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Analysis
Bout of summer sickness for German economy

Bout of summer sickness for German economy

Challenge ahead for Merkel 

by David Marsh

Mon 11 Aug 2014

The German economy is suffering a bout of summer influenza. A heated-up debate may follow on whether the European Central Bank (ECB) should turn to quantitative easing (QE) as a remedy.

If German growth really does come under pressure because of worsening geopolitics, then Chancellor Angela Merkel, once back from holidays, is far more likely to re-invent herself this autumn as a disciple of reflationary state spending and tax measures rather than to overcome her supreme distaste for QE-style monetary adventurism.

Last month the International Monetary Fund upgraded its forecast for German economic growth this year to 1.9% from 1.7%, but since then the news-flow has been resolutely downhill.

Mario Draghi, the ECB president did his best last week to play down suggestions that the European economy is being blown off course, but it is clear that he has no weapons of mass expansion up his sleeve.

The most dynamic action Draghi could display at his regular press conference was an announcement that the ECB is close to hiring an external consultant to help it design a relaunch of securitisation in Europe through an asset-backed securities (ABS) programme.

Draghi’s other big idea is to engineer weakness of the euro. In an extraordinary statement, equivalent to an invitation for foreign exchange markets to bet against his currency, Draghi said last week: ‘The fundamentals for a weaker exchange rate are today much better than they were two or three months ago… There has been a decline in short-term capital inflows. There has been a quite significant increase in the short-term positions on the euro.’

Unusually, Draghi gave some indications of official transactions: ‘Other central banks have been reducing their exposure to the euro.’ And he made clear that such trends are expected to persist. ‘If you look at how markets are expecting real rates to be for the foreseeable future, meaning until 2019, current expectations are that real rates will remain negative in the euro area for a much longer time than they will be in the US.’

Meanwhile, a combination of worries over a potential Moscow-led attack on Ukraine, stepped-up sanctions over the Russian imbroglio from both east and west, worsening tension in the Middle East and fresh bad news over the lacklustre European economy have all taken their toll on German business and consumer sentiment.

Leading indicators such as from the Ifo economic institute (down for three months in a row), as well as industrial production and order figures, show a downwards trend. Deutsche Bank, for example, now says it regrets having earlier this year increased its 2014 German GDP forecast to 1.8% from 1.5% – and has revised its projection down to 1.5% again.

Official figures for the euro area economy second quarter growth, to be released on Thursday, are expected to show still very sluggish expansion across the 18-nation region, possibly even lower than the 0.2% GDP rise registered for the first three months of the year. Harmonised inflation in the euro area remains at 0.4%, less than a quarter of the ECB’s benchmark 2%.

Italy has set the downbeat tone with figures showing that the economy slipped back into recession in the second quarter for the third time since 2008. In a chutzpah-laden interview with the Financial Times, Matteo Renzi, the prime minister, said he will meet the European Commission’s target of 3% of GDP budget deficit this year, making light of his earlier recommendations for more flexibility in Europe’s budgetary policies. With a few months, we will know which of these two statements turns out to be the more accurate.

The ECB’s monetary policies are still highly restrictive on some measures. Annual broad money (M3) growth stood at 1.5% in June, compared with 1.0% in May, while loans to non-financial corporations (adjusted for loan sales and securitisation) were contracting at 2.3% annually in June, only slightly better than the 2.5% decline in May and 3.2% in February. So there is no clear end in sight to the euro area’s economic malaise.

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