ECB action alone can’t lift gloom over Europe

Europe has gotten another dose of stimulus. But the latest medicine by itself will not bring life to an economy that over the past six years has slid from crisis to crisis.

Though the European Central Bank surprised markets Thursday with the broad thrust of its stimulus measures, most economists think the recovery in the 18-country eurozone will continue to lag its counterparts – in particular, more dynamic economies such as the United States – for years.

Several eurozone countries are still grappling with high public debt that pushes them to hold back spending that would otherwise help growth – new roads and schools, for example. And the No. 2 and No. 3 economies, France and Italy, are reluctant to reform their economies to make it easier for companies to do business and hire.

Meanwhile, low inflation threatens to turn into an outright fall in prices – something that could hurt consumer spending as shoppers wait for prices to drop further. The economy is expected to grow slowly at best, after not expanding at all in the second quarter. Unemployment is proving hard to bring down – at 11.5 percent it is only marginally down from the peak 12 percent last summer.

That’s why the ECB, the central bank for the eurozone, came up with another rescue package just three months after its previous one in June. As well as cutting its benchmark interest rate from 0.15 percent to 0.05 percent, a new record low, it announced a program to buy bundles of bank loans that aims to stimulate bank lending to businesses and households. Details of the program – in particular, its size – remain to be filled in.

Few economists think the latest measures alone can heal the economy. As ECB President Mario Draghi keeps saying, the ECB can only do so much. Governments need to make reforms – and spend more, within the limits EU on deficits.

“The truth of the matter remains this: no amount of ECB `action’ will change the grim outlook for the eurozone if politicians do not confront the need for, and implementation of radical reforms,» said Marc Ostwald, market strategist at ADM Investor Services International.

Change needed

Until 2012, when politicians and the policymakers at the ECB were fighting to keep the euro alive, the single currency zone’s economy was held back by countries that were hit hard by the debt crisis, such as Greece, Portugal and Spain. Now those countries are slowly improving, and it’s the larger, richer countries that are being blamed for the economic morass: France, Italy and even Germany.

“In reform terms France and Italy’s woeful economic performance makes the need for reform extremely acute, even if there is scant historical evidence to expect any meaningful progress,» Ostwald said.

France’s economy, Europe’s second-biggest, is stagnating. Its Socialist president, Francois Hollande, is trying to cut taxes for businesses and reduce government spending but is facing so much political resistance he had to reform a new government this summer.

Italy, the third biggest economy in the eurozone and with the second-highest debt burden after Greece, shrank in 11 of the past 12 quarters. Matteo Renzi, the country’s youthful premier, is under pressure to deliver on the big economic promises he made when he took the helm this year. The country’s clogged courts, which hinder resolution of contract disputes, and tough worker protections continue to discourage investment.

Germany has low unemployment and a balanced budget – but is balking at calls to spend more on infrastructure.

In the end, it’s all about jobs. Employers are reluctant to hire when they know they can’t adjust their workforces for the ups and downs of the economy. Starting a business in Europe can mean delays for paperwork and permissions. And taxes tend to be high in Europe. Efforts to shrink deficits removes demand at a time when consumers, banks and businesses are trying to work off debt.

Spain has made some progress reforming its economy – and seen stronger growth as a result, though its unemployment rate remains sky high at 24.5 percent.

“The long-term cohesion of the euro area depends on each country in the union achieving a sustainably high level of employment,» Draghi said recently. «Given the very high costs if the cohesion of the union is threatened, all countries should have an interest in achieving this.”

ECB backstop

As governments delay reforms, and Germany insists on fiscal restraint over boosting growth, the ECB risks being asked for help once again. That means it may have to use the last weapon in its armory – creating massive amounts of new money to buy large amounts of government bonds.

The stimulus the ECB announced Thursday will create new money, but on a smaller scale. The market for the assets it will buy – asset-backed securities, which are essentially bundled bank loans – is not as large as that for government bonds.

Draghi confirmed Thursday the ECB had discussed buying government bonds. After all, its peers such as the US Federal Reserve and Bank of England have done so.

Such a program, commonly referred to as quantitative easing, or QE, can drive down market interest rates, making it cheaper for businesses and consumers to borrow.

Some think the ECB won’t go for it. The idea is unpopular in Germany, the biggest eurozone member. Its benefits are uncertain. And it would keep down government bond yields, or borrowing rates, taking pressure off governments to enact the very reforms Draghi has been harping on.

Yet the 24 members of its governing council might not feel they have a choice if the economy does not improve.

“We still believe that the ECB will have to put its remaining reservations aside and take the plunge into a full-blown QE program later this year,» said Jonathan Loynes, chief European economist at Capital Economics. [AP]