No wonder the Reserve Bank cut interest rates yesterday. Central banks and governments around the world are increasingly concerned about the debacle in Europe. With Friday’s critical summit meeting approaching and the policy options looking decidedly limited, the RBA’s timing is impeccable, even with the confirmation of how robust the local economy is via the GDP figures. But let’s hope the pre-emptive cut will prove to be a bonus, and not the first of a few as Europe slowly implodes over the Christmas New Year period.
On current form that looks overly optimistic. When the RBA cut rates in November, the bank was more confident Europe was moving to tackle the crisis. “Financial markets have recovered somewhat from the turmoil of recent months, helped by stronger economic data in the United States and by signs that European governments are making progress in their efforts to deal with the sovereign debt and banking problems,” Glenn Stevens said in the November 1 meeting statement. But yesterday was a completely different story:
“The sovereign credit and banking problems in Europe, to which European governments are still seeking to craft a full response, are likely to weigh on economic activity there over the period ahead. Financial markets have experienced considerable turbulence, and financing conditions have become much more difficult, especially in Europe. This, together with precautionary behaviour by firms and households, means that the likelihood of a further material slowing in global growth has increased. Commodity prices have reflected this, declining further over recent months and taking pressure off CPI inflation rates. This has increased the scope for some easing in monetary policy in a number of countries.”
And, in the most significant change of all, the bank has moved monetary policy from November’s “neutral stance” to one in which “the Board will continue to set policy as needed to foster sustainable growth and low inflation over time”. In other words, rates will be cut if Europe continues to worsen (and Friday night’s summit fails) and they will be held at low levels until the situation stabilises, much like in 2008-09, when they will be returned to normal levels.
The Europeans are ostensibly concentrating on two issues. One is longer-term reform of the eurozone, or the EU if they can herd recalcitrants like the British along, to reduce the policy disparity between monetary union and fiscal regionalism that is one of the core problems of the Euro. The other is the decidedly more urgent task of saving the Euro. The former is about establishing a framework to prevent a repeat of the crisis. The latter is about preventing immediate catastrophe.
The problem is, no one has any confidence Europe’s leaders can avert catastrophe. The Asian edition of the Financial Times this morning reported on negotiations over “a much bigger financial ‘bazooka’ … that could include running two separate rescue funds and winning increased support for the International Monetary Fund. According to senior European officials, negotiators are considering allowing the eurozone’s existing €440 billion bail-out fund to continue running when a new €500 billion facility comes into force in mid-2012, almost doubling the firepower of the bloc’s financial rescue system.”
This is about as close to a clear admission of failure as we’ll be getting from European leaders. The €440 billion euro stability fund was devised in May last year and has since been used to provide rescue loans to Ireland, Greece and Portugal, with €220- €240 billion committed so far. As part of the last big deal to “resolve” the crisis, European leaders agreed weeks ago to try to find ways of boosting the fund by raising more money from other countries, such as China and Japan, or doing a deal so that the European central Bank and the IMF become involved.
All that has failed to happen but rather than admit defeat, European bureaucrats are now looking at a European Stabilisation Mechanism (ESM) which could be funded by up to €500 billion of cash from member states. The ESM was supposed to replace the EFSF (confused already?) in 2013, but the new ploy is to keep the existing fund going and to boost the total amount available to defend the eurozone to 900 billion euros, less the amounts committed to the bailouts of Greece, Ireland and Portugal. To further boost its attractions there’s talk of doing a deal with the ECB, but seeing the Germans refused to consider a funding deal for the existing fund, why would they agree to the central bank funding the ESM?
The ESM hasn’t been approved by member countries (and remember the existing fund saw governments in Slovakia and Finland collapse over the issue before approval was given, and the Dutch Government come under enormous internal pressure) and that will be another sticking point. Who will contribute to the additional fund is unclear: Greece, Ireland and Portugal will hardly be expected to put cash into the new fund (it would never be approved anyway) and Spain and Italy, as two potential beneficiaries, don’t have the cash to do so either and their governments are focused on inflicting more pain on their citizens to avoid bailout.
None of this is likely to get the ogres at Standard & Poor’s onside. Why S&P? Well, a day after delivering their historic warning to the eurozone, including the six AAA rated countries led by Germany, of a mass downgrading of credit ratings, S&P yesterday took aim at the rating of the EFSF, placing it on “negative” watch.
“Depending on the outcome of our review of the ratings on EFSF member governments, we could lower the long-term rating on the EFSF by one or two notches, if any,” said S&P. A “CreditWatch negative” placement means there is at least a one-in-two probability that the rating will be lowered in the short term, it warned. With a AAA rating, the EFSF is able to raise funds in the bond market with much lower interest rates than bailed out nations would get on their own. If it’s downgraded, the cost of raising funds increases.
Then again, the EFSF isn’t, by the ready admission of European leaders, going to be sufficient anyway. Europe is out of money, out of ideas and, soon, out of time. Barring a miracle on Friday, we’ll be seeing more rate cuts from Martin Place early next year.