If there’s anyone out there who fervently hopes that the China-US trade war and the Brexit conflict be settled, it would be the European Central Bank (ECB). Without any doubt, the fights weigh-down the global economy, and this obviously hit the Eurozone hard, given that it already has trouble with the economic growth rates.
Any central bank, of course, wishes for a prosperous economic life for the country and its citizens. But the ECB is caught in a trap where an uptick in the GDP growth gives some relief for the Eurozone central bank. It might even get the institution out of the limelight, as the past two weeks continue to be stormy for the ECB.
In my view, it was a huge mistake by the ECB to show willingness to adopt the role as being the saviour of economic growth in the Eurozone. The result is that the ECB is trapped or lost in a situation, with an economy that is moving towards a stuck zero-growth condition, an extreme monetary policy, and an emerging fight within the central bank about the monetary policy direction – this is close to a disastrous situation for one of the world’s leading central banks, and of course, it should worry investors concerning the long-term prospects in the Eurozone. Instead, the financial markets would normally favour a strong and independent central bank lead by experienced central bankers.
It’s hardly what the ECB stands for nowadays, which is why some relief probably would be welcomed. The past week has given hope to a bit of optimism concerning finding some sort of solution between US and China, and further might the Brexit dispute be solved. If these two heavy issues are cleared, the whole world would feel new optimism, and will no doubt help economic growth for a period into next year. Though despite a possible positive short-lived rebound in the Eurozone GDP growth, which is the brightest scenario that I can imagine right now, I still argue that the very low growth reality will return.
The ECB has one major and import assignment, which is to keep inflation close to, but below, 2 percent. In the current low inflation environment, this target is hardly possible to achieve in an open economy that is part of a globalised world with excess labour force, energy, and production capacity. The inflation target might not even be compatible with the Eurozone GDP growth, that is more than soft, currently at 1.2 percent but with an outspoken downside risk.
Under such economic circumstances, I find it natural to loosen-up the 2 percent inflation target. What’s important is that a central bank remains independent and keeps its focus on the monetary policy.
Actions like using quantitative easing (QE), I do regard as a very extreme intervention in the financial markets. But an intervention only works if a financial market for some reason, has become clearly out of order. This is not the case in the Eurozone, as it’s the economy that has derailed, and some argue that QE helps the economy get back on track, though I don’t support this view.
On the contrary, I have never seen a good argument from a central banker explaining why the interest rates should be below the inflation rate, that for long has been around one percent in the Eurozone. Meaning, the extreme monetary policy leads to significant negative real interest rates, which is now a European-wide challenge.
This favors borrowers like the Italian government, but punishes for example, European pension savers, as they need to save even more and spend less, due to the negative real interest rates. It has gone so far, because the ECB involved itself in saving the economy instead of focusing on conducting an adequate monetary policy.
Looking into the new upcoming presidentship of the ECB, I simply see more of the same to come, which underscores the risk of ECB being caught in a trap or lost – which should keep investors alert. But right now, there is a good chance that the ECB can breathe a sigh of relief.