The ail­ing euro­zone is still hooked on QE

The Sunday Telegraph - Money & Business - - Business - LIAM HALLIGAN Fol­low Liam on Twit­ter @liamhal­li­gan

The Eu­ro­pean Cen­tral Bank is on a knife edge. In­vestors are ques­tion­ing whether the Frank­furt­based in­sti­tu­tion will fi­nally, as promised, end its gar­gan­tuan quan­ti­ta­tive eas­ing pro­gramme by the end of 2018. And will the ECB re­ally de­liver on its pledge to raise in­ter­est rates, for the first time since 2011, next sum­mer?

The US Fed­eral Re­serve and Bank of Eng­land, hav­ing long since moved away from QE, are now clearly in rate-ris­ing mode. The Fed has in­creased rates eight times over the last three years, with the bench­mark US rate now 2.25pc.

The UK base rate is still ul­tra low, at 0.75pc. Since last au­tumn, though, the Mon­e­tary Pol­icy Com­mit­tee has man­aged to raise rates twice with­out un­duly jeop­ar­dis­ing fi­nan­cial mar­ket sta­bil­ity or broader growth. Both the Bank and the Fed, as the economies they over­see have strength­ened, are shift­ing from post-cri­sis emer­gency mea­sures to­wards some kind of nor­mal­ity. The euro­zone, in con­trast, re­mains on life sup­port. ECB nom­i­nal in­ter­est rates re­main neg­a­tive, at mi­nus 0.4pc – deep in Alice in

Won­der­land ter­ri­tory.

The sin­gle cur­rency zone grew just 0.2pc over the three months from July to Septem­ber, the slow­est pace in over four years. The UK econ­omy, in con­trast, ex­panded 0.7pc over the same pe­riod. This euro­zone slump has sparked re­newed spec­u­la­tion that ECB QE, still €15bn (£13.3bn) of vir­tual money-print­ing a month, will con­tinue into 2019 and be­yond – as Eco­nomic Agenda has long pre­dicted. ECB supremo Mario Draghi de­nies this, as do the min­utes of the cen­tral bank’s Oc­to­ber meet­ing, just re­leased.

The ECB has, since the 2008 fi­nan­cial cri­sis, con­ducted “ex­tra­or­di­nary mon­e­tary mea­sures” on a, well, quite ex­tra­or­di­nary scale. Draghi has over­seen a four­fold ex­pan­sion of the cen­tral bank’s bal­ance sheet – which now stands at the equiv­a­lent of $5,300bn (£4,132bn). That’s 30pc big­ger than the Fed, de­spite the euro­zone econ­omy be­ing 25pc smaller than Amer­ica.

The ECB cur­rently faces its worst ever po­lit­i­cal cri­sis. Draghi’s still wildly ex­pan­sion­ary mon­e­tary pol­icy is deeply un­pop­u­lar in Ger­many. The euro­zone’s pay­mas­ter has been push­ing hard, for years, for QE to end. Neg­a­tive rates rile the na­tion’s army of savers, while Draghi’s loose-money an­tics play on Ger­man fears, forged dur­ing the in­ter-war years, of sud­den in­fla­tion. De­cem­ber 2018 has been cir­cled in Berlin’s di­ary for a long time.

Yes, Angela Merkel and Em­manuel Macron are at odds over the fu­ture of the euro­zone. The lead­ers of “Project Europe” last week struck a deal that, once again, fell woe­fully short of the bud­get-shar­ing and bank­ing union needed if the sin­gle cur­rency is to avoid break­ing up. Such in­te­gra­tion is vi­tal to any long-term cur­rency union, as fi­nan­cially lit­er­ate his­to­ri­ans know.

Un­less democ­racy is crushed com­pletely, though, and Europe’s na­tion states dis­solved, it is never go­ing to hap­pen. Why? Be­cause, in a com­pet­i­tive world, vot­ers in more pro­duc­tive coun­tries like Ger­many and the Nether­lands will never ever ac­cept a per­ma­nent, an­nual bailout for the poorer na­tions to their south.

