By Johanna Treeck
FRANKFURT (MNI) – The rapid return of the Eurozone debt crisis and
a deteriorating economic outlook may have pushed the European Central
Bank back into the starting blocks, but the starting gun is unlikely to
be fired just yet.
President Mario Draghi on Thursday not only put the onus firmly on
governments but also highlighted the ultimate impotence of ECB policies,
no matter how radical, in the absence of bold political measures.
Dismal economic data in recent days is likely to have shaken the
Governing Council’s confidence that economic activity will “recover
gradually over the course of the year,” and may well spark a downward
revision of the ECB staff’s 2012 EMU growth forecast, due to be
published next week.
May’s PMI showed Eurozone business activity contracting at its
steepest rate in nearly three years. Even the Eurozone’s growth motor is
stuttering. According to the PMI, activity in Germany slid for the first
time in six months, while the country’s IFO business sentiment indicator
dropped sharply.
The weakening economic outlook coupled with easing inflationary
pressure will certainly put interest rates back onto the agenda next
Wednesday. The Governing Council has not discussed any specific rate
move since February. Now, there may well be voices calling for a move as
as soon as the June 6 monetary policy meeting.
On balance, however, the ECB will probably want to keep the small
amount of maneuvering room it still has given the potential for
considerable additional turmoil following national elections in Greece
on June 17. Should Greece end up exiting the euro area and panic ensue,
the central bank would need the maximum possible monetary firepower.
But even more powerful than anything the ECB can do would be a
clear articulation by European political leaders of a vision for the
Eurozone, Draghi argued on Wednesday. “The next step is for our leaders
to clarify what is the vision of the future,” the ECB chief said, noting
that the mere expression of it would be the best way to boost economic
growth.
Interest rates aside, the chance of an additional ultra-long tender
at the current juncture appears slim. While Draghi on Thursday observed
“renewed bouts of volatility and uncertainty,” he noted that they had
not reached the same level of intensity as in November when the ECB had
decided to launch its two three-year operations.
Draghi pointed out that ECB support measures are futile unless
fiscal authorities do their part. “Credit has not started flowing
because risk aversion is still very high and because of the lack of
capital,” he said. “The ECB cannot cope with those two situations.” What
the ECB can do – namely, reduce risk aversion related to bank funding –
it has already done, he said.
It is clear that LTRO-enabled carry trades and the ECB’s own bond
purchasing programme can have only a limited impact on sovereign
borrowing cost unless governments do their part. While sovereign bond
spreads came down significantly after the first two 3-year LTROs, it
only took one miscalculation by the Spanish government – unilaterally
revising its deficit target – to send spreads spiralling again.
Draghi stressed Thursday that the ECB cannot fill the vacuum left
by inadequate government action. His argument, in a nutshell, is that
Europe can only overcome the crisis if there is confidence in a stronger
and more unified currency union in the future.
Governing Council member Ignazio Visco went further, warning that
“there are now growing doubts among international investors about
governments’ cohesion in guiding the reform of European governance and
even their ability to ensure the survival of the single currency.” Only
a clear path to political union can save the euro, said Visco, who heads
the Bank of Italy.
But building such a union will clearly take quite some time. And
while it is true that a move towards fuller political integration might
help avoid future crises, it would be a moot point if the Eurozone did
not survive the current one.
Draghi’s suggestion for “the first step” towards this new, stronger
Europe is a case in point. The ECB President proposed that the first
step could be a “banking union,” including centralized supervision, a
Eurozone-wide bank resolution fund and a shared deposit insurance
scheme.
Calls for a joint deposit guarantee plan have grown louder amid
fears that a Greek exit could speed up the steady but slow deposit
outflow from many banks in the Eurozone periphery. This in turn might
further accelerate the negative feedback loop between weak sovereign
governments and their ailing banks.
The European Commission is working on a banking union plan,
offering a vision of the reinforced Eurozone that Draghi calls for. But
even if the Commission were to adjust its entirely inadequate timeline
of a full-fledged union by 2018, it still would not be ready quickly
enough to prevent worried depositors in vulnerable peripheral countries
from withdrawing their funds in the coming weeks and months.
Growing tensions are pushing policy-makers to look for alternative
solutions in the shorter term. Draghi expressed hoped that the
Eurozone’s permanent rescue fund, the European Stability Mechanism,
could be used to inject recapitalization funds directly into the
region’s banks. So far, however, Germany insists that the ESM funds can
only be distributed to governments, as its founding statute stipulates.
Since the crisis has moved faster than politicians, the ECB has
always stood in for them. Departing Executive Board member Jose Manuel
Gonzalez-Paramo on Thursday hinted at some flexibility after Eurozone
leaders have made significant efforts to adjust their policies.
Gonzalez-Paramo said that the ECB’s bond-buying program was
ongoing. “It has a specific purpose of addressing malfunctioning in a
segment of the market, but it also takes into account the overall
policies in the union,” he added. If the ECB is ready to budge on its
most contested policy tool, it will no doubt show more flexibility
elsewhere should push come to shove.
In the final analysis, however, Draghi is right. Should investors
and depositors lose faith in the survival of the single currency bloc,
the ECB as the institution at its core will have inadequate tools to
make the Eurozone an attractive place for investment. Unless governments
act fast, time may be running out.
–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com
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