Europe's Slowdown Prompts the ECB to Action
posted by Karim Pakravan on March 8, 2019 - 1:44pm
The European Central Bank (ECB) replicated the Federal Reserve Bank’s earlier U-turn on monetary policy at its latest meeting. Barely three months after the central bank announcing an end to Quantitative Easing (QE), Mario Draghi, the ECB president, pulled the alarm over the sharp economic slowdown and announced a two-pronged approach. First, the central bank would continue its ultra-low interest rates policy at last through the end of 2019. Second, barely three months after announcing), the ECB will provide continued support to financial markets and banks.
The ECB switch was driven by the significant worsening of the global and Eurozone economic prospects. In its latest Economic Outlook, the Organization for Economic Cooperation and Development (OECD, the grouping of the 36 major economies) has downgraded its global economic projections. Citing the slowdown in China and the Eurozone, the slowdown in global trade and manufacturing, high levels of policy uncertainty and volatile financial markets, the OECD cut its global growth projections for 2019 and 2020 to respectively 3.3% and 3.4%. The biggest downward revisions from the OECD’s November projections have come in the Eurozone, in particular Germany and Italy (the latter expected to slip into recession).
The following table shows the change of growth estimates between November 2018 and March 2019
Table1: Eurozone Economic Projections (% growth)
The downward revisions by the ECB were consistent with those of the OECD. After a strong first half of 2018, the Eurozone economy slowed down significantly in the second half of the year, with growth registering 0.2% quarter–on–quarter in 4Q18. Overall, output growth slowed down from an average of 2.0% per annum in 2015-2017 to 1.8% for 2018 as a whole. The Eurozone is expected to slow down further, growing by respectively 1.0% and 1.2% respectively in 2019 and 2020, down from earlier projections (made last November) of respectively 1.8% and 1.6% in 2019 and 2020.
Germany, the largest European economy, has recently come under increasing pressure. After barely escaping a technical recession (two consecutive quarters of output contraction), German economic growth is expected to slow down from 1.4% in 2018 to 0.7% in 2019 and 1.1% in 2020. The country’s famed export machine has weakened significantly as a result of trade wars and the slowing of the Chinese economy. The Merkel government has maintained fiscal austerity, leading to an overall (federal, state and local) budget surplus of 1.4% of GDP. Manufacturing, highly exposed to global economic conditions, is slowing down. On the positive side, however, unemployment, at 3.3%, is at a post-reunification low, and business confidence has yet to be dented.
In addition to the slowdown in the global economy (and in particular China), the main risks facing the Eurozone are Brexit, trade wars and increased strains within the EU.
Brexit has emerged as major risk, not only for the UK economy, but for the rest of the European Union (EU). In particular, policymakers are concerned by the disruptions in trade and investment flows. In both the UK and the EU, small and middle market manufacturing, finance and agriculture are likely to be adversely affected by the disruption of trade flows. On the positive side, larger corporations and financial institutions are likely to move some operations to the European mainland. Smaller countries that are heavily exposed to the UK economy, in particular the Netherlands, Denmark and Ireland are likely to be the most affected in the short and medium term.
Trade tensions have been stoked by U.S. tariffs on European steel, as well as threats by the Trump administration to impose tariffs on European automobile imports. While trade negotiations between the United States and the EU are continuing, progress has been scant. Europe is also affected indirectly by the U.S.-C trade tensions, as Chinese trade is diverted from the United States into Europe.
Political and policy dissensions within the EU have deepened. In particular, the coming to power of a populist and Eurosceptic government in Italy (one of the founding members of the EU and a part of the “EU’s “core”) has created a de factor anti-Brussels alliance between right-wing governments in Europe (Italy, Poland, Hungary and Austria), challenging the Franco-German leadership and complicating solutions to Europe’s deep seated problems. Furthermore, even the most committed EU members, France and Germany, do not seem to agree on the way forward. While the French president Emanuel Macron is pushing for greater economic integration, Germany is skeptical of any fiscal schemes that would put a greater financial burden on the country.
New Thinking: Beyond the need to deal with short term economic problems, Europe needs to find solutions to its structural problems. In particular, Europe is caught between a slackening of the U.S. security and economic commitment to Europe and concerns about aggressive Chinese expansionism. Rising populism and Brexit are adding to these challenges. As a result, we are seeing efforts by the EU leaders to pursue a more independent and active policies in both the security and economic realms. Recently, the German Minister of Economic Affairs, Peter Altmaier, has proposed a “Blueprint for Industrial Strategy 2030”. Altmaier sees the world economy as comprising three competing blocs led respectively by the United States, China and Europe. In this universe, Europe has been a passive observer, but this must change. Europe must adopt industrial and technological sovereignty. This would mean pursuing an active industrial policy, promoting national and European champions, and restricting foreign companies’ access to the European markets. These idea have been well received in other major countries. While preliminary, they would represent a profound shift in policies and a new direction for the Continent.