There was no shortage of determination. Nor was there any lack of will.
When the European Central Bank (ECB) unveiled a raft of measures last month designed to head off deflation and lift the eurozone out of recession, it was its most determined effort yet to launch the kind of monetary activism that has worked for its counterparts in America, Japan, and the UK.
It cut interest rates, introduced a funding scheme for small companies, and took the almost unheard of step of introducing negative interest rates for the banks. Many saw this as throwing the kitchen sink at the problem.
The trouble is, the sink wasn’t big enough. Just a few weeks later, it is clear that its efforts have not worked. The ECB had two main objectives: to weaken the euro and to strengthen confidence. Both would have led to stronger growth. Neither has happened. And that leaves the ECB with no alternative but to launch full-scale quantitative easing (QE).
There was little question that the ECB had to ‘do something’ last month. The immediate threat of the euro collapsing has been dealt with. Bond markets are no longer in open revolt. But the eurozone is stuck in a grinding recession from which there seems no escape.
Spain shows signs of recovery, but France and the Netherlands are now recording flat or falling output. Even once-robust nations, such as Finland, are getting into trouble.
Meanwhile, deflation is taking hold. Prices are rising at an annual rate of just 0.5% across the eurozone. The likes of Greece, Cyprus and Portugal are seeing prices fall year-on-year, and at an accelerating pace.
There is nothing necessarily wrong with prices falling. But for countries with high debts it can be catastrophic – the debt stays the same, but the income to pay it keeps falling.
If the eurozone falls into deflation, it is probably game over for the currency. So it was no great surprise that even the Bundesbank lined up in favour of doing whatever might be needed to stop it. The Germans are no fans of printing money – but neither are they fans of deflation.
In response, the ECB cut rates to a new low of 0.25%. It introduced a negative rate for banksleaving money on deposit with the central bank, in the hope they would lend it out instead. And it introduced a scheme for getting money to cash-starved small companies, similar to the ‘funding-for-lending’ programme the Bank of England introduced in the UK.
“If required, we will act swiftly with further monetary easing,” said the ECB president, Mario Draghi, as he announced the measures.
But it looks as though he will have to make good on that promise, and probably sooner than expected. There were two main mechanisms through which the ECB might have expected its measures to impact on the economy – the exchange rate, and confidence.
A lower exchange rate would help countries such as France or Italy. At $1.37 to the euro, the single currency is clearly overvalued, and interest-rate cuts typically weaken a currency. Unfortunately, it has not worked for the euro.
After briefly dipping on the ECB’s news, the currency is back to pretty much where it started. There is certainly no sign of the 20% devaluation that might have made a difference. In that objective, the ECB has clearly already failed.
As for confidence? That is not looking in much better shape either. Last week, data firm Markit reported that confidence had fallen across the eurozone for a second straight month in June, down from 53.5 to 52.8. The slowdown was evident everywhere, even in Germany, but the French numbers were the most worrying.
Manufacturing activity fell to its lowest in six months, and the overall data suggested that the French economy is now shrinking. Given that we are in the middle of the upswing of the business cycle, that is a catastrophic performance for the eurozone’s second-largest economy.
And so far this month, the ECB has reported that lending to businesses has fallen once again. So, there is not much sign of confidence picking up – if anything, it is getting worse.
Sure, you can’t expect central-bank measures to work immediately. It can take several months for interest-rate cuts to feed through to the economy. But the ECB’s moves should be having more impact than this – the effect on the exchange rate should have been instantaneous. And the impact on confidence should come through very quickly.
Both will take time to feed into expanding output and more jobs – but the trend should be clear by now. If you don’t get the lower exchange rate or the upturn in confidence, you aren’t going to get expanding output a few months ahead.
Meanwhile, the eurozone is stuck with minimal growth, rising joblessness, and inches ever closer to deflation. In reality, the ECB now has no choice but to move on to full-blown QE. Its first round of policy measures has already failed. The only question is how long it takes it to get there.
For investors in Europe’s equities, that is probably reassuring. QE will lift share prices, the same way it has everywhere else it has been tried. But it may well be too late to head off deflation – and for the eurozone itself, that will only deepen its crisis.