Trichet Faces `Headache' as Record German Growth Pulls Ahead of Periphery
While Europe’s largest economy expanded at the fastest pace since the country’s reunification, the region’s southern periphery is still struggling to recover from a sovereign debt crisis. Greece’s recession deepened, Spain expanded less than economists forecast and investors are turning their attention to their budget deficits again.
“This is going to become a very serious headache for the ECB,” Marco Annunziata, chief economist at UniCredit Group in London, said in a Bloomberg Television interview. “If the ECB were the Bundesbank it would be raising rates very quickly. But Spain, Greece, Italy -- they can’t afford it.”
Trichet is trying to steer a course that will prevent Germany from overheating while also keeping the euro region’s sovereign debt crisis at bay. In a sign that investors are again questioning the ability of the most deficit-laden countries to cut their budgets, the extra yield that investors demand to hold Greek bonds over benchmark German bunds today rose to the highest since May 7.
Stocks, which initially rose on the German growth figures, later dropped and the premium on Greek 10-year bonds rose 10 basis points to 807. In Ireland, where investors are concerned the cost of bank bailouts will exceed estimates, the spread climbed 5 basis points to 293. That’s the most since Jun 29.
Today’s reports highlighted the scale of the growth divide in the euro region, which expanded 1 on the quarter. Germany, which grew 2.2 percent, was responsible for almost two thirds of the bloc’s second-quarter expansion even though it only makes up about one quarter of the economy. In Spain, whose government is pushing through the toughest austerity measures in three decades, the economy expanded just 0.2 percent after economists predicted growth of 0.3 percent. Greece contracted 1.5 percent.
That split is making it harder for Trichet to gauge the timing of when to remove emergency measures and tighten policy. Pulling back too soon could choke off credit and roil investors, while acting too late could stoke inflation.
For now, the data is on Trichet’s side. While prices rose 1.7 percent in July, the most in 20 months, Trichet said Aug. 5 that inflation expectations are “firmly anchored.” Governing Council member Athanasios Orphanides said in a Reuters interview published Aug. 9 he’s “not worried” by energy price “swings.”
At the same time, Belgium’s Guy Quaden told La Meuse newspaper that the ECB needs to be “more attentive about this issue.” Oil prices have gained 11 percent since the height of the sovereign debt crisis in May. Germany’s Axel Weber, one of the toughest inflation fighters, has also signaled discomfort with some of the emergency measures taken by the ECB to date.
Joerg Kraemer at Commerzbank AG says Trichet can afford to wait before raising rates because inflation is not yet a serious threat and economic growth this year will stay below the euro region’s potential rate.
“Growth is not strong in the eurozone as a whole,” said Kraemer, chief economist at Commerzbank in Frankfurt. “You should not make the mistake of taking Germany for the eurozone as a whole. In most countries we have downward wage pressure and core inflation is only at 1 percent.”
The ECB, which last week kept its benchmark interest rate at a record low of 1 percent, is running down the emergency government bond purchases it introduced in May and officials will next month decide how to further scale back their unlimited loans to banks.
That may lead to further tightening of monetary conditions and drive up the euro, potentially hurting exports at a time when the U.S. recovery is struggling to gain traction, said Ken Wattret, chief euro-area economist at BNP Paribas in London.
“Monetary conditions should be looser, not tighter,” he said. “While the Fed is considering a second round of quantitative easing, the ECB is aiming to normalize policy as the economy slows down and might even grind to a halt around the turn of the year.”
Recent data show China’s economy is slowing, with growth in industrial production and new bank loans trailing economist estimates. In the U.S., companies added fewer workers than forecast in July, signaling the labor-market recovery there will be slow to take hold.
David Owen, an economist at Jeffries Group Inc in London says the euro area economy may even shrink again as soon as the fourth quarter. “A lot of the growth was driven by the inventory cycle and by its nature this is very temporary.”
For now, Trichet says that the ECB is not “declaring victory,” though Carsten Brzeski at ING Group in Brussels says Weber may soon argue that the growth figures warrant tighter policy.
“The divergences in the euro area are not going to go away and that will give the ECB something to chew on,” he said. “Even so, Weber might push them to start pulling the exit trigger sooner than expected.”