So, how did things at last night’s crucial European Central Bank announcement fare?
The ECB won the initial battle: stockmarkets were up in Europe and the US (although some early jobs optimism in America helped) hit new four year highs. And the surge continued in Asia this morning as investors generally liked the ideas outlined by ECB head Mario Draghi. So instead of “buy on the rumour and sell on the fact” we saw markets continuing buying after the announcement. Draghi has given the Eurozone some breathing room. Now for some political will, which is even shorter supply in Europe than positive economic growth.
More on the specifics in a moment, but first some critical context. The ECB also last night cut its forecasts for the eurozone economies to a deeper recession. There was bad jobless data from France (it’s double Australia’s rate) and Greece (nearly four times our 5.1%). Protesting policemen clashed with other policemen in Athens. Reuters reported a new poll in Greece showed the Nazi-like Golden Dawn party was now Greece’s third most popular party. We’ve seen how this plays out before in the 1930s.
The OECD’s new outlook also outlined the dangers to the global economy from the sliding eurozone economies. It said the continuing euro area crisis is dampening global confidence, weakening trade and employment and slowing economic growth for OECD and non-OECD countries alike. And it forecast the UK economy to fall by 0.7% instead of the 0.5% estimate made a few months ago.
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New data also emerged that eurozone GDP fell by 0.2% in the second quarter. The contraction was partly due to a drop in domestic demand, down by 0.5%. Spain, Italy, Belgium and France all contracted, while Germany expanded by 0.3%. Germany is now expected to start contracting for one or two quarters.
Now to the ECB plan (there’s an explainer here): Outright Monetary Transactions (OMT — another acronym to get used to) will replace the €200 billion-plus Securities Markets Program that was used for a couple of years to buy the bonds of countries like Greece, Portugal and others (without much success; the program was very limited in its scope and was subjected to intense criticism by Germany). OMT is designed to enable the ECB to provide support to a government like Spain that needs to keep raising debt but which faces unsustainably high costs, by allowing the Bank to purchase bonds on an unlimited basis (the purchases will also be “sterilised”, or offset by deposits so that don’t add to the money supply).
The ECB hopes that by committing to unlimited purchases, speculators will stop driving borrowing costs to unsustainable levels, which will eventually require a sovereign bailout. OMT purchases will focus on bonds of up to three years and the purchases will be made in the secondary market (i.e. after the bonds have been issued and sold by countries like Spain and Italy). The ECB won’t be acting alone — the European Financial Stability Facility and the future European Stability Mechanism (subject to that German Constitutional Court decision next week) will also be available.
But there’s a but, called “conditionality”: as expected, to get help, a country must apply to the rescue funds. And in order to get it, governments must swallow their pride and agree to abide by strict, and likely very austere, policy conditions, just as Greece, Ireland and Portugal have done. If countries fail to meet targets, the program could be terminated.
That brings us to Spain, where the new(ish) conservative government has been twisting and turning to avoid asking for help. The ECB announcement has now destroyed its hopes of getting “conditions-lite” aid — maybe around €100 billion — to help recapitalise the country’s broken banks. To seek help now will be to invite demands for full-on austerity. The Spanish economy is already smashed, with truly frightening levels of unemployment. An austerity package would be both political suicide and entrench a depression that is leaving a generation of young Spaniards without jobs — not to mention the loss of sovereignty as troika officials arrive in Madrid, as they did in Athens, to closely vet fiscal policy.
So the current Spanish strategy is to not request a bailout until the conditions of it become “crystal clear”. But the ECB has made clear, no request, no agreement, no bond buying; it is setting up a stand-off that could unravel, damaging the Euro and the eurozone. Chris Beauchamp, market analyst at IG Index, summed it up nicely:
“Too many eurozone meetings, summits and decisions have been followed by euphoria, only to see the good feeling fade. Given the wide-ranging commitments made by Mr Draghi, today’s bounce might be longer-lasting, but, as the ECB itself noted, the outlook for the eurozone economy remains bleak. The ECB has the firepower to hold the line for quite a while, but now the politicians have to show comparable determination to work on other elements, such as closer financial supervision, if we are to sustain this rally beyond a few days.”
The ECB has done its part (and lost further German support in doing so). Now it’s up to Europe’s politicians, who only ever show deft footwork in finding ways to kick cans down the road. What is clear, indeed as the ECB itself says, the ECB’s move won’t slow the slide in Europe into a deeper recession in coming months, nor will that ease the pressure on China and other economies important to Australia.
But it has bought more time for something more permanent to be done, assuming political will.