New Year, New Central Bank Measures to Promote EU Growth?: Investors Anxious for Bold Decisions as Concerns Shift to Oil Price Collapse, China’s Slowdown, the Russia’s Tailspin, Looming Eurozone Triple-Dip Recession (12/17)     Print Email

spellmanBy James David Spellman, Principal, Strategic Communications LLC

When Europe’s financial markets open in the New Year, investors will be looking for any signs indicating whether the European Central Bank will broaden and deepen measures to stimulate an economy that cannot throttle into high speed to outrace the mounting risks of Eurozone deflation.

In each of the last three months, ECB President Mario Draghi reaffirmed repeatedly in nearly identical terms the bank’s “commitment to using additional unconventional instruments within its mandate.” In October, the ECB began buying asset-backed securities and covered bonds while auctioning cheap loans to banks for extending credit to businesses and others.

When pressed recently whether the bank’s governing council will make the decision to provide more stimulus at the January 22 meeting on monetary policy, evasiveness persisted. “It doesn’t mean at the next meeting,” he said. In response that day, European equities fell and the euro rose, investors disappointed that the printing press was not going to start operating immediately on overtime.

Meanwhile, the factors that mattered to investors in the summer shifted dramatically throughout the fall and early winter as a new Weltschmerz, or “world pain,” took shape. "The eurozone is overshadowed by global worries," says Reinhard Cluse, an economist with UBS.[1]

Oil prices fell unexpectedly and quickly this year, a 40-percent slide since June, with the price of crude down to 2009 levels. An oil glut in the United States and China’s slowdown hastened the downward spiral. For the Eurozone, the consensus among analysts suggests that this decline will push the region into deflation, with the slight move downward in the inflation rate (to 0.3% in November from October's 0.4%) a harbinger. Already, Spain, Poland, Hungary, Bulgaria, and Greece have had negative rates of inflation in October, and France joined the group in November with an unexpected fall in retail prices (negative 0.2%).

Source: Mike Bird, “Europe’s Plunge into Deflation is Coming.” Business Insider, November 28, 2014.

The scope and depth of China’s pullback broadened and deepened with recent statistics showing the country’s growth falling to the 1990 pace. In response, the Shanghai stock market had its biggest fall in five years in mid-December before rebounding, albeit unsteadily. When the global financial crisis forced countries worldwide into a recession, China sustained its growth through massive investments in fixed assets. Even the government’s own researchers now see these as wasteful, concluding that $6.8 trillion was squandered on “ineffective investment” in manufacturing overcapacity, ghost cities, and empty shopping malls.

Prices of Chinese manufacturers’ goods dropped in November, a record 33rd-straight decline, as consumer inflation slowed. That signaled that “China has entered into a rapid dis-inflation process, and faces the risk of deflation,” said Liu Li-Gang, chief Greater China economist at Australia & New Zealand Banking Group Ltd. in Hong Kong.[2] Whether this means manufacturers will suffer depends on the strength of profit margins, which Julian Evans-Pritchard of Capital Economics notes have remained “healthy.”[3] It is hard to see that remaining true in the year ahead, especially since Beijing raised banks’ borrowing targets.

The danger of deflation in China spreading to Europe, China’s largest trading partner, and elsewhere is high on the list of possible risks in 2015. “[W]ith Chinese deflation accelerating, Europe seems doomed to suffer a deflationary crash as consumers delay purchases, companies cancel investments, and workers suffer rising layoffs,” writes Chriss W. Street in Breitbart.[4] “Disinflation and weak demand growth in China could have adverse spillover effects on other countries grappling with even more severe versions of these two problems,” says Eswar Prasad, economics professor at Cornell University.”[5]

Then there is the downward tailspin of the Russian ruble, a consequence of the fall in oil prices and sanctions the United States and European countries to punish President Vladimir Putin for military actions in Crimea. The oil and gas industry generates about half of Russia's revenue On December 16, the currency’s value had tumbled 19 percent over 24 hours, “the worst single-day drop for the ruble in 16 years,” according to Bloomberg.[6] Russia’s central bank tried to reverse the slide with a surprise – some said “shocking” -- increase in the interest rate to 17 percent from 10.5 percent, the largest since 1998.


Source: Natalie Kitroeff and Joe Weisenthal, “Here's Why the Russian Ruble Is Collapsing.” Bloomberg, December 16, 2014.



