At first blush, Thursday provided much fodder for anyone wanting to strengthen the case that Germany is the eurozone’s bogeyman.
Angela Merkel rejected a European deposit-insurance scheme, suggested the ECB’s loose monetary stance was inappropriate for German’s economy, while the Bundesbank was revealed to have sharpened its legal campaign to the ECB’s bond-buying plan.
It restated the argument that the mooted crisis circuit-breaking plan fell outside the mandate of the central bank to guarantee the “irreversibility” of the single-currency or to take aggressive steps to boost the transmission of monetary policy.
What's more, the Bundesbank said the jury was still out on whether monetary transmission is indeed broken in the periphery. Even if this monetary mechanism has broken down, “the question arises as to whether and why such a development must be corrected” – an opinion written by the Bundesbank for the German constitutional court, revealed by Handelsblatt.
These developments came against a mixed economic backdrop. While the Cyprus crisis has mercifully not triggered market contagion – with no evidence of deposit outflows from the periphery to core Europe – ECB data also showed that periphery banks continue to deleverage, with loans falling between -0.2% and -0.7% in the periphery (except Greece) between October 2012 and March 2013.
In the words of RBS: “ECB liquidity has averted a rapid, uncontrolled deleveraging. Instead banks are allowing existing loans to roll off and reducing new loans. This is necessary to reset the banking system, but it is hurting credit availability.
“The SME lending (Safe) survey confirmed that credit availability is still deteriorating: 10% more SMEs found it harder to obtain credit over the last six months than easier, albeit this is down from 22% more in the previous period. Credit constraints are most severe in the periphery, where 20% to 30% of firms’ number-one problem is access to finance.”
Against this weak macro-financial backdrop, market consensus decrees the ECB will cut the refinancing rate by 25 basis points to 0.5 per cent on May 2 while the governing council is in two minds on monetary instruments to boost stimulus to the real economy.
“The ECB does not have a magic wand,” said council member Benoit Coeuré recently. “The central bank cannot compensate for a shortage or a misallocation of equity. That is something that has to be addressed, in one form or the other, by other stakeholders.”
On the other hand, ECB governor Draghi has revealed the central bank is exploring instruments to boost the provision of credit – which would presumably require the central bank to take credit risks on its balance sheet.
What then to make of Merkel’s highly unusual intervention? Does it exert extra political pressure on the ECB just as it mulls further easing? And doesn’t the intervention once again expose the institutional deficiencies in the ECB’s governance – that is council members are expected to put the interests of the collective economy above that of their own country?
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| German finance minister Wolfgang Schäuble Source: Reuters |
Well-respected eurozone economist Malcolm Barr of JPMorgan has a more nuanced take. In an interview with Euromoney, Barr suggests Merkel’s comments were a dispassionate take on the ECB’s challenge of implementing policy, given a lack of synchronicity between the various countries’ economic cycles, and designed to temper German finance minister Wolfgang Schäuble’s more uncompromising stance adopted last week, calling for the ECB to tighten policy because there is “too much money”. Barr says: “Merkel’s comments were less leading in the way it was reported. Her comments are in a sense a recognition that the ECB is trying to set policy of a region as a whole, by averaging out economic conditions.”
He adds: “Obviously, no central bank – not least the ECB – enjoys political commentary surrounding their policies. But Merkel’s comments are more conciliatory and designed to row back on what Schäuble is saying.”
And, in the short-term, Germanic constraints won’t in themselves impede the ECB’s policy stance. “The ECB is going to be feeling some pressure given growth dynamic,” says Barr. “But it has already internalized some constraints with respect to its ability to respond, rather than pursuing Anglo-Saxon stimulus.”
For now, German opinion, and perhaps the EU commission, accepts that concentrating on the headline budget deficit in the periphery, at the exclusion of growth, is self-defeating. German inflation is contained while the eurozone economy, in aggregate, is facing a demand deficit.
All these forces suggest the political pressure on the ECB “for the next six to nine months, perhaps” will ease, before the disadvantages of loose monetary policy on German inflation and asset prices become more pronounced, says Barr.
In that context, he concludes, “the ECB will obviously be more sensitive to issues like price pressures in the north since it holds the key to institutional building. The ECB feels this is an ongoing process and does not want to be viewed as an inhibiter so will attempt not to antagonize the north.”
Indeed, the following chart highlights the ECB’s bailout of Germany, pre-Lehman, and how interest rates are too low for Germany:
Still, if the ECB thinks central banks can’t generate growth, there is an alternative route for the eurozone, given the bank-led financial system: weaken financial regulation and banks' capital requirements.