ECB: How to burn ammunition for nothing

In Sintra, at the ECB seminar, Mario Draghi stressed the risk on growth and the difficulties of converging to the inflation target (close but below 2%).

If additional risks materialize then the ECB could reduce its rates and restart an asset purchase procedure. The idea is to take back and accentuate what has been the success of the ECB since 2013. (Low rate = less incentive to defer its wealth over time given the low return associated with has been strong support for a stronger momentum for the domestic demand)

At the same time, Draghi called for an active economic policy. On this point, the failure to implement a euro area budget reflects non-homogeneous behavior in the euro zone. As a consequence there will be no common fiscal policy in the euro area. One can not therefore imagine a two-component euro-zone policy.

A major rule of the theory of economic policy is that it requires as many instruments as objectives. There are two objectives (growth and inflation) and one instrument, monetary policy.

This will not work especially with a series of negative external shocks. In 2016/2017, monetary policy benefited from a favorable international context even if fiscal policy was not active. Today, the environment is no longer as buoyant and the absence of fiscal policy will make it difficult to cushion external shocks. The ECB will act alone and becoming more accommodating it will burn ammunition for a poor result.

The ECB monetary policy is too tight

Mario Draghi said the ECB was ready to act if necessary.

But there is something I don’t understand: the ECB revised down its forecasts for growth and for inflation for this year and the 2 years to come. Growth will barely converge to 1.4% in 2021 and the inflation rate is expected to be at 1.6% for the same year(way below the ECB target).

Can it be satysfying ? No, this level of forecasts are too low.

This means that the Euro Area has not been able to cushion the external negative shock. If there is still leeway on monetary policy side this means that the current stance is too tight. Today’s forward guidance on future monetary policy measures is not sufficient to reverse the trend. Need more

European elections: changes but no revolution

Elections for the European Parliament mobilized more in the May 26 poll. The participation rate is at 50.8%, the highest since 1994. For France also this change is strong with a participation of 50.1%, the highest since 1994.

We can see on the graph the change of pace This mobilization has been observed in most European countries.

Only 8 countries have a participation rate which is down compared to the 2014 elections. We note the very strong increase in participation in Central Europe.

In Poland, Hungary and Romania, this rate had never been so high.
In other words, the European question has rather mobilized in all European countries.

This vote has also resulted in greater diversity and this may be a consequence of this increased participation.
The conservative party (EPP) is no longer so dominant and the social democrats can no longer make an alliance with them for a broad coalition. The counterpart of this weakness of the parties that traditionally dominated the Parliament, is the circa forty seats won by the liberal centrists, the circa thirty won by the greens and the twentieth gleaned by the nationalist parties and extreme right. The radical left, however, loses about fifteen seats.
The question that was important on the eve of these elections was the balancing point between those who want to make the evolution of Europe within the existing rules and those who want to use rules when they fit them. The parliament remains very oriented towards the respect of the rules. The nationalist and far-right parties will represent just under 180 seats out of 751 and will not participate in any coalition.
There has not been a tidal wave towards nationalism and that is why the financial markets do not experience any ups and downs. Salvini’s victory in Italy was long overdue, so it’s no surprise, just like Orban’s victory in Hungary.
There may, however, be local stories like in Greece where the Democratic Party has supplanted Prime Minister Tsipras’ s party while legislative elections will be held soon.
On this point, moreover, the impact of the elections to the European Parliament is still very small at the national level. Each time we imagine strong changes but this vote remains European with little impact on national policies.
It will nevertheless be interesting to look at the British situation closely since if Farage wins the elections, pro-brexit are not the majority. That’s why the situation across the Channel will become complex after May’s resignation on June 7th. It will be necessary to find a new political balance to designate a prime minister who will negotiate the Brexit and that will be necessarily very complex (see here (in French) on the resignation of Theresa May)

The question now is that of the election of the European Commission.
There is a double change here. The first is that the grand coalition will not take place. There will necessarily be greens and liberal centrists. The balance will be different from that observed for a long time.
The other point is that the German candidate is no longer as strong as expected because of the low score of the CDU / CSU in Germany (but also maybe because of the Selmayrgate that weakens Germany within the Commission). Angela Merkel will not necessarily have the capacity to impose Manfred Weber. The game will be played between this German candidate, Michel Barnier, Frans Timmermans and Margrethe Vestager.
For the Euro zone, the choice of the President of the European Commission can not be neutral because in a few weeks, the new president of the ECB, will be named. A few months ago, Angela Merkel said she did not support Jens Weidmann at the head of the ECB preferring the Commission’s presidency to that of the central bank. If Manfred Weber is not the future president, then the Weidmann card could be played. This is already an attitude we have seen for some time. The candidacy of the President of the Bundesbank is once again on newspapers’ front page.
I do not think it would be a positive for the Euro Area if he replaced Draghi’ after his departure. He does not have a cooperative attitude within the countries of the zone. He was opposed to the OMT, hostile to a policy that was too accommodating (which may not have been enough) and to a possible fiscal stimulus in the event of a negative shock to activity. To the German influence on fiscal austerity it is not necessary to add monetary austerity if we want the Euro zone to continue functioning.

This arbitration will be important and that’s what will excite us in the coming weeks.

GDP, Employment and Productivity in the Euro Area

Employment increased in the euro area during the first quarter (+ 1.4% annualized). The pace of job creations is solid. However, since the beginning of 2018, productivity has lost momentum and it doesn’t improve. GDP is not growing fast enough in the face of rising employment.
The risk is that an external shock from, for example, global trade will penalize activity with after that a quick adjustment on employment. The economy does not create leeway (no productivity gains) that may cushion negative shocks. That’s worrisome.