MacroScope

Taking stock

By Mike Peacock
May 1, 2013

It’s May Day and most of Europe, barring Britain, is taking a holiday so maybe it’s a day to take stock.

But first, a nervous glance at little Slovenia. Last night Moody’s cut its debt rating to junk, forcing Ljubljana to abandon a planned bond issue which looked set to raise several billion dollars and making a fifth euro zone sovereign bailout much more likely. Given the ham-fisted effort to rescue Cyprus didn’t put markets into a spin, it’s unlikely Slovenia will upset the euro zone applecart but it’s a reminder that this crisis isn’t over and won’t be until the currency bloc gets serious about creating a banking union. Slovenia’s problems, like Cyprus’s, are rooted in the banking sector, which is stifled by about 7 billion euros in bad loans.

One bullet was dodged when the Cypriot parliament narrowly approved its bailout late yesterday, which will avert bankruptcy but at a painful cost.

Looking at the wider picture, Item One on the agenda is that after euro zone inflation plunged to 1.2 percent yesterday – way below the European Central Bank’s target of close to but below two percent – it now has the greenest of green lights to act at Thursday’s policy meeting.

We already had it on very good authority that a quarter-point interest rate cut is on the cards, which will take rates to a record low 0.5 percent. However, nobody is under any illusion that that alone is going to lift the currency bloc out of recession, one reason perhaps that a debate is now raging over the benefits of cutting debt versus going for growth at a governmental level.

The killer point is if the ECB fears deflation could take hold, suddenly all the arguments about what its mandate allows it to do (one reason it has not mimicked the Federal Reserve, Bank of Japan and Bank of England in printing stacks of money) fall away and all sorts of expansionary policies are possible. An increasing number of pundits are mentioning the lost (deflationary) decade and more that Japan has suffered as a parallel.

While France, Spain and others will get more time (up to two years) to meet their deficit targets, a lot of the calls for an end to austerity are overblown. EU economics czar Olli Rehn had it about right when he said the euro zone had no choice but to cut debt while the crisis raged, the bond market would have tolerated nothing else. But now, with the ECB’s underpinning promise to do whatever to save the euro, there is a little more room for manoeuvre – with the emphasis on little.

Germany may look somewhat isolated with the new Italian prime minister, Enrico Letta, adding his voice to calls from France, the European Commission and elsewhere to produce a meaningful growth strategy. Having flown straight to Berlin after winning a vote of confidence, Letta is in Paris today to meet Francois Hollande in what should be more of a meeting of minds. However, it is worth noting that Italy’s new leader also told Angela Merkel last night that he would meet his budget commitments.

Either way, it’s Germany as the EU’s paymaster that counts, not Italy and France. Which is a long-winded way of saying there will be a lot of talk about going for growth, even from Berlin as elections approach – and some measures to back it up — but none of them is likely to be a game changer.

The ECB is also considering ways to help small- and medium-sized companies get easier access to credit. This is a thorny debate. There is clearly some internal opposition and even disinterested outsiders say it is an unusual thing for a central bank to get involved in. The betting is that it does nothing though it’s intriguing that Berlin has floated doing something similar bilaterally with Spain. More rhetoric or is this a sign of a new approach in Berlin, albeit of the micro variety?

May Day can be a day of unrest and there’s certainly a lot for those in southern Europe to be restive about. Greek unions have called a strike but there aside, violent popular protest has been the dog that hasn’t barked during the three years of this crisis … so far. A rally is planned in Madrid today. If unrest really took off and people started voting en masse for anti-European parties then the EU project would be in a whole world of trouble. We’re not there yet but next year’s European Parliament elections will be unusually laden with meaning.

The UK may have skirted recession in the first quarter but exactly the same debate is going on about how to get back to growth. Today’s manufacturing PMI survey is unlikely to suggest there is much of a rebound going on while China’s equivalent survey unexpectedly slowed in April, casting further gloom on the world economy. Ireland, an earlier recipient of EU/IMF aid which hopes to quit its bailout programme this year, has just seen its manufacturing survey shrink at its fastest rate in 19 months.

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