The European Central Bank’s governing council meets this week amid a less optimistic mood than before the summer break. The recovery in Europe is losing speed and there are early signs of divergence, with some euro-zone countries rebounding faster than others.
ECB President Christine Lagarde still has several tricks up her sleeve to help the monetary union respond to the pandemic’s economic shock. But, unlike previous crises in Europe, governments will have to take the lead this time. Unfortunately the response from individual countries is mixed so far: Some, like France, have already put together ambitious plans to relaunch their economy. Others, such as Italy, are struggling to rise to the challenge.
Economic activity in the euro-area economy slowed down between July and August, according to the IHS Markit composite Purchasing Managers Index. Manufacturing remained relatively buoyant, but services stagnated, signaling a possible slowdown in domestic demand. The inflation rate also turned negative for the first time in four years, and core inflation, which strips more volatile items, fell to its lowest-ever level of 0.4%. There are also early signs of divergence, as the composite PMI for Germany and France showed an expansion, while that for Spain and Italy a contraction.
It is unwise to read too much into one batch of monthly data, and even more so during a pandemic. The outbreak has changed patterns in both consumption and production, while affecting some businesses more than others. It’s possible that statistical offices and other data collectors are struggling to produce sufficiently precise estimates. The ECB will produce its own set of forecasts this week, and these too may fail to capture exactly what is happening to the economy.
Still, on balance the evidence points to an outlook that remains very fragile. The balance of risks is tilted toward the downside: It’s possible the health situation will continue to worsen, as it has done in recent weeks, forcing governments to take more draconian decisions such as imposing harsher social-distancing rules or even closing some economic activities. Scientists are working at breakneck speed on a vaccine. However, even if they were to discover an effective and safe one in the coming months, it will take longer before it’s mass produced and distributed.
The ECB has sufficient reasons to act now and expand monetary policy further. It can increase and extend its pandemic asset purchases and insist it’s committed to using the full envelope. There’s also a case for cutting the deposit rate below its existing level of -0.5%. This would have the additional effect of reining in the euro, which has risen substantially against the dollar, putting downward pressure on inflation.
However, the most important lever in this recession is undoubtedly fiscal. After an initial stumble, the ECB has managed to bring calm to the sovereign debt market, allowing governments to borrow at extremely low rates. The euro region has acted swiftly in suspending fiscal rules and in creating a €750 billion ($887 billion) fund that will issue joint debt to support recovery, particularly in the hardest hit countries of the monetary union. From Germany to France, governments look willing to continue to press on with fiscal stimulus, which is necessary to support consumers and viable businesses.
However, the speed and strength of the recovery in the various European countries will also depend on the quality of the measures approved. France has put together a courageous 100 billion-euro plan based on three pillars: a tax cut for businesses, large-scale investment into new technology such as green hydrogen and funding for training and other labor market policies. These measures coincide with the priorities identified at the EU level. They also appear well targeted to tackle both short-term problems, such as helping the unemployed, and long-term challenges, such as boosting productivity growth.
Meanwhile, Italy is still far from coming up with a coherent plan: The wobbly government majority of the left-wing Democrats and populist Five Star Movement is struggling to resist calls to disburse the money into hundreds of small measures that would have a dubious impact on the economy. There have also been bureaucratic delays in ensuring the steps taken so far, including a string of income support schemes, quickly reach those who apply for them. Italy has coped better economically since the start of the pandemic than other countries, such as Spain, and the government is confident the economy will rebound strongly. However, Rome remains extremely vulnerable because of its structurally weak growth and high public debt levels.
The ECB can do little about economic convergence, beside ensuring — as it is doing — that weaker countries do not face a risk of unwarranted financial instability. Stronger countries, such as Germany and the Netherlands, must be ready to continue to support their economy and help their neighbors, as they are doing through the recovery fund. But states such as Italy and Spain must also be willing to help themselves. Just invoking the ECB’s help will not work this time.
Bloomberg
