It’s no exaggeration to say that tonight’s meeting of the European Central Bank’s governing council and the subsequent statement and then press conference with president Mario Draghi are the most important for the organisation in its short history, for the eurozone, the euro and for economies such as Australia, the US and China, to name just three. In fact it is not too much of an exaggeration to also say that the immediate fate of the global economy depends upon tonight’s meeting.
Europe has become a giant black hole, sucking growth out of not only itself, but the economies in Asia (such as Australia, as we saw in the June quarter) and the US and South America and parts of Africa. Whether it continues to do so, and for the moment more importantly whether markets believe it will continue to do so, depends fundamentally on tonight’s meeting. The ECB and Mr Draghi need to reveal a set of measures sufficiently convincing to markets that the euro and the eurozone will be protected, no matter what happens.
But given the number of times the EU, EZ and ECB have kicked the can down the road and not made important decisions on issues such as Greece, Portugal, European banks and now Spain and Italy, you’d have to be naive to accept that the ECB will do tonight what Draghi promised in late July, which was to “save the euro” no matter what it cost.
This morning the Financial Times was reporting that “the European Central Bank will refrain from publishing any formal cap on bond yields when it announces a new plan to buy distressed eurozone sovereign debt.” A “monetary outright transactions” program is set to be revealed. The program is backed by the leaders of Spain, Italy and France, as well as business leaders, but vehemently opposed by the German Bundesbank.
That’s before we get to the political problem. The promise of ECB action has seen the Spain’s cost of its debt (10-year bonds) slide from more than 7% a month ago to just over 3% yesterday. Spain doesn’t want to submit to tough cuts in spending and debt, which will mean more unemployment and misery for an economy that is already mired in a depression and truly frightening levels of unemployment. But Germany and the ECB say the Spanish have to agree to a tough campaign of austerity, stricter than the one now hitting the country. The problem for the Spanish government is if the ECB doesn’t come to the rescue, or if the Spanish frustrate the move, its debt costs will rise and Spain will be right back where it was a month ago. It’s that simple, and so will be the rest of Europe and the world.
But providing that the ECB is convincing and German opponents do not try to sink it (starting with the September 12 decision on the legality of the European Stability Mechanism from the German Constitutional Court, then there’ll be significant benefits for Australia. The ECB’s move could see a reduction in the value of the dollar. It fell to a near two-month low overnight of $US1.0167 and has settled under $US1.02. A believable deal and commentary from the ECB and the markets will see the dollar rapidly fall through parity as it adjusts to the 10%-plus fall in our terms of trade in the past year thanks to weaker commodity prices, especially for iron ore, and the impact of the slowdown in China.
That means some of the pressures will be taken off manufacturing, tourism and retailing, and exporters will see an immediate boost to income, or see cuts to income that has previously factored in from the high dollar, reduced. In fact, a believable deal will mean the RBA will probably sit back and not cut rates as it was probably going to do either in October or November. A believable deal will see commodity prices surge (gold and oil have already risen to multi-month highs in expectation of the ECB’s move).
For our major export markets such as China, Japan, South Korea and the like, the impact will be similar, but more gradual than in Australia. China’s pressures are being generated internally from the slowdown in the economy. That will run until early next year as the leadership changes and a new set of hands emerge to take control of the economy.
That will in effect reverse what Australia has been copping for the past few months — all the negatives of a mining boom from a high dollar, while the actual returns from the mining boom have been curbed by falling commodity prices. It should also help Wayne Swan’s chances of securing a budget surplus without ripping into spending too much.
But if the ECB flubs this chance, or the markets remains unconvinced, the Aussie dollar will remain high, above parity and perhaps will rise if investors again start worrying about the stability of the eurozone and the euro. That is not what we want in this country because it will end up crippling the economy, no matter how solid the resource investment boom remains. The RBA will be forced to cut rates and will start fretting about inflation. Australia’s key export markets will continue to soften, as will commodity prices. Government revenue will fall. Not even our golden economy will be able to withstand an extended period of weakness from our major trading partners.
That’s why all eyes will be on the ECB tonight.