欧洲政经问题讲座 ‘The problem with Europe’ Lectures held at Peking University
This week, the ECB will hold its monetary policy meeting on Thursday (September 7th), two weeks after Draghi’s tight-lipped speech in Jackson Hole. As the current asset purchase program will end in December, the ECB has to make a choice of either extending the current QE program or starting QE tapering at the beginning of next year, if not at this week’s meeting then at the October’s meeting. With little meaningful hints so far, on the ECB’s future moves, we expect the central bank to delay any formal announcement of changes to its monetary policy until the October meeting. Thus, the focus of September meeting would be possible signals sent by Draghi during press conference, as well as the updated economic projections by ECB staff members.
As we have mentioned before, the ECB is facing a complicated situation: the conflict between the resilient economic recovery and the scarcity of eligible German debt versus the still subdued inflation. Specifically, the Eurozone’s GDP grew by 0.6% QoQ for both 1Q and 2Q, with recent data pointing to continued economic expansion and we have seen no signs showing that the impressive economic performance could end soon. Besides, after almost 3 years of bond buying, the ECB’s balance sheet expanded from EUR 2.05 trillion (20% of GDP) to EUR 4.28 trillion (40% of GDP). More important, the ‘scarcity’ of eligible debt has become a notable technical issue. The German sovereign bonds purchases have been falling in recent months, as the 33% limit is about to be reached (around 1Q 2018); and due to the capital key restriction, replacing the German bonds with other sovereign bonds could only be a temporary solution which cannot last long. So, without any adjustments to the purchasing rules, such technical limits suggest the need for QE tapering in next year.
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However, despite the recent mild recovery of the region’s inflationary pressure, the HICP inflation is expected to stay below the 2% target at least until next June. The August HICP picked up in the headline reading (increased from 1.4% YoY to 1.5% YoY) as energy prices recovered; but the core measure remained unchanged at 1.2% YoY, suggesting that the increase may be short-lived and not self-sustaining. Moreover, despite some gradual improvements, Eurozone countries continue to suffer from high unemployment and low wage growth, which will hinder the development in inflation. According to the ECB’s inflation projection, significant improvement of inflation will not show up until June 2018.
Given such an outlook, we still keep our baseline case that the ECB could start gradual tapering in 2018, but do not rule out the scenario that it will extend the current asset purchase program for several months before tapering, in order to see clearer improvements of inflation. Especially, the euro has appreciated against the US dollar by more than 13% this year, which could put downward pressures on inflation further, which strengthened the case to delay the formal announcement of changes to ECB’s monetary policy until October. But we expect Draghi to hint again on the press conference that the current pace of purchases need not be sustained in 2018. Due to the still lower-than-target inflation and the strengthened euro, we only expect tiny steps of tapering and the interest rates should remain at current levels throughout next year.
Rethinking EMUThe final lecture analyses EMU and will argue that the political-economic bas is of EMU is considerably more fragile than commonly thought. the argument proceeds in three steps. Despite the official view, the Euro-zone is de facto still an asymmetric monetary arrangement, with Germany (still) at its core. However, in contrast to the situation in the monetary arrangements that preceded it, within EMU Germany is stuck paying a disproportionately high price: outside EMU, German growth could be considerably higher, and its unemployment rate lower. The conventional view on Germany within EMU (ECB and Commission) is that the country needs to deregulate its labour markets and the unemployment will start to fall. Since that is precisely what Germany has been doing since the mid-1990s, this view now no longer seems to hold as much sway, even within the OECD who proclaimed it, as it did ten-fifteen years ago. Under such circumstances, it is farfrom impossible that powerful groups within the German political economy, both Left and Right, start questioning the wisdom of EMU, and that the resentment within the German population over abandoning the Deutschmark in favour of the Euro is organised by these interests. If this happens, the only country that could credibly leave the Euro, might eventually becompelled to do so, and the Euro will be history ?Cpossibly dragging the entire post-war European construction along in its fall.
In sum, formal announcement of any changes to ECB’s monetary policy is expected to be delayed until the October meeting, but we will focus on some possible signals regarding the QE tapering next year. Based on the sluggish inflation outlook, we maintain our previous view that the ECB could even announce to extend the current asset purchase program for several months before announcing the tapering, if it does not see convincing signals on improvements of inflation by its October meeting.