Economic uncertainty could also be a factor influencing Europe’s slow growth. The relationship between high-uncertainty environments and recessions has been well-documented by economists. In the aftermath of political, economic and financial crises, firms tend to defer new investments awaiting new information about where the economy is going, which in turn has a negative impact on aggregate demand.
In the case of the Eurozone, the ESI index suggests that episodes like the trade war between the US and the EU, anti-government protests in France and the continuing Brexit saga have increased economic uncertainty, with a knock-on effect on growth.
It should be noted that despite the challenges the Eurozone economies are currently facing, their situation today is far more solid than it was a few years ago. The unemployment rate is at near historically low levels. What’s more, the countries that triggered the debt crisis in 2009 are now in much better shape shape. Ireland has experienced spectacular economic growth in recent years, while Portugal and Spain have reduced their unemployment rates considerably. Even Greece, whose GDP fell by a catastrophic 26 per cent between 2009 and 2016, has balanced its budget and is now growing at a good pace. The exception to this general improvement is Italy, which seems to be lagging behind.
Either way, complacency is not an option. The Euro area still has a number of structural problems that will have to be dealt with over the coming years. Spain and France have barely taken advantage of the tailwinds resulting from low oil prices and low interest rates to undertake the structural reforms that would help them cope better with future shocks. In addition, populism is gaining momentum, with Italy – the third largest economy in the Euro area – now ruled by a coalition of right-wing and left-wing populists.
The ECB might have good reasons to delay monetary tightening at least until 2020. But make no mistake: long-term economic growth doesn’t depend on monetary policy, but on productivity increases. Eurozone countries will thus have no choice but to carry out supply-side, growth-boosting reforms if they wish to continue growing in the next decade.
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