There’s been a lot of noise surrounding the rhetorical shift away from austerity in the euro zone in recent days, the notable exception being Germany. It is now widely acknowledged that monetary policy alone cannot turn economies around. But of course it has a vital part to play.
That puts the focus on the European Central Bank and growing expectations that it will cut interest rates to a new record low next month. Yesterday’s poor German PMI could have been the tipping point. On three of the four times the survey reading has fallen below 50 since the collapse of Lehman Brothers a rate cut followed the month after. Germany’s PMI duly slipped into contractionary territory yesterday.
In all this, we shouldn’t lose sight of the fact that a quarter-point rate cut may move markets but will have only a small impact on the euro zone economy. It’s also true that the ECB has shown no signs of wanting debt-cutting drives to be mothballed. Its reaction to any shift in that direction remains to be seen.
Germany’s Ifo sentiment index will give another readout on the latest state of play in Europe’s largest economy and we have a host of key policymakers speaking – Angela Merkel and Bundesbank chief Jens Weidmann in Germany and ECB vice-president Constancio delivering the central bank’s annual report to the European Parliament. He said earlier this week that inflation had fallen “rather significantly” and a rate cut was “always a possibility”. Eurogroup chairman Jeroen Dijsselbloem appears in the Dutch parliament.
Hopes that an Italian government will soon be formed have driven euro zone peripheral bond yields lower this week, to levels not seen since 2010. Today, newly re-elected president Napolitano will announce his choice of prime minister, having apparently secured the backing of both the centre-left and centre-right. It’s a big moment. 75-year-old Giuliano Amato is the favourite and the sort of figure who will persuade investors that there aren’t any policy shocks around the corner.