European policy makers are shifting focus from a financial crisis to an economic-growth crisis.
“We are now back in a normal situation from a financial viewpoint, but we are not at all seeing an early and strong recovery,” European Central Bank President Mario Draghi said yesterday. Luxembourg Prime Minister Jean-Claude Juncker, who leads euro-area finance ministers, echoed that by saying, “the worst is over, but what we still have to do is difficult.”
As the Euro Stoxx 50 posts its best start to a year since 2003 and bond yields from Greece to Spain recede from euro-era highs, markets are endorsing last year’s ECB-led rescue efforts and rebutting warnings of an imminent euro breakup. The next test for authorities will come if the economic slump reignites investor doubts about cash-strapped governments.
The ECB “may be unhappy with the current economic situation of the euro zone, but optimism about the future is growing,” said Christian Schulz, a former ECB official and now an economist at Berenberg Bank in London.
The central bank yesterday held off doling out more recession-fighting medicine, keeping its benchmark interest rate at 0.75 percent in a unanimous decision a month after calls for a cut from some of its Governing Council. It maintained its so-far untapped offer to buy the bonds of sovereigns acquiescing to reform demands and will hand banks further cheap long-term funding.
Draghi’s optimism that the three-year Greece-led turmoil is in remission led Morgan Stanley to suspend its predictions for further rate reductions, while Nomura International Plc pushed back its forecast for lower borrowing costs to June from March.
The “combination of a slightly less dovish ECB combined with the likelihood that the survey indicators will continue to improve means we no longer expect the ECB to lower rates in March,” Nick Matthews, senior European economist at Nomura in London wrote in a research note. “Our bias for lower rates remains given our weak economic picture and upward momentum in the survey indicators stalling into” the second quarter.
Draghi’s change in language spurred the euro to its biggest gain in four months versus the dollar and to its strongest since July 2011 against the yen. It euro dropped 0.1 percent today and traded at $1.3259 at 9:39 a.m. in Frankfurt. Spain’s 10-year borrowing costs, which hit a euro-era record of 7.75 percent in July, yesterday fell below 5 percent for the first time since March after a bond sale. The yield dropped as low as 4.88 percent today before rising to 4.91 percent.
‘Whatever it Takes’
Following a year in which he cut interest rates to a record low and crafted the Outright Monetary Transactions program to validate a July pledge to do “whatever it takes” to defend the euro, Draghi began 2013 highlighting the positive response of investors.
Sovereign bond yields, market volatility, demand for insurance against default, the ECB’s balance sheet and loan redemptions are falling, while deposits in peripheral banks, capital inflows from abroad and equities are rising, he said. He went as far as to see signs of exuberance in private equity and leveraged buyouts.
“We spoke a lot about contagion when things go poorly, but I believe there is a positive contagion when things go well,” Draghi said. “That’s also what is in play now. There is a positive contagion.”
Economists from Citigroup Inc. to Roubini Global Economics LLC have already suspended projections of an imminent Greek departure from the euro area. Bets placed at Intrade.com imply a 15 percent chance of an exit by the end of this year, down from 49 percent a year ago.
“I heard a thousand times both in Europe and the rest of the world ‘the euro is about to collapse,’” former ECB President Jean-Claude Trichet said Jan. 5. “The euro is much more credible than what is perceived from the outside.”
Standard & Poor’s this week spoke of 2013 proving a “watershed year” for Europe, in which bailed-out Portugal and Ireland may return to financial markets again.
The hope now is that the market uplift spreads to the economy, which entered recession in the third quarter of last year and is set to remain there through the start of 2013. European services and factory output contracted for a 17th month in December and unemployment rose to a record 11.8 percent in November. The pain is more prevalent in the crisis-torn economies, with jobless rates exceeding 25 percent in Greece and Spain.
For now, Draghi predicts recovery to begin later this year and pushed governments to drive it by restoring health to their economies and budgets. That onus is because the ECB lacks fresh stimulus tools, with another interest-rate cut unlikely to deliver much, said Carsten Brzeski, an economist at ING Group in Brussels.
“It is hard to see that the ECB could invent anything similar to an OMT for the real economy,” he said. “The ECB will secretly keep its fingers crossed, hoping that better financial-market conditions and structural reforms eventually really lead to an economic recovery.”
Another rate cut would potentially force the deposit rate, currently at zero, into negative territory, which could hurt lending between banks and money market funds. “Given all this, we think that a long period of steady interest rates is in prospect,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam.
Less convinced is Howard Archer, an economist at IHS Global Insight, who repeated his forecast of a rate cut to come, given that “growth will remain elusive and already disturbingly high unemployment will continue to rise.”
There have been false dawns before. At the ECB’s debut policy meeting of 2012, Draghi pointed to “tentative signs of stabilization of economic activity” before bowing to a rate cut in July as recession began and markets gyrated.
For all the upbeat talk yesterday, four countries remain in bailout programs, with Cyprus set to become the fifth. Italian elections, Spain’s debate over whether to tap sovereign aid and ongoing political fragilities in Greece could all serve as further crisis flashpoints.
To avoid those, Draghi sought further action from politicians to cement progress in cutting budget deficits, current account gaps and labor costs as well as integrating the region through steps like a banking union.
“The point now is not to be complacent with what has taken place and relax,” Draghi said.