Can Europe’s central bank address the slowdown in its economies?

Looming signs of a slowdown in growth, are not only apparent in China and the US, but also in Europe, and the European Central Bank’s actions are crucial in trying to reverse this slowdown.

The European Central Bank’s (ECB) first Monetary Policy Meeting of 2019 will be conducted under the cloud of a sharper-than-expected deceleration in Eurozone growth in the last few months of 2018, complicating the ECB’s already supremely cautious 2019 exit strategy from its non-standard stimulating measures.

Any formal revisions to the ECB forecast will have to wait until the second meeting on March 7, and there is no need or desire in the Governing Council yet to tinker with its existing language around rates’ lift-off.

But ECB President Mario Draghi will acknowledge the slowdown, point to continued stimulating policy measures at the central bank’s disposal, including the roughly 15 billion Euros per month still of bond reinvestments expected for 2019, and emphasize the conditional nature of the ECB’s policy path forward in case forecasts do materially change.

In addition, there will be a discussion at this meeting about a renewal of the program to provide additional cheap funding to the banking sector, and the contingency plan all along for the Governing Council has been to revisit the program by March if necessary – and that is increasingly looking to be the case.

With the US Federal Reserve also signalling toward fewer interest rate hikes in 2019, the ECB leadership may also slow down any European interest rate rises into the beginning of 2020. And, as such, the ECB’s president is more likely to emphasise that any future rise in interest rates is conditional on the economy and the ECB’s inflation forecasts.

Current market expectations are that the first hike, when it comes, is likely to be an adjustment only in the currently -0.4 percent deposit rate, while leaving the other benchmark rates unchanged. It will also probably hike by as little as 10 basis points. This should be a relief to European companies struggling with sluggish demand and the aftershocks of a possible messy UK Brexit.

In the meantime, the ECB is putting on a brave face. On January 24, in the closing remarks following a speech before the European Parliament in Strasbourg, Draghi said while he does not see a recession, he frankly conceded he is bracing for a slowdown that will indeed be longer than originally expected.

Unsaid is that the slowdown has also come sooner, and is deeper than expected by the ECB. To add to general economic worries, there are country-specific issues facing the Eurozone, with Italy at the forefront with several Italian banks of various sizes facing some liquidity issues.

France is another country where macroeconomic risk has been elevated. Already, the “yellow vest” protests in Paris and across the country are seen to have had a dampening effect on consumption and tourism over the holiday period in France.

But looking ahead, the expectation, or at least hope, is that these riots will slowly play their course, and polls indeed suggest that after a brutal year, France’s President Emmanuel Macron’s popularity rating may even have finally bottomed.

But, there are bright spots where Germany leads the way, despite the planned exit of Angela Merkel as Chancellor. ECB officials seem to be pleased to note that the fiscal debate between the CDU and SPD coalition partners have all been about tax cuts and additional stimulus, and not about further budgetary savings, even as the German Debt to GDP ratio, at a tantalizing 60.2 percent, approaches the Stability and Growth Pact target of 60 percent.

But, perhaps most to the point, with growth flagging, Berlin has already taken pre-emptive steps, quietly stashing an extra 11 billion Euros in the budget under what ostensibly appears to be some sort of “refugee fund,” but which could be drawn on for a rainy day. Not many European countries can do the same.

Unlike economies, which have one central bank to address issues in that country, the ECB has a more difficult role in juggling the economic and fiscal pressures facing multiple member states and trying to steer a neutral course to please as many members as possible.

Sometimes it works, especially during periods of economic growth in leading Eurozone economies which cascades to the poorer members, but in a period of populist economic and nationalist policies adopted by different European states, the ECB’s tasks becomes harder.

If the policies are adopted, even if delaying and reducing any future interest rate hikes to ease pressure on economies most affected, in the end domestic political pressure becomes a critical one on whether the ECB can really act as a catalyst for slowing down economic growth. The implication for oil producers is that a European economic slowdown only adds to pressure on future oil prices coming on top of Chinese economic weakness.

While the Brexit talks between the UK and the European Union are now entering a crucial stage, any final break up from Europe might not impact the relationship between the Bank of England and the ECB as feared, as many are confident that their relationship will remain strong into the future as it is based on trust.

This is bearing in mind that a huge part of the EU financial industry is in the UK, that fundraising for the broader EU is based in England, and that the clearing, foreign exchange and bond trading are also important assets for the Bank of England, and few European countries are prepared to step in and fill that gap quickly.

The UK is still one of Europe’s biggest economies - so despite not being part of the European single currency- the Bank of England owns a share of the ECB’s capital stock instead.

Of course, there are always surprises and if the United Kingdom exits with no Brexit deal, then all cards are off the table, even for this anchor finance relationship.
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Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran , Saudi Arabia and co-author of ‘OPEC in a Post Shale world – where to next ?’. His latest book is on ‘Saudi Aramco 2030: Post IPO challenges’.