© Dario Perkins
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I think that the recovery we had has come almost entirely from consumer spending. Hence, if you look over the last year, it has mainly been on the back of the oil price story, which has dropped very sharply, and real incomes in Europe were lifted. Since the consumption did not grow for several years and there was this sort of pent up demand, consumers immediately started to spend. I think the question now is whether that will continue.
Obviously, oil prices are going to stabilize at some point, therefore, incomes will not keep rising and the risk is that it starts to fade if investment picks up, since Europe has not had any kind of investment recovery. There has been quite strong investment recovery in the US and the UK, but nothing in the Euro area. At the moment, getting the investment going is quite difficult, because the ECB has reduced improved credit conditions in Europe. In case you look at things like lending spreads – those have dropped down since the Bank implemented QE. Nevertheless, I believe that the asset quality review helped provide more transparency to the banking sector, but for some reason the European countries are very reluctant to invest and that is quite difficult to manage with policy.
The demand for credit is very depressed and I believe, given what is happening in the rest of the world, the uncertainties around China and the emerging markets are making the situation even more difficult, since the companies just will not invest, because they are simply too nervous. Hence, I am not sure whether there is any policy measure that could deal with the issue. You can say that governments could do some of the investment, but obviously there is a lot of the mentioned fiscal tightening going on and expanding the investment would be quite difficult. I believe that European government authorities should have more flexibility to do so, since they have approved their loss a few years, which may put focus on consolidation.
The ECB has been doing all that is in its power to combat the very low inflation, however, since the QE launch the numbers have not reached the desired 2% levels. Moreover, economists from Barclays mention that they see no grounds for attaching a high probability to a reflation scenario for the Euro area, at least in the near term. What is your thought on the matter? When do you expect to see some healthy inflation on board?
I must say that I am not too worried about inflation in either direction. I believe that underlining inflation or core inflation is fairly sticky around 1% and yes, that is below the 2% target, but I think the important thing is that since the ECB started doing QE, it helped with the growth dynamic in Europe. Even though the measures have not been particularly inflationary, obviously there is some inflation coming through from import prices from the lower currency. Obviously they are missing the desired target, but every central bank is missing their target.
Therefore, I believe it is almost impossible to meet the estimated target next year just like it is impossible for every other central bank, because of the mentioned massive collapse in the commodity prices. In addition, we are seeing the emerging market countries are cutting their prices very aggressively, so that deflation is going beyond commodity prices, and it is actually a helpful type of deflation as like we had in the 1990s and the early 2000s. That time the central banks were also missing their inflation targets, but it was mainly due to imported prices deflation coming from the rest of the world. Hence, I do not think that it is particularly harmful, on the contrary – I believe it is quite helpful to offset some of the effect of weaker trade in the emerging market.
Overall, I am not too critical on the ECB action; they took a long time to implement the QE, but they did it on a very large scale. I am not sure whether slightly expanding it would make much difference now. This might help keep down the currency a little bit; however, it is not the most suitable type of inflation that comes from the currency going down. For instance, the Japanese keep pushing down their currency and that keeps generating import inflation, but actually that turned out to be quite destructive, since it hurts consumer income and it is not clear whether we want Europe to go down the same road.
It seems that all the stars are aligning for a weaker Euro, the mentioned deflation is knocking on the Euro zone's door, a string of lackluster economic data and the European Central Bank is increasingly expected to launch more QE. What behavior do you expect from the Euro zone single currency in the near and long term?
Obviously there are a lot of factors depreciating the Euro, and particularly the QE is doing its job. When it looked like the Federal Reserve would be raising interest rates, it seemed obvious that the EUR would go down. However, I believe we are in a slightly different environment now, where the Fed is postponing rate increases or even considering inaction. The important thing is that for now it is not a one way down for the Euro and I see the currency stabilizing from here; it could even rise from now.
Moreover, I do not expect parity in the EUR/USD, whilst the pressure at the moment is going the other way towards a stronger Euro. That sets up this bizarre dynamic; every time the Euro rises, some of the ECB officials would try to talk it back down again. Therefore, I believe the ECB officials in their mind actually want the currency to stay at that level; the question is that whether that is possible to keep it, given this verbal intervention. My best guess is that the Euro will be fairly stable around where it is now.