The notion that the eurozone could be the new Japan “did not seem realistic five years ago”, says Hamish McRae in the Evening Standard. “Now I am afraid it does.”
The eurozone economy is still 2% smaller than at its pre-crisis peak. In 2011, its post-global-crisis recovery gave way to another slump – a record, six-quarter recession, thanks to the euro crisis.
Now, after a feeble, year-long recovery, GDP is weakening again. And this triple-dip recession is centred on the core economies rather than the highly indebted southern states that hit the headlines last time.
A slide into deflation
August saw the fastest slide in German industrial production since 2009. Economic output will grow modestly in the third quarter if at all, after declining in the second quarter.
Meanwhile, according to the September eurozone composite PMI survey (a measure of both manufacturing and services activity), the region’s tepid recovery is well past its peak. GDP is set to grow by 0.2% after the second quarter’s stagnation.
So what’s gone wrong? The conflict and sanctions against Russia “caused a collapse in consumer confidence and business investment in the eurozone’s one strong economy” – Germany, says Anatole Kaletsky on Reuters. That has rattled confidence elsewhere.
Meanwhile, the relatively strong euro has hit export growth. Many governments are still cutting spending and a lack of progress on structural reforms hasn’t helped.
The ongoing credit crunch is a major problem. Banks still haven’t dealt with the bad loans on their balance sheets. So, they aren’t keen to write more loans. At the same time, households and businesses are still coping with the hangover from the debt binge and don’t want to borrow much.
As McRae says, you can take a horse to water, but you can’t make it drink. No wonder the latest attempt by the European Central Bank (ECB) to bolster growth – offering banks cheap four-year loans for them to fund businesses with – was hardly a roaring success. Banks only took up €82m of the €400bn on offer.
This subdued backdrop explains why eurozone inflation, now sitting at just 0.3%, is melting away and on the verge of turning into deflation. That would bode extremely ill. While inflation nibbles away at debt (because the real value of a fixed sum of money falls), deflation does exactly the opposite.
So, there is a danger of a Japan-style slump as households and businesses react to their growing real debt burdens by cutting back even further, sending prices even lower, and so on in a vicious cycle.
ECB to the rescue?
Given the grim backdrop, the clamour for the ECB to head off deflation and prop up growth has grown louder. The bank has announced purchases of asset-backed securities (ABS) and covered bonds, with the aim of pumping more money into the system.
But hoovering up these private securities won’t make much difference, as we noted last month. The markets for these securities aren’t very big.
That leaves quantitative easing (QE). For now, the ECB is loath to offend German sensibilities and launch a full-scale QE programme, whereby the central bank buys up government debt with printed money. But with the outlook deteriorating, Barclays expects QE by the start of 2015.
That won’t be a miracle cure. It can’t revive lending if the banking system remains broken. But it should trigger a big fall in the currency, which would underpin exports, increase expectations of inflation, and buy time for other growth-boosting polices, such as structural reforms or a relaxation of austerity.
More immediately, much of the liquidity sloshing around should find its way into asset markets, as QE did in America and Japan. Throw in still-reasonable valuations, and European stocks remain a good bet.