MARKETS have been unexpectedly volatile this week. The biggest upset was Thursday’s interest rate cut by the European Central Bank (ECB). However, game changing as this cut is, it was hardly surprising.
The ECB intervention was presaged by a public warning from Romano Prodi, one of the original architects of the euro and head of the European Commission (EC) when it was introduced.
He weighed in against Germany’s somewhat “Freudian” obsession with imposing austerity and anti-inflation policies on its neighbours: “German public opinion is by now convinced that any economic stimulus for the European economy is an unjustified help for the ‘feckless’ South, to which I have the honour of belonging. They are obsessed with inflation, just like teenagers obsessed with sex. They don’t understand that the real problem today in deflation.”
With this prompting, Mario Draghi, a fellow Italian and the boss of the ECB, felt confident enough to cut the bank’s refinancing rate by a quarter point, to 0.25 per cent. Draghi was even bold enough to say the ECB might cut rates to below zero.
The ECB intervention comes in the nick of time. On Tuesday the EC downgraded its growth forecast for the 18-country eurozone for the second time this year.
Austerity is tipping the zone towards deflation, even in Germany. Result: the real debt burden is accelerating faster than budgets can be cut, reinforcing contraction.
Paradoxically, deflation makes the euro more attractive to foreigners – China has been buying the currency hand over fist. Consequently, the euro has jumped 8 per cent in value against the dollar since June. That hurts European exports, tightening the squeeze.
Alas the ECB rate cut is only a single shot across Berlin’s bows. Prediction: to counter deflation, the ECB’s next move will be to offer unlimited loans to banks in the eurozone beyond its present commitment, which expires next July. After that, can Draghi really persuade the Bundesbank reps on his board to accept negative interest rates?
‘Tapering off’ least of US worries pre-Christmas
ACROSS the Pond, the outlook was infinitely more positive. The US labour market defied the recent Federal shutdown with non-farm employment rising by a healthy 204,000 in October. The consensus prediction was for only 120,000. This follows news on Thursday that the American economy grew more than forecast in the three months to September, at a healthy, annualised 2.8 per cent.
But in this topsy-turvy world, good news can be bad. Strong GDP and employment data has again sparked worries that the Federal Reserve might start “tapering”; i.e. winding down its monthly purchases of bonds on the open market for fear of inflation.
I’m more sanguine. US monthly employment data is very erratic, so let’s wait for the official revisions to October’s data before we start breathing again. Also, delve into those September GDP numbers and you will find there was a lot of inventory building in the run-up to Christmas. Let’s wait for the holiday retail numbers before uncrossing our fingers.
Meanwhile, the UK trade deficit in manufactures unexpectedly widened in the three months to September. Exports dropped sharply by 4.6 per cent –g the biggest fall since early 2009.
With the ECB rate cut boosting sterling, trade could prove a drag on UK growth in the fourth quarter.