Will Europe’s economic miracle be derailed by a central-bank power struggle?
By David Brown
Europe's economic leaders deserve a pat on the back. Dodging disaster by the skin of its teeth in recent years, Europe has bounced back, with economic confidence brimming over, more Europeans back in work and stock markets booming. The pessimists have been proven wrong and the euro single currency and European Monetary Union live to fight another day. Optimists say a new economic miracle is underway.
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And who would deny it, especially considering the dark days of 2009-2012 when Europe's back was against the wall and odds for the euro's survival seemed grim? Policymakers, especially the European Central Bank, dug deep and dredged up recovery by hook and by crook.
Zero per cent interest rates and huge swathes of quantitative easing might have been against Germany's better judgment, but the proof is in the pudding. Europe is back on the road to recovery and Germany relished the spoils.
The only doubt that springs to mind is one of sustainability. Will Europe be capable of maintaining solid forward momentum, once the super-stimulus fuel runs out? It ought to be the 2.6 trillion euro question testing markets right now. The ECB has already called time on super-loose policy, the taper is now in place and the economy needs careful scrutiny for early warning signs of future fatigue.
So far, everything looks fine. Economist polls for 2017 suggest the euro-zone economy should notch up its best performance in a decade. Growth of gross domestic product is expected to average 2.2 per cent this year and should probably average close to 2 per cent over the next couple of years, if the upbeat mood is maintained.
Economic confidence is booming. The euro zone's benchmark economic sentiment indicator, which correlates closely to GDP growth, is running at a 16-year high, a good sign for the future. German business indicators are surging too, which is no surprise considering the glut of cheap and easy money flooding its economy.
The worry is that German growth is pushing up to levels which are sounding alarm bells in the nation's conservative-leaning central bank, the Bundesbank. In the third quarter alone, annualized German GDP growth accelerated to 3.2 per cent from 2.5 per cent in the previous quarter. Even though German inflation remains pretty languid at 1.6 per cent and below the ECB's 2 per cent target, the Bundesbank is rattled.
Its inflation hackles have been up for a while. The cocktail of negative euro-zone interest rates, overgenerous quantitative easing and quickening German growth is anathema to Bundesbank hardliners, who fear deepening risks to domestic price stability. It is casting doubts over ECB policy unanimity and could embroil markets if it spills into a full-blown public row.
The problem is what's good for Germany is not necessarily in the euro zone's best interests, especially for more vulnerable economies like Greece, Portugal, Spain and Italy, who want to see super-stimulus last for as long as possible to get growth back onto terra firma again.
The ECB has managed to keep a lid on policy differences so far, but the pressure cooker is waiting to blow. In pre-EMU days, the logic was simple. The Bundesbank was the monetary anchor for European rates, what it decreed was absolute and Europe just had to follow suit. Germany will be reluctant to wait until October 2019 when Mario Draghi's term runs out as ECB president. After years of footloose policy expansion, Germany wants to restore better monetary stability as soon as possible.
European markets are waiting nervously to see how it all pans out. Since 2014 Europe has enjoyed a unique monetary boost worth around 25 per cent of GDP, but from here on it will be the dynamic impact of changing expectations which will inflict the most damage. If the future policy thrust reverts back to guidance on interest-rate intentions being the Pole Star, markets will end up muddled. All markets want is simplicity, clarity and certainty. If they are forced to second-guess blurred ECB policy messages, European stocks, bonds and the euro will suffer. And Europe's economic miracle will end up no more than a short-lived mirage.
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