The rapid deterioration in Russia’s economic health affects Europe in many ways. East European nations’ currencies immediately suffered. Europe depends on Russia’s oil and gas for roughly one-third of its energy needs. Economic ties are deep, with many European companies taking ownership stakes in Russian businesses, as Germany’s energy giant E.ON did with $8 billion in investments and Airbus’s reliance on Russian titanium to make plane parts. Rotterdam is Russia’s most important port to ship exports.

Despite those concerns and others, ECB asset purchases slowed in early December. In the first week of December, asset backed-securities purchases totaled €233 million (note: $1 = 0.8028 euros, Reuters, December 11), down from €368 million during the program’s first week in October. Purchases of covered bonds dropped to €3.126 billion, down from €5.078 million the week before. To date, ECB asset purchases totaled €21.528 billion, with €20.927 million in covered bonds.[7]

Equally anemic was the December 11 auction of four-year ECB loans called “targeted longer-term refinancing operations” (TLTROs), the second of eight planned each quarter through mid-2016. Banks purchased only €129.8 billion ($161 billion) of a possible €317bn.[8] Another constraint on liquidity: at the end of February, banks must repay €256 billion borrowed 2011-2012. To date, “banks have taken barely more than half the €400 billion ($498.28 billion) of loans on offer this year,” Reuters reported, a sign of banks’ low confidence in borrowers and weak credit demand.[9] Meanwhile, inflation fell rather than moving closer to the ECB two-percent target rate.



Source: Sara Sjolin,”These 5 charts show how much Europe needs QE.” Marketwatch, November 28, 2014.

This “will raise fresh doubts about the feasibility of the ECB's intention to increase its balance sheet by around €1 trillion,” said Martin van Vliet, an economist at ING Bank. That “further shortens the odds” that the central bank will begin quantitative easing.[10]

Draghi said in early December that the ECB “intended” (a change in nuance from “expected”) to boost its balance sheet by €1 trillion. To do so, though, requires only one option that has sufficient traction, sovereign bonds. As The Economist’s “Free Exchange” blog noted, “that will involve the ECB trampling over German sensibilities arising from their view that such purchases trespass on fiscal policy.”[11]



Source: Jana Randow, “Europe’s QE Quandary: Shouldn't the ECB Buy Bonds, Too?” Bloomberg, December 4, 2014.

EU treaties prohibit the ECB from financing governments, so purchasing sovereign bonds as part of “quantitative easing” would be doing just that. Germany strongly opposes such moves since it removes incentives preventing governments from overspending, part of the cause of the economic malaise in their view. Bank observers sense that these complications have prevented Draghi from pursuing the €1 trillion ($1.24 trillion) commitment, with news reports surmising that as many as 10 of the 24 governing council members are opposed.

In this interregnum, headline writers resorted to Hamlet’s soliloquy, “to QE or not.” As Hamlet contemplated the meaning of life and whether the pain of life outweighs taking one’s life for the serenity of death, Draghi, too, equally faces an impossible choice, a definitive one for the ECB.


[1] John O'Donnell and Paul Carrel “Tepid Interest in Its Cheap Loans Edges ECB towards Printing Money.” Reuters, December 11, 2014. 

[2] “China Deflation Risk Deepens Signaling Room for Easing: Economy.” Bloomberg News, December 10, 2014. 

[3] “Economists React: China Inflation Hits Five-Year Low.” Wall Street Journal, China Realtime, December 10, 2014. 

[4] Chriss W. Street, “Europe Crushed by Importing Chinese Deflation.” Breitbart, November 11, 2014. 

[5] Josh Noble and Gabriel Wildau, “China: Fear of a Deflationary Spiral.” Financial Times, November 30, 2014. 

[6] Bloomberg xxxxx


[8] Claire Jones, “ECB’s liquidity auction falls short of expectations.” Financial Times, December 11, 2014. James Mackintosh, “The Short View: ECB fails to woo Europe’s banks.” Financial Times, December 11, 2014. 

[9] O'Donnell and Paul Carrel, op cit.

[10] Jack Ewing, “Cheap Loans from E.C.B. Get Tepid Response among Eurozone Banks.” New York Times, December 11, 2014. 

[11] “The ECB's second funding offer: Thanks but no thanks.” Economist “Free Exchange,” December 11, 2014.