This euro­zone mis­match is crys­tallised, of course, in the now se­ri­ous stand-off be­tween Brus­sels and Rome. Italy’s pop­ulist govern­ment was elected last year on a prom­ise to rip up the EU’S fis­cal rule book and, hav­ing sub­mit­ted a high-spend­ing bud­get, is de­ter­mined to make good on that com­mit­ment. The Eu­ro­pean Com­mis­sion last week es­ca­lated this trial of strength, dis­miss­ing Rome’s plan as “in par­tic­u­larly se­ri­ous non-com­pli­ance”, threat­en­ing to im­pose sanc­tions on Italy of 0.5pc of GDP. Should such fines be levied, Italy’s al­ready smoul­der­ing po­lit­i­cal at­mos­phere, fanned by yet an­other loom­ing re­ces­sion, would erupt. There would be re­newed calls, not least from

the govern­ment it­self, for the euro­zone’s third largest econ­omy to ditch the sin­gle cur­rency al­to­gether. If Brus­sels rolls over, though, and Rome pre­vails, ex­pect a bud­get free-for-all, with the likes of Por­tu­gal, Spain and even France drop­ping all pre­tence of spend­ing con­trol – again pre­sent­ing huge sys­temic dan­gers.

This Italy-eu show­down is as­ton­ish­ingly dan­ger­ous. As the grip of Angela Merkel’s steady­ing hand gets looser, it could spi­ral out of con­trol, up­end­ing fi­nan­cial mar­kets across the world. The spread be­tween yields on 10-year Ger­man and Ital­ian bonds is now well over 300 ba­sis points, a sign of grow­ing mar­ket dis­tress. With Ital­ian banks hold­ing €380bn of do­mes­tic govern­ment debt, far from a do­mes­tic bailout, spik­ing bond mar­kets would see Italy’s govern­ment and banks go into a down­ward spi­ral. Greece is back on the agenda too, with the Athens stock ex­change down 60pc since May, amid mar­ket spec­u­la­tion this ham­mered econ­omy now needs a fourth bailout to stop yet an­other im­plo­sion. Omi­nously, the share price of Deutsche Bank just hit yet an­other all-time low.

Both these bat­tles – over euro­zone bud­getary pool­ing and next year’s Ital­ian bud­get – hinge, for now at least, on the ECB’S next move. Rome is openly call­ing for Draghi to keep print­ing money dur­ing 2019 and be­yond, so as to douse down Italy’s in­creas­ingly angst-rid­den bond mar­kets. Bun­des­bank pres­i­dent Jens Wei­d­mann, mean­while, is cry­ing foul.

The en­tire Ger­man es­tab­lish­ment, of course, has been both mor­ti­fied and deeply spooked by the re­cent elec­toral surge of Al­ter­na­tive fur Deutsch­land, a hard-right party that re­sents not only QE and free­dom of move­ment, but also Ger­many foot­ing the broader re­gion’s bills. Euro­zone QE won’t be ex­tended, then, with­out a ma­jor, mar­ket­spook­ing tus­sle. And An­drea En­ria, the in­com­ing head of the ECB’S su­per­vi­sory arm, has just warned that the euro­zone’s bank­ing sys­tem, with­out a ma­jor clean-up that for a decade has been avoided, would “not survive the next cri­sis”.

What you’ve just read has barely fea­tured in the main­stream UK me­dia over re­cent weeks. Yet it is an ax­iomatic truth that the EU re­mains blighted not just by ris­ing pop­ulist out­rage, but by an ill-de­signed and deeply dys­func­tional mon­e­tary union – a union that will lurch back into a fully-blown cri­sis, which it lacks the fis­cal and mon­e­tary scope to tackle, when the next global eco­nomic down­turn hits in 2019 or 2020.

This is the con­text in which British politi­cians are call­ing for a sec­ond ref­er­en­dum, lash­ing us to the EU. This is the back­ground to Theresa May’s ut­ter ca­pit­u­la­tion – back­ing a legally bind­ing With­drawal Agree­ment that ve­toes a true Brexit and a non-bind­ing “fu­ture re­la­tions” state­ment that’s noth­ing but warm words.

‘The EU re­mains blighted not just by ris­ing pop­ulist out­rage, but by an ill-de­signed mon­e­tary union’

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