In World Economy News 20/01/2016
European Central Bank policy makers here are accustomed to looking south for economic trouble spots. In the past, weakness in Greece and southern Europe has hindered growth in the 19-country currency bloc.
But when rate-setters meet for a policy decision Thursday, they are expected to be looking far to the east, because Chinese market turmoil is weighing on stock markets and investor sentiment world-wide.
That volatility combined with low energy prices globally threaten to put more pressure on the ECB’s inflation target. That could prompt ECB chief Mario Draghi, a central banker with proven dovish tendencies, to loosen monetary policy even further this year.
Though trade with China remains small relative to the size of Europe’s economy, it has become a more significant partner as its economy boomed. In 2014, it was second only to the U.S. as a destination for Europe’s exports, accounting for 9.7% of the total, and as a source of imports, at 18% of the total.
Germany has by far the most significant trade relationship, accounting for 46% of Europe’s total exports to China, but that was equivalent to just EUR75 billion ($81.5 billion), a fraction of Germany’s EUR3 trillion of economic output.
Experts predict a continuation of Europe’s modest economic growth this year, but Mr. Draghi has suggested that while there was little direct connection between the eurozone and China, a drop in confidence in China could hurt Europe.
“Any very large surprise in a very large economy might have the potential to affect confidence world-wide, and then we would have to see in which way and how to cope with that,” he said at the Oct. 22 news conference.
Markets will be watching closely what he says Thursday.
The ECB has tools at its disposal that could help the eurozone by weakening the exchange rate. One is lowering the deposit rate further into negative territory, beyond the minus 0.3% where it has been since early December. It could also increase the monthly volume of its large-scale asset purchase program put into place in early 2015, or extend the end date again after prolonging it by six months in December.
Most experts don’t think the ECB is ready to pull the trigger yet on new easing measures so soon after that extension. But the ECB might want to signal readiness to act in March.
The central bank’s task is complicated by falling commodity prices spurred in part by the Chinese slowdown.
While global growth worries are serious, lower commodity prices carry an upside for the eurozone since they leave consumers with more money to spend on goods and services produced inside the bloc, and businesses enjoy lower costs and higher profit margins. But they also push the bank’s inflation target of just under 2% out of reach.
Policy makers had hoped inflation would start to pick up around the turn of the year, but have been frustrated by the renewed slide in oil prices.
The International Monetary Fund has said the eurozone continues to be at risk of a slide into deflation, or a situation in which falling consumer prices weaken economic output. That could in turn lead to lower prices.
IMF Chief Economist Maurice Obstfeld said Tuesday that while there is some opposition within the ECB’s governing council to further stimulus measures, he is confident the central bank will react to the threat of deflation.
“We would expect policy broadly to respond in a positive way to growing evidence of deflationary pressures,” Mr. Obstfeld said.
The eurozone’s annual rate of inflation was 0.2% in December, and economists at Barclays now reckon prices will begin to fall again in February and continue to be below their levels of a year earlier through July.
They now expect consumers prices to rise by just 0.1% in 2016 as a whole, well below the forecast of 1% provided by ECB economists in December.
“We’re thinking there’s a strong case now to move [policy],” said Nick Kounis of ABN Amro, though he predicted the ECB would wait until March.
Other experts don’t expect action so soon, unless conditions change.
“The latest market turmoil, continued concerns about the Chinese economy, adverse effects from low oil prices and recent worries that the Fed might have jumped the gun in December have clearly increased the external risks for the eurozone,” said ING economist Carsten Brzeski.
He expects the ECB to hold fire this month. He also doesn’t “see a strong case” for a March easing of policy unless economic conditions in the eurozone worsen, there’s a sharp dip in core inflation or there’s “a strong unwarranted tightening of financial and monetary conditions in the eurozone,” he said.
