Trichet points to possible double-dip recession in Europe

September 3, 2009

In his cautious Franglais central-bank speak, Jean-Claude Trichet has pointed to the strong possibility that the euro zone may face a double-dip or W-shaped recession.

Of course, that’s not exactly what the European Central Bank president said. But how else are we to interpret his repeated references to a “bumpy road” ahead, and his comment that we are likely to see quarters with positive growth and other quarters with “less flattering” figures? All this was illustrated with a hand gesture that drew a W (or a corrugated iron washboard) rather than a V or a U.

True, he also said a significant contraction in economic activity has come to an end, and may be followed by a very gradual recovery. The ECB staff have lifted their economic forecasts for the 16-nation euro area after Germany and France surprised markets by exiting recession in Q2. The bank is now forecasting 2010 growth in a range from -0.5 to +0.9 percent, compared to its June prediction of -1.0 to +0.4 percent. But Trichet made clear there remains a high degree of uncertainty.

Furthermore, the ECB’s only significant policy announcement — that it will offer banks yet more 12-month liquidity at its basement 1.0 percent refi rate later this month — was a strong indication that rates are on hold for the next year, coupled with another clear signal that ultra-loose monetary policy would not be withdrawn any time soon. “Today is no time to exit.”

Even the ECB’s most outspoken inflation hawk, Juergen Stark, is cautioning against any early withdrawal of the monetary stimulus.

The latest growth figures may indeed flatter to deceive. Germany probably only grew in Q2 because the government’s cash-for-clunkers handout boosted the auto sector. That scheme ran out at the end of August.

Private consumption in France and Germany has been buoyant because of state-subsidised short-time work programmes that have kept people in jobs despite the collapse in orders. Those schemes expire late this year or early in 2010. In some cases, order books have filled and workers have gone back to full-time jobs. But unemployment is bound to rise over the next year to over 10 percent. That will likely depress consumer spending leaving the euro area’s two biggest economies reliant on exports for growth.

Against this background, Trichet is right to keep monetary policy loose. With some voices in Germany’s Sept 27 general election campaign calling for a premature return to fiscal orthodoxy, sage words from Frankfurt suggesting that recovery is not the bag, and that inflation is not currently the biggest worry, are welcome.

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