Eurozone: a real growth or a simple bounce up?

According to what Mario Draghi claimed during the last press conference in Frankfurt, in the next few months the ECB will adapt its monetary policy to the better Euro-System conditions, even if it has decided to not change the expansive approach followed until today.

Stepping back to the day before the press conference, we can try to analyse the economic situation of Europe in order to understand the Council’s arrangements. Only a year and a half ago the world economy faced stalling development and financial markets’ turbulence, with the weakest growth since the financial crisis (only 3.2%). These conditions are a sort of bitter memories now, because of the cyclical upswing that began midway through 2016 and continues to gather momentum.
These positive developments could send a misleading message to the policy-maker and could let them think that markets have already got over the crisis. Deepening these recent events, it is possible to understand why it is not so. Not all the countries are participating to the recent development; the wage growth continues to remain weak while the inflation is still below target. The recovery could be threatened by serious risks that cannot be underestimated for any reason.

Concerning the conference, what decisions were taken by the governing council?

  • The interest rates will be kept unchanged, and the ECB expects them to remain at the present value for an extended period of time.
  • As regards the Non-Standard monetary policy measure, they will continue to make purchases at the current monthly payments of 60 billion until the end of December 2017. From January to September 2018, and beyond, if necessary, monthly payments will be equal to 30 billion.
  • The euro system will reinvest the principal payments from mature security purchased for an extended period of time in order to contribute to the liquidity increase.
  • They have decided to continue to conduct the main refinancing operations at a fixed rate for as long as necessary and at least until the end of the last reserve maintenance period of 2019.

It could be interesting to highlight some expressions inside the announcement as “beyond, if necessary” or “as long as necessary”. The use of them has not been fortuitous. Indeed, a more tightening announcement could have led to an increasing in the power of euro, pushing down exportation and close off the growth. If the ECB had declared precisely the end of the assistance, global markets would have thought wrongly about an approaching monetary policy independence of the area. Normally, this condition is related to a steady growth (not completely attributable to Europe up to now), that would lead to an increase in purchasing power. It implies a rising price of goods, whose purchase by other countries becomes more expensive and so more awkward, entailing an exportation’s drop. Considering the GDP in which export are embedded with a positive sign, it is possible to understand the reason of the Gross Domestic Product “tumble”.

Figure 1: Inflation Rates in the Eurozone, retrieved from Bloomberg

Even if it could be simple to imagine the points listed above as four ways for four different objectives, actually, the ECB only has one aim: the return of the inflation rate to the target level of 2%, while it hovers around 1.5%. The domestic price pressure is still unaltered overall and the path of inflation remains conditional on continuous backing from monetary policy. Therefore, an ample degree of monetary stimulus persists in being necessary for underlying inflation pressure to continue to build up and support inflation development on the medium term. This support is provided by the net asset purchases, by the sizable stock of underlying assets and the forthcoming reinvestment, and by the forward guidance.

For what concerns the net asset purchases, it has been modified in term of size and length, as it is possible to notice from the second point. Even if inflation rate is stable at 1.5%, the better economic conditions have caused a growing confidence on the policy-maker’s side. Cutting down by 50% the so called QE, means to give a crucial signal to the market: UE’s economy has been growing and continue to upscale in the future. The ECB pursues to help Europe in a way in which it can begin to act independently. Namely, Europe would have lulled into complacency if its Central Bank had issued the same amount of money in the system through QE.

On the other hand, even the policy-maker is able to manage different scenarios without stress. Nobody can reassure them that nothing wrong will happen in the future. Here is the link with the title, even though the final answer is a mix of the two main hypothesis. Nowadays developments should not be seen only as a bounce up, since increase in real GDP, the rising employment and the improvements in corporate profitability, are caused by solutions that governments have sought out in order to overcome the financial crisis. However, it is impossible to ignore that after every burst there is always a natural boom, but what is indisputable now is that the same expansion cannot be serendipitous but reached with great effort. Consequently, even if we ought to consider it as necessary, we have to keep in mind that it cannot be the only reason for current results.

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