Business Irish

Friday 19 January 2018

Confidence creeps back but recovery is still not certain

Brendan Keenan

Brendan Keenan

IF things get really bad, and you receive a flyer from a guy called Mario Draghi offering to do the garden, bin it. Last week, the president of the European Central Bank described the nascent eurozone recovery as "the greenest of green shoots".

By this, he meant it was the most fragile of recoveries. Right about the recovery, wrong about shoots. Vivid green would be a sign of health and strength, which is not what he meant.

There is much argument about how green the shoots really are. The monthly ECB press briefing saw the odd situation of Mr Draghi being more cautious than the month before, despite the better statistics.

He was also more cautious than many market analysts. Central banks are not supposed to be cheerleaders, but one might have expected him to at least grasp at the available straws – or, in this case, green shoots.

But these are odd times. At an annual briefing for financial media last week, Standard Life Investments described the global economy as "entering a new phase".

For its analysts, the change is mostly positive – although the shoots are the palest of green – and involves a shift in the balance of growth, including in Europe.

The new phase has been marked – if not actually caused – by the announcement from the US Federal Reserve that it was to reduce the amount of dollars it creates by buying loans in the debt markets.

A new word entered the financial lexicon – 'tapering'. This was intended to convey caution and gradualness: nothing too exciting would happen, you understand. But the details of the taper were quite precise.

The first reduction in money creation – the so-called 'quantitative easing' – will begin this month and is due to end completely by next summer, allowing the Fed to get back to the normal business of managing the money supply rather than increasing it.

Unfortunately for tapering, the markets have been waiting for this day for a long time and had all their ducks in a row, ready to fly. They flew from emerging markets, with dramatic declines in the Indian rupee, Brazilian real and South African rand as money went back West in anticipation of higher interest rates.

Naturally, this anticipation produced higher rates, even in Europe. Market rates rose almost three-quarters of a per cent, which is a lot from current ultra-low levels. Here lies one explanation for Mr Draghi's caution. This is not what the ECB wants, or Europe needs.

On the positive side, it should be said that both the tapering and the reaction to it are symptoms of greater confidence in economic prospects. The Fed is happy that the US can average 2pc annual growth out to 2015; the eurozone is seen as finally posting positive growth, although only of 1pc.

The biggest recipient of this new-found optimism is Britain, with talk even of annual growth of 4pc by the end of the year.

If such forecasts should turn out to be correct, it would of course be highly beneficial to Ireland.

As usual, this country is in a peculiar position. As a member of the highly indebted periphery, it has borne the brunt of the ghastly eurozone depression. I have noted before the €1trn loss in European output, as compared with the recovery trajectory in the US, but the difference in unemployment is, if anything, even more striking.

In 2009, the world's two largest economic blocs had unemployment rates of 10pc. This year, the US rate is down to 8pc but the eurozone's has risen to 12pc. That four percentage point swing amounts to eight million jobless Europeans. Worse, the bulk of it occurred in the peripheral countries.

Ireland's economic links with the rest of the periphery, though, are just as distant as its geographical ones. Recovery in the UK and US is at least as important as a return to growth in the euro area.

Not that the Irish domestic situation is unimportant. Standard Life's chief economist, Andrew Milligan, talks about the "fiscal headwinds" easing as peripheral countries complete their austerity programmes (or perhaps have them amended).

Next month's Budget ought to mark a turning point. Even with a Labour Party soother attached, it is likely to include more than €2.5bn in corrections; enough to knock 1.5pc off economic growth next year. A return to neutral, or even mildly austere budgets from 2015 would make a huge difference to growth; to which any stronger international demand would to be added.

Such a welcome turn in events is, of course, anything but a certainty. One might have a debate as to whether the risks are still "on the downside", as the analysts like to say, or now merely balanced. But the risks are there, and certainly not yet "on the upside".

The obvious risk is another outbreak of fear and loathing in the euro area. There are various high hopes for progress after the German election, but they are unlikely to be realised. It is important, though, that they are not dashed completely.

Greece will be the trigger point. It is strange to Irish observers to see the voluntary moratorium on discussing further direct aid for Greece during the German election. It wouldn't happen here, although the combative finance minister Wolfgang Schaeuble did break ranks to point out that some of the money lent to Greece will have to be written off, even as still more is lent.

The comment and the general vow of silence are both a recognition that the write-off will happen. It should keep alive the vital belief that the eurozone will do "what it takes" in the end and keep muddling through.

The more immediate risk is that the tapering turns into a downturn. A damaged financial sector will have to face higher borrowing costs and a fall in the price of the government loans it holds as assets. Fragile businesses in Europe especially are also vulnerable to higher interest rates.

Mr Draghi has assured us that rates will not go up until recovery is established. But the recovery could turn out to be German over-heating combined with continued peripheral stagnation, but adding up to significant eurozone growth. Which way would the ECB jump then?

Germany is also quietly re-balancing, with wages rising at 4-5pc. They deserve credit for this, even if they do not want anyone to notice, but it is not clear how much difference this can actually make to the problems of the southern periphery. It is another factor which could be good for Ireland though.

The question is whether domestic risks might outweigh better external conditions. What is left of the resolve to fix public finances and private protectionism could collapse at the first sign of better times. That would be a sure way to guarantee that the better times do not last.

Irish Independent

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