The Punk Rock Life Is No Place for the ECB
(Bloomberg Opinion) -- It’s hard to find similarities between the European Central Bank and a punk band.
But there may be no better line than Green Day’s “Wake Me Up When September Ends” to describe what must be going through the minds of President Mario Draghi and his colleagues.
In the third quarter, German output contracted for the first time since 2015, data on Wednesday showed. This helped push euro zone growth down to just 0.2 percent. There are good reasons to think this was a temporary blip. But even so, the ECB’s policy path may not be a smooth one.
The case for optimism on Germany lies in the auto industry. Car production plunged by a quarterly 7.4 percent, which subtracted more than 1 percentage point from expansion in industrial production and around 0.3 percentage point from gross domestic product growth, according to Stefan Schilbe, economist at HSBC. Producers’ delays in preparing for new environmental standards, that came into effect for passenger cars in September, meant they couldn’t make new vehicles as quickly as they wanted.
But as this production is dragged into the current period, revenues can rebound. Add in a strong labor market, rising wages and falling oil prices, and there should be firm support for household spending and a good case for a fourth-quarter recovery in GDP growth.
The ECB appears to share this rosy outlook: In October, Draghi said that the risks to the region’s economy were “broadly balanced.” Bundesbank President Jens Weidmann echoed the sentiment on Wednesday, saying the data fluctuations shouldn’t mask the broader recovery, and policy should be normalized without delay. This suggests that the central bank remains on course to end its net asset purchases at the end of December, as it announced last June.
There are still plenty of reasons for concern. Schilbe said he expects only a “moderate” recovery for the auto industry. And German exporters are also vulnerable to the slowdown in external demand and the risk of a trade war between the U.S. and Europe.
The other major peril is Italy, which stagnated in the third quarter while other countries grew. The arrival of a populist administration in Rome has pushed up sovereign bond yields and now risks causing a credit crunch. The Italian government points to the recent slowdown in the euro zone to justify its decision to stick to an expansionary budget, in spite of the sharp rebukes from the rest of the EU. But so long as bond spreads remain elevated, this strategy is set to backfire, as the government will use much of the extra borrowing to cover higher interest payments.
So far, Italy has not been a source of contagion. As its government bond yields widened to Germany’s, the debt of other nations has held relatively firm. But if Italian spreads blow out, a knock-on impact to other big borrowers in the bloc could create a liquidity squeeze that may dampen the recovery in other countries. In turn, this would encourage the central bank to reconsider the pace at which it withdraws stimulus.
The ECB should pay very close attention to how any new data or market moves that come in before its next meeting, on Dec. 13, change the outlook for prices. Even then, it is very hard to see officials reneging on their guidance that they will end quantitative easing in December: The ECB launched its bond purchase program at the start of 2015 to stave off the risk of deflation. While core inflation is only gently rising, the headline rate is now above the bank’s target of close to but below 2 percent. These figures make it much harder to justify an extension of QE.
However, officials have other instruments to address risks to prices. For a start, they will continue to reinvest the proceeds from bond redemptions. This can be engineered to provide greater stimulus, for example buying more longer-term debt in lieu of shorter-dated securities. Most importantly, it could use forward guidance to push back market expectations over the first interest-rate rise, which would weaken the euro and further loosen financial conditions.
Ultimately, the ECB’s next moves will depend on what happens to inflation. It will only be able to reopen its toolkit if underlying price pressures in the euro zone remain weak. It would find it harder to intervene again to combat a slowdown if core inflation were to climb suddenly.
Policy makers guided by the inflation outlook? It sounds the stuff of boring central banking — not of punk rock.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
©2018 Bloomberg L.P.