9th March 2016 by Simon Ward
Posts here in late 2014 and early 2015 argued for optimism about Eurozone economic prospects because monetary trends had strengthened significantly. Growth was solid in 2015 and domestically-generated inflation recovered. Monetary trends continue to give a reassuring message. Further monetary policy stimulus, therefore, does not appear to be warranted and – depending on the form it takes – may prove counterproductive.
Revised data released yesterday show that Eurozone GDP rose by 1.6% in the year to the fourth quarter of 2015 – see first chart. This is well above EU Commission, OECD and IMF estimates of potential growth in 2015 – 1.0%, 1.2% and 1.0% respectively. Potential growth was more than 2% when EMU began in 1999. In terms of the impact on the “output gap”, therefore, GDP growth of 1.6% now is equivalent to about 2.75% then.
The economy, moreover, was held back last year by a significant decline in net exports, reflecting global demand weakness. Eurozone domestic demand expanded by 2.2% in the year to the fourth quarter, the fastest annual growth rate since the third quarter of 2007 – first chart.
The labour market, meanwhile, has been stronger than even optimists expected. The unemployment rate fell by a full percentage point between January 2015 and January 2016. The most recent employment statistics showed a 3.0 million rise in the year to the third quarter of 2015. A monthly rise in US payrolls of 200,000 or more is generally regarded as evidence of a strong economy. The equivalent increase in the Eurozone in the latest 12 months was 250,000. (The level of employment is similar in the US and Eurozone.)
Monetary policy doves claim that deflation risk has increased. The annual change in consumer prices fell below zero again in February, mainly reflecting further oil price weakness around the turn of the year, which has since reversed. Core inflation, however, has remained comfortably positive and above its 2014-15 low. The most comprehensive gauge of domestically-generated price pressure is the GDP deflator, which measures labour costs and profits per unit of output of all domestically-produced goods and services. The annual change in the deflator bottomed at 0.7% in the second quarter of 2014 and recovered to 1.3% in the second quarter of 2015, remaining at this level in the third and fourth quarters – second chart.
Monetary trends, meanwhile, remain solid. The monetary measure with the strongest correlation with future economic activity, according to ECB research, is non-financial M1, which rose by 9.8% in the year to January. Broad money M3 increased by 5.0% over the same period, above the ECB’s 4.5% “reference value” deemed to be consistent with its inflation target.
Based on the above, the case for further monetary policy stimulus is unproven. The ECB may argue that further action is required as insurance against downside risks. The danger is that, far from providing stimulus, the measures under consideration will cause banks to slow balance sheet expansion while damaging consumer and business confidence.