June 3 (Bloomberg) -- Europe faces Japan-style stagnation as governments delay reforms and the European Central Bank comes close to exhausting its options, said Clemens Fuest, president of the ZEW Center for European Economic Research.
“I would expect the politicians to really take the problems in hand and face the need to restructure the banking system,” Fuest said in an interview in Mannheim, Germany. “But I see the risk that what’s concentrated on now is shunting the problems down the road and going the Japanese way, into stagnation. The ECB has done its part to solve the crisis. The central bank has used up most of its ammunition.”
ECB officials meeting in Frankfurt this week will refrain from cutting the benchmark interest rate again after they reduced it to a record low of 0.5 percent last month, according to a Bloomberg News survey of economists. The euro area is facing the longest recession since the single currency’s creation 14 years ago.
Aside from trimming rates further and charging to hold bank deposits, policy makers might also consider measures to aid lending to small businesses and rekindle the market for asset-backed securities.
Fuest, who took the helm of the research center from outgoing president Wolfgang Franz in March, said the ECB is sending the wrong signals with its activism.
“Maybe it would be good to refrain from comments that suggest monetary policy can solve the crisis -- it can’t,” he said. “I don’t think much of the ECB buying asset-backed securities because that’s getting into an area which is classically a business for the banks.”
The prospect of an ABS program is also “an invitation for banks to do what they did before the financial crisis, namely to grant loans, package them and hand them on,” Fuest said. “I fear it’s an attempt to get credit provision going, even though the banking sector is so weak.”
“There are significantly more effective ways to stimulate lending,” he said. “The right way would be to recapitalize banks, not such trickery with ABS.”
ECB Vice President Vitor Constancio said in an interview on May 29 that expectations for an ABS program have become inflated, adding that the market is “very small indeed.” Officials are also “far away from any decision” on taking the deposit rate below zero, he said.
Fuest, who also serves on an academic advisory council for the German finance ministry, urged policy makers to be wary of negative rates because there are only very few prior examples.
The Federal Reserve and Bank of Japan have avoided negative deposit rates, and Bank of England Deputy Governor Paul Tucker said last month they are “most unlikely” to be deployed in the U.K. Denmark is the only country in Europe to currently have a rate below zero.
“One mustn’t forget, that something like that also reflects how the central bank assesses the economic situation,” Fuest said. “It’s not a step that should be taken now. The signal would be very negative.”
Gross domestic product in the 17-nation region fell 0.2 percent in the three months through March, the sixth consecutive quarterly decline. With unemployment at a record 12.2 percent and a gauge of services and factory output signaling contraction, the ECB’s scenario of a gradual economic recovery in the second half of the year is increasingly at risk.
“I don’t care too much if it comes in the second half of 2013 or in the first half of 2014; I see the danger that it doesn’t come at all,” Fuest said. “I don’t think that the U.S. will recover quickly or that the economy in Asia will pick up to generate a demand pull in Europe. And I don’t see a recovery in its own right.”
The ECB in March predicted the economy will shrink 0.5 percent this year before growing 1 percent in 2014. It will publish new projections after its decision on June 6.
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