Last week there was a meeting of the Governing Council of the European Central Bank, during which it analyses the latest economic indicators and determines the monetary policy stance for the immediate future.
During the previous meeting, the ECB had decided to cut the base interest rate to 0.25 per cent. No one expected the ECB to increase it back or to cut it further. That interest rate cut had signalled that the ECB believed the economic recovery was still very fragile and needed to be supported by a rather loose monetary policy to strengthen it.
The importance of this meeting and the subsequent declarations lay in trying to understand how fragile the economic recovery in the eurozone really is. The president of the ECB, Mario Draghi, reiterated the view that inflation is expected to remain at subdued levels of around two per cent even in the medium term, and as such there was no reason to raise interest rates to counteract the pressure on prices.
He said that the monetary policy stance “will remain accommodative for as long as necessary” and will continue to assist the gradual economic recovery in the eurozone. He went as far as saying that the ECB interest rate is expected “to remain at present or lower levels for an extended period of time”.
To my mind the two keywords are “lower levels”, as if the implication is that the only way forward for interest rates is to move downwards, certainly signalling a fragility in the economic recovery that is greater that many are willing to admit. In numerical terms, economic growth was of 0.3 per cent in the second quarter over the previous quarter and 0.1 per cent in the third quarter. Thus, at best, we can talk of insignificant growth across the eurozone with some countries still in deep recession. And the decisions taken by the ECB confirm all this.
The negative message is made even clearer when one notes that the ECB feels that the little economic growth that there has been is attributable to an improvement in domestic demand supported by the accommodative monetary policy. Moreover there are risks surrounding this fragile economic recovery, and they have been described as being on the downside, mainly due to uncertainty in the world’s financial markets and possible higher commodity prices.
The solution that the ECB appears to be giving to strengthen the economic recovery and even increase potential growth is product and labour market reforms. Admittedly this is something that, with the exception of a few virtuous ones, governments have been very unwilling to implement.
The reason is fairly simple. Reforms do not win votes, while governments have not even been able to sweeten the pill of reforms through some form of fiscal stimulus because of the high level of public debt. The real message between the lines is that the ECB seems to believe that we may be getting to the limit as to the benefits that can accrue to the eurozone economy from an accommodative monetary policy.
In the meantime, the value of the euro against the dollar initially slipped back, but has since recovered. Such a relatively high value continues to hinder the expansion of exports from the eurozone, and as such reduces the positive impact of measures taken to improve competitiveness.
Should this lead to a sense of helplessness? Possibly not, but one certainly cannot feel upbeat about prospects for the eurozone economy for the coming year.
There is also one important consideration to make. The accommodative monetary policy may have suited Germany well so far. But what happens if the German economy accelerates at a faster pace than the other main eurozone economies? There may come a time when it would be in Germany’s interests to raise interest rates because inflation would have gone over the two per cent target set by the ECB, while it would not be in the interests of the other members to have such a rate rise. If economies in the eurozone do not grow at the same pace, that may also jeopardise the fragile economic recovery that we have had.
One may ask what is in it for little Malta. Low interest rates help the Maltese government to reduce its borrowing costs. They may also be of benefit to the business sector if banks also reduce their interest rates.
I have already expressed my view that we should not let the opportunities presented by low interest rates slip by. But a fragile economic recovery in the eurozone will also represent a threat to the Maltese economy, and we must take proactive measures to face up to this challenge.