ECB RULES OUT STIMULUS DESPITE RECORD JOBLESS AND FISCAL SQUEEZE / THE TELEGRAPH

ECB rules out stimulus despite record jobless and fiscal squeeze

The European Central Bank has dashed hopes of further stimulus to pull the eurozone out of recession and fight record unemployment, deeming the economy strong enough to heal itself.

By Ambrose Evans-Pritchard

6:29PM GMT 10 Jan 2013
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ECB President Mario Draghi unveils the new €5 note on Thursday

Mario Draghi, the ECB’s president, said the financial landscape has been transformed, citing a sharp drop in bond yields across the EMU periphery, a stock market rally and recovery of bank deposits in Greece and Spain. Capital flight has begun to reverse.

 

He even spoke of "exuberance" creeping into pockets of the credit system, with leveraged buy-outs and private equity deals becoming frothy - the first warning by the ECB of an incipient bubble as the fresh cycle gathers momentum.
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The euro surged more than two cents to $1.32 against the dollar after he revealed that the ECB’s governing council had agreed "unanimously" to hold interest rates at 0.75pc, implying that "doves" who called for rate cuts last month have been silenced by a clutch of rising confidence indicators.

 

However, the ECB is gambling that the rosier mood will be enough to lift the real economy out of a deep slump during another year of fiscal contraction, with the sharp squeeze spreading from Italy and Spain to France.

 

Athanasios Orphanides, a former ECB governor and a world expert on deflation, said the bank has misjudged the severity of the underlying economic crisis and is once again claiming victory too soon.


"I don’t subscribe to the optimistic view that the worst is behind us. None of the fundamental issues has been addressed," he told Bloomberg, warning that the ECB pledge to buy Club Med bonds has created "a false sense of calm".



He said there was no excuse for policy-makers "to stand idly by" as unemployment climbs to crippling levels across southern Europe, reaching 26.6pc in Spain.

Mr Orphanides said the eurozone is sliding into an even deeper slump than 2009. "We are in the middle of a policy-induced recession and monetary policy can do more to contain it, without compromising price stability."


Mr Draghi’s pledge to back-stop Spain and Italy has caused a sharp fall in bond yields for these two countries in what amounts to a surgical rate cut, but businesses are still paying twice the rates of German counterparts to raise funds.


Andrew Bosomworth from PIMCO said Europe’s financial system is still partially broken. "Your borrowing cost depends on your postal code, not on your credit quality or business model. The ECB will instead have to think of unconventional ways of getting credit to those worthy of receiving it," he said.


Mr Draghi acknowledged that Europe is still at risk and will not start to recover until later this year. "We have signs that fragmentation is being gradually repaired, but this is not feeding through to the real economy yet," he said.


Currency analysts said he has invited further inflows into euro by signalling that the ECB would stand aloof as other central banks around the world take action to drive down their currencies. "The very last thing that Europe needs right now is a strong euro. The risk is that the European economy will bear of the full brunt of the world’s currency wars," said Simon Derrick from BNY Mellon.


French finance minister Pierre Moscovici has begun to complain openly about the effects of currency strength on France’s struggling industry. "We have no interest in an over-valued euro," he said, vowing to raise the issue in talks with China.


Lars Christensen from Danske Bank said the ECB is making the same mistakes as the Bank of Japan in the early 1990s, allowing stagnation of the money supply and an asphyxiating exchange rate.
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"They think monetary policy is loose because interest rates are near zero, but what long bond yields in the market are telling us is that monetary conditions are in fact very tight," he said.


"Their view is that quantitative easing will be hyper-inflationary and lead to a collapse of credibility, but if you look at the contrast in unemployment between the eurozone and the US, it is clear that the Fed has been vindicated," he said.


Mr Draghi said the ECB does not have a "dual mandate" like the Fed to target jobs and must stick to its one designated task of ensuring price stability, but added that the bank could not alleviate structural unemployment even if it tried. "Monetary policy cannot do much about that," he said.


The comment underscores a deep split in thinking on the two sides of the Atlantic. The Fed has vowed to keep adding stimulus until the job rate reaches 6.5pc.


"The contrast is now striking," said Julian Callow from Barclays. "The eurozone has corrected some of the external imbalances but at enormous costs and chiefly suppressing demand."
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The ECB’s hardline stance is also at odds with the findings of the European Commission’s 400-page report on the EMU jobs crisis this week. It concluded that the chief cause of rising unemployment is a "demand shock" to the Euroland economy and that structural flaws in the labour markets were "less relevant".


The report said a widening gap between North and South had emerged that was pulling peripheral Europe into a downward spiral and a "poverty trap".


The eurozone remains as fragmented as ever. The stress has merely switched from the financial markets to the real economy.