Russia tensions may help cut knot on euro zone policy: James Saft

August 28, 2014

Aug 28 (Reuters) – New tensions in Ukraine, which has
accused Russia of further incursions, may serve to light a fire
under efforts to bring looser monetary and fiscal policies to
the euro zone.

While Russia has denied the allegations, NATO on Thursday
said that well over 1,000 Russian troops were now inside Ukraine
in what would represent a large increase.

This makes more likely some interruption of Russian energy
shipments this winter and will exacerbate the economic effects
of sanctions both sides are imposing on one another.

The net result is clearly not good for the euro zone
economy, which is already struggling with outbreaks of recession
in Italy, dangerously low inflation and high rates of

“In August, economic sentiment in the Eurozone already
dropped by the biggest margin since the heyday of the euro
crisis in mid-2012. A further escalation would pose a serious
risk of a renewed recession in the still-fragile economy,”
Christian Schulz, senior economist at Berenberg Bank, wrote in a
note to clients.

“The likelihood that governments and the ECB would then
react with stimulus programmes, including full-scale
quantitative easing, is rising.”

Already, German German Chancellor Angela Merkel has said
that further sanctions will be discussed at a meeting of the
European Council this weekend. That may well be called for, but
will do little to encourage households or businesses to hire and

Even before these developments, the euro zone economy was in
need of fiscal and monetary help, a case laid out by European
Central Bank President Mario Draghi last Friday in a speech at
Jackson Hole, Wyoming. He called for more stimulative government
spending, though without being overly specific about by whom or
under what circumstances.

Draghi also acknowledged that market prices were
demonstrating how very low inflation was quite possibly
undermining future inflation expectations. That, rightly, has
led markets to export more from the ECB by way of extraordinary
monetary policy, both in the form of buying up asset-backed
bonds and possibly an eventual move to buy government bonds on
secondary markets.

Bond markets certainly are pricing in the risks of slow or
negative growth, dangerously low inflation and economic fallout
from Russia/Ukraine. The Eonia rate, a euro overnight index
gauge of borrowing costs, fell to negative territory for the
first time ever on Thursday, at minus 0.004 percent. Meanwhile
German two-year government bunds have a negative 0.02 percent
yield and 10-year German yields are at a record low 0.87


The problem, which the Russia/Ukraine situation may help to
loosen, is that both main avenues for relief – monetary and
fiscal policy – face substantial roadblocks.

The asset-backed bond market which the ECB is exploring
supporting is relatively small, and there are both political and
legal issues which may complicate large-scale outright
government bond QE. Those issues won’t go away quickly, but it
would not be at all surprising if the political atmosphere for
ECB movement suddenly became a lot more supportive.

The ECB meets to set policy next week, and while bond buying
isn’t likely, a cut in the refi and deposit rates is a
possibility. I would also look to Draghi next week at the
post-decision press conference to take note of the potential
damage from Russia tensions and to make noises about being
mindful of this in making policy.

At the very least that will drive the euro lower, which is
of some help.

Similarly to QE, expansionary fiscal spending will be far
from easy. The Stability and Growth Pact presents obstacles, as
does the deteriorating budget situation in recessionary Italy
and elsewhere.

But remember, Russia/Ukraine is an unexpected and
uncontrollable outside shock of the kind to which sensible
governments make some economic response. It will be far easier
today for Germany to do something stimulative to protect its
good farmers and savers from suffering due to Russian aggression
than it would have been three months ago, when it could have
been portrayed as a sop to the supposedly feckless governments
of southern Europe.

All of this is a bit of a nonsense, in that 95 percent of
the issue has nothing to do with Russia. But, as is so often the
case, nonsense often gets things done.

To see the potential for movement on fiscal issues look at
Germany’s newfound willingness to countenance a loosening of
French austerity. German Finance Minister Wolfgang Schaeuble
went out of his way on Thursday in Paris to say he agreed with
French President Francois Hollande that public and private
investment is needed to stimulate growth.

Europe’s instiutional arrangments are just as confining and
difficult as they were a month ago, but Russia/Ukraine has
probably made cutting the knot a bit more likely.

(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at and find more columns at

(Editing by Jonathan Oatis)

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