ECB rate cut ‘a start’ towards the recovery

The European Central Bank’s decision to cut its key interest rate last week to a record 0.50 per cent may not solve all of the eurozone’s problems but it is, at least, a start to encourage demand for loans, according to Bloomberg economist David Powell.

Five years from now, the euro area will not have all 17 members

“It’s certainly a good thing,” Mr Powell told The Sunday Times of Malta on the fringes of the Finance Malta annual conference a few days ago when the interest rate cut was widely expected.

“Unemployment in the euro area is reaching the highest levels since the birth of the single currency, but inflation is not posing any problems at all. Those factors point to a need to reduce the main policy rate for the eurozone.

“The ECB’s quarterly bank lending survey showed that the primary reason for the slow credit growth is not to do with a tightening of lending standards, but a lack in demand. At this point, the ECB should be doing everything it can to promote recovery.”

Mr Powell, a keynote speaker at the Finance Malta event, had three weeks earlier authored a document for Bloomberg outlining why the Cyprus bailout was unlikely to be repeated for Malta. He explained that although Malta had the eurozone’s third highest deposit-to-GDP ratio at 173 per cent, the figure was distorted by the presence of foreign banks. Malta has been labelled for having an “oversized banking system”, but Mr Powell pointed out it was not completely justified as the island’s banking community stood shoulder to shoulder with many of its euro area peers.

Slovenia, another small eurozone state, has different problems altogether – last Thursday it borrowed $3.5 billion (€2.7bn) on the international markets to shore up its ailing banks and stave off a bailout. Losses in its banking system could continue to grow, Mr Powell warned.

“It is very comparable to Spain,” he explained. “Going into the crisis, the Spanish government had a very low level of debt, much below the European average. However, the estimates for losses in the banking system in Spain were continuously underestimated, and that has been partially responsible for the ongoing crisis in the country. Slovenia has a banking system that is characterised by numerous bad loans and there is a lack of transparency.”

Mr Powell said history was repeating itself: it was unclear to what extent Slovenia’s banks needed to be recapitalised as present estimates were “not so bad”. The adverse scenario stood at five per cent of GDP, which was not likely to lead Slovenia to bankruptcy.

Each country in crisis had a different story to tell but the systemic aspect was common to all. Some countries were not optimal candidates to share the same currency as others. For investors to return to bailed-out countries, they must first be convinced that the situation is sustainable. Investors have not returned to Spain because they are uncertain of its future, and the economy has not rebounded as a consequence.

“Policies must be in place to convince the world that these countries have moved to a position of sustainability,” Mr Powell continued, adding how it was important to stem the freefall and stabilise output.

So what will enable a currency union to weather these problems?

Some countries would either have to exit the eurozone for the union to return to sustainability or aid programmes created for the countries which needed them – which has been happening to some extent with the bailout packages, he said.

Mr Powell has doubts on the current eurozone members going the distance, however.

“I do not think that five years from now, the euro area will have all the 17 members it currently has,” he said.