The European Central Bank (ECB) could cut down interest rates if official economic data from February turns out to be disappointing. Yet, action is urgently needed now, not later.
The German private sector is already slowing down, and the euro has fallen more than 1 percent per US dollar due to the amount of bad news coming from Europe during the past weeks. But the ECB has a unique mandate among other central banks, which is to maintain price stability. In the current environment, though, deflation is likelier than out-of-control inflation, and a too strong euro can harm some eurozone’s national economies.
In spite of Germany opposing any monetary expansion measure, though, we think the ECB should cut reference interest rates at least by 0.25 percentage points. Otherwise economic activity will stall. The ECB is an independent institution, it should be more flexible and look at the sorry state of the eurozone as a whole, as not even Germany or France can avoid being dragged down by what is happening in the southern countries.
And what about a more flexible deficit target? Governor Mario Draghi recently said that “relaxing fiscal adjustments would imperil reforms already achieved.” Would you agree?
Absolutely. In the end, whether the ECB intervenes or the Union finally sets up a pan-European banking supervisor will have no effect unless countries make the effort to balance their fiscal deficits. The countries that inspire less confidence among investors and lenders must work harder to return to economic growth levels and reduce their unemployment figures, which are staggering.
These unbalances, though, can be corrected in different ways. I believe the wrong mechanism is to increase taxes while cutting the most productive public spending items like education. In Spain, for instance, the right plan would be to shrink the size of public administrations, to cut waste and useless duplicities.
Draghi also said the eurozone could recover gradually during 2013. Do you expect real green shoots this year?
Europe has made progress towards adjusting fiscal unbalances, and this should help us to leave the days of the financial and economic crisis behind. At the same time, the Union seems to be on its way to more integration and co-ordination beyond currency requirements. Now, what is urgent is that the weaker countries keep up their reform plans and core countries increase their imports. The ECB appears to be waiting for the global demand to pick up, but the US, Japan and emerging economies altogether offer a confusing picture, so far.
What is true is that the worst has been avoided: the risk of a eurozone breakup has all but vanished, and the efforts made to improve competitiveness–in Spain, for example–has been remarkable.
We think we’ll see better statistics by the end of the year, although it’s still important that the cost of credit for peripheral governments falls further and capital flows and revives the European economies. Then, there is the global economic forecasts: it is vital that the US grows, even if the recourse for more public investment is now scarcely available, and equally important is that China dispels fears of a ‘hard landing’.
In this context, does it make any sense that the euro appreciates?
In terms of economic growth, no, it does not. Our economies are troubled, unemployment is rampant and we are in the middle of a deleveraging process, which hits our internal demand and consumption. It is no good to have a strong euro. But the ECB behaves in a different manner than most central banks, so we don’t get near zero percent interest rates, nor injections of capital into the economic systems.
Yet, the announcement of a limitless intervention to support short-term sovereign debt sort of took away the threats of systemic risk that lingered over the eurozone. Investment flows into equities and fix income products are today higher than before last July. This is precisely why the price of the euro has risen.