Europe’s economy deeply exposed to growing global gloom
Quantitative easing no panacea for a multi-faceted economy with myriad different needs
It is claimed hope springs eternal, but confidence can be a very fickle thing. Sure enough, when things are going well it is all too easy to be swept up in the euphoria and end up detached from reality. In the case of the euro zone economy, the optimists are in for a rude awakening.
European economic confidence surveys might be pointing to better times ahead, but with the rest of the world drowning in pessimism right now, the euro zone looks very exposed and swimming against the tide.
Headwinds are blowing hard from all quarters. China’s economy is slowing down, the US Federal Reserve remains hell-bent on tightening policy, energy and commodity prices are in deep descent, and financial markets are threatening to descend into chaos again. The omens are deeply disturbing.
With the global economy under duress and deflation risks still on the rise, it is unlikely to be too long before Europe’s leading indicators begin to waver and point the way towards slower growth ahead.
Right now, Europe’s economic sentiment index, Germany’s IFO business climate index and the euro zone purchasing managers’ survey are taking their cue from the super-stimulus generated by the European Central Bank’s (ECB) quantitative easing (QE) programme. The surveys anticipate the euro zone becomes so flooded with liquidity that self-sustaining recovery eventually kicks in.
QE measures have had some positive effects, with euro zone monetary indicators showing definite hints of stronger activity. Loan demand has picked up and money supply growth is accelerating too. Consumer credit, mortgage borrowing and corporate loans are all back in positive growth territory again, albeit from a very weak base in recent years.
The pace of M3 money supply growth has even shot up to 5.1 per cent, above the ECB’s 4.5 per cent growth reference target. This is fastest rate of monetary growth in the euro zone for seven years.
Monetary conditions might have improved on the surface, but problems still persist. Recent ECB loan surveys show net credit conditions have hit their tightest level since the before the global financial crisis kicked off in 2008. Despite the availability of cheap money from QE, euro zone banks are still struggling to lend freely under a regime of much tougher capital adequacy requirements being applied to European bank balance sheets.
If the global economy spins into a downward spiral and Europe’s banks feel the pinch, the flow of easy credit to the markets will dry up again. It is not just loan supply that will be affected, as the demand for credit from consumers, companies and investors will wither as conditions turn sour and economic activity gets scaled back.
The ECB might have pledged to do “whatever it takes” to jump-start stronger recovery and stifle deflation risks, but there is a limit to how much more it can do by pushing interest rates further into negative territory and by ploughing extra QE money into the monetary system.
The trouble is QE is no panacea for a multi-faceted economy with a myriad different needs. Flooding the euro zone with more QE cannot simultaneously solve the problem of an economy in dire need of stronger export growth, while crying out for a resurgence of domestic demand and faster job creation.
Germany’s export driven economy remains extremely vulnerable to a slowdown in global trade, while the distressed euro zone economies, especially in southern Europe, remain plagued by dangerously high unemployment levels and weak consumer demand.
Even fuelled by cheap QE money, it is expecting too much for the euro zone to hit the ECB’s targets for 1.7 per cent GDP growth in 2016 and 1.9 per cent output expansion in 2017.
A strong global economy is a must for the euro zone economy to thrive. Germany is already starting to show stress fractures from slower global growth, with recent industrial production and manufacturing orders data showing clear signs of a downturn in demand from abroad.
If Germany’s export powerhouse begins to falter, the rest of the euro zone will suffer as internal demand starts to trend lower. With up to 50 per cent of euro zone exports traded internally within the single market, the consequences for growth and employment could be severe. Another quick recession should not be ruled out.
The immutable truth is that Europe cannot go it alone. Europe needs a strong world economy to do better over the future. There will be no soft landing for Europe as the global economy nose-dives.
David Brown is chief executive of New View Economics