Europe’s Economic Challenges About to Be Laid Bare for Lagarde

(Bloomberg) --

Christine Lagarde is about to get a harsh snapshot of the challenges that face her when she takes up the European Central Bank presidency this week.

As the former French finance minister counts down to taking over from Mario Draghi, the deteriorating backdrop that pushed the ECB into a new round of monetary stimulus less than two months ago will be brutally exposed. Figures are due to show the euro area’s worst economic performance since 2013 and inflation slipping further from the ECB’s goal.

Draghi, who changed the course of the debt crisis back in 2012 by pledging to do “whatever it takes,” still departs having failed on his inflation mandate. Once ensconced in the ECB chief’s office, Lagarde will need to find new ways of lifting the bloc out of its torpor, possibly above and beyond the recent package, which included rate cuts, asset purchases and better terms for loans to banks.

They are both due to speak at a farewell event in Frankfurt on Monday, before the official Nov. 1 handover.

With a manufacturing slump threatening to spill over into services, euro-area growth was probably just 0.1% in the third quarter. France is also cooling, while Italy’s economy is predicted to have stagnated. Germany is likely in a technical recession, though that won’t be confirmed for another two weeks.

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“Elevated uncertainty and a turn in the global investment cycle have dented external demand and weighed on sentiment in the euro area and Germany in particular. We expect GDP growth slowed slightly in the third quarter -- a lot depends on how the services sector held up.”

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Adding to the problems, the ECB got a warning last week that faith in its ability to maintain price stability is waning. In its survey of professional forecasters, the outlook for longer-term core inflation was cut to 1.6%. The ECB aims to keep the headline rate -- seen at 0.7% in October -- below, but close to, 2%.

“The euro zone economy is stuck in low gear,” said Commerzbank economist Peter Dixon. “It’s not a great time for the central-bank governor to be taking over the job, but it wasn’t that great when Draghi took over in 2011 either.”

Given the ECB’s depleted arsenal and growing aversion against further action, Lagarde may find herself following Draghi’s lead of encouraging European governments to add some of their firepower. Germany, Europe’s largest economy, is so far not showing much enthusiasm. The government said Friday that it’s sticking to its balanced-budget policy and sees no need for a spending program.

Yet there are also signs of hope. Spain, once crisis-plagued, is forecast to have kept up a 0.4% quarterly pace. In Germany, business expectations improved in October from a decade low and a decline in manufacturing demand eased, indicating the downturn may be bottoming out.

It will take a lot more to shift the baseline view, however, and economists don’t expect the ECB to lift rates before late 2022.

“Slow GDP growth in the third quarter and the prospect of a similarly weak or even weaker result in the current quarter could motivate policy makers to take action again,” said Bantleon Bank economist Joerg Angele. “But it’s a close-call forecast, especially because there should be large opposition to renewed easing.”

--With assistance from Zoe Schneeweiss.

To contact the reporter on this story: Catherine Bosley in Zurich at cbosley1@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Jana Randow

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