The European economy is currently growing at a rate that hasn't been seen for many years. Eurozone GDP grew by 0.6 per cent in the third quarter after a revised 0.7 per cent in Q2, and by 2.5 per cent over the last year. This is the fastest annual rate since 2011. Annual GDP growth in the European Union averaged 1.72 per cent from 1996 until 2017, so current figures look very positive indeed.
In recent months industrial production has been rising strongly. Consumer spending is picking up in many countries. Business confidence and the manufacturing Purchasing Managers’ Index point to that trend continuing. Forecasts are being revised upwards to suggest growth of around 2 per cent this year and next. Germany is likely to spend its projected budget surplus on infrastructure and other projects under pressure from the partners in the new coalition that Chancellor Angela Merkel is putting together.
What’s more French growth, now at an annual rate of 2.2 per cent, is picking up, allowing president Emmanuel Macron some room for manoeuvre as he pushes reforms through. Spain has been one of the best performing large European economies (though the Catalan crisis may knock it back). Even Italy is having a bit of a recovery despite the uncertainty created by forthcoming elections. And conditions in Greece are slowly improving—though there is still a long way to go.
The expectation therefore would have been that the European Central Bank (ECB) would be trying to “normalise” interest rates by now, moving from the low—in some cases negative—rates that it currently offers for certain types of deposits and lending. One might also have expected that it would have started to think about reversing Quantitative Easing, a process by which the ECB purchases assets with electronic money that did not exist before, and which has formed part of its “unconventional” monetary policy since mid 2015.
After all, the US Federal Reserve board recently announced that it will do this, and something may need to be done soon to deal with the ECB’s balance sheet, which has been swollen by the purchase of some €2 trillion of government bonds in the secondary market since the start of QE, in addition to other types of assets including corporate bonds.
But Mario Draghi, the head of the ECB, seems to have ignored all this. After announcing in the summer that the ECB board would be reviewing its monetary stance in the October ECB meeting, last week he left rates unchanged. And instead of signalling an end to QE he actually extended it to September 2018. The implication of what was announced in fact suggested that purchases under the programme could continue well into 2019.
“Draghi feels justified in continuing to help the economy—and the evidence so far supports his actions”To be sure, he announced cutting purchases by half, from €60bn a month to €30bn from January 2018. But varying the amount bought each month has happened before. The ECB’s QE started at €60bn a month and then was raised to €80bn for a while before moving back down to €60bn a month, where it has been for a while. So flexibility has been seen before. Moreover Draghi announced that he would be re-investing money paid to the ECB when bonds matured so market liquidity would not be affected. Additionally other elements of assistance, such as the long-term refinancing operation—which provides cheap liquidity to banks on the condition that they lend it on—is continuing.
What lies behind all this is Draghi's belief that it is monetary policy that has allowed the eurozone economy to recover from the recession following the financial crisis, while fiscal policy has been restrictive or at best neutral for most of the post-crisis period. His policies have enabled yields across countries to converge and “normality” to return but much of this is still precarious.
Unemployment for the eurozone as a whole is only just below 9 per cent with huge internal variations—from 3.6 per cent in Germany to 17 per cent in Spain and 22 per cent in Greece. And youth unemployment remains frighteningly high across much of southern Europe.
In addition banking difficulties remain. The ratio of Non-Performing Loans, though reducing, is still too large and threatens banking stability. Eurozone debt is now nearing 100 per cent of eurozone GDP and is much higher in places like Italy and Portugal (over 130 per cent) and Greece (188 per cent). This is unsustainable and destabilising—and inhibits growth.
Add to that relatively subdued wage pressures with inflation remaining stubbornly below the 2 per cent target and it is therefore not surprising that Draghi feels justified in continuing to help the economy. And the evidence so far supports his actions. When attacking central bankers for the distortions an accommodating monetary stance may be creating, it is always worth contemplating how low growth would have been if monetary policies had not stepped into the public policy void.
