As the year comes to a close, the markets await two monumental decisions. It is thought by many and priced into the market that the European Central Banks, Governing Council have already agreed upon an expansion of their already large Quantitative easing program.
Whereas, across the North Atlantic in Washington, it is assumed that the Federal Reserve Open Market Committee has all but rubber-stamped a decision to increase interest rates for the first time in some 9 years.
Back in the day, a central bank’s decision to increase or decrease interest rates although an important event never carried such significance, or was written about in such detail. However, in an era of globalization and an interconnected international economy, a decision to tighten or ease monetary policy has become very big news indeed.
The decisions that will be taken over the next few weeks come after a deep recession that hit the global economy in 2008. Although stock markets around the world have recovered, anything other than a rally in the major indices would have expected with so much cheap and abundant money looking for somewhere to be parked.
The United States Federal Reserve and the Bank of England was quick to step in and boost their economic systems by embarking on substantial stimulus programmes. The European Central Bank, shackled by the German Government and Bundesbank, only decided to initiate its own QE programme on January 22 of this year.
The ECB President, Mr. Mario Draghi, announced a few months back that the central bank would do what it takes to bring back growth to the sluggish European economy. This was an admission that all was not well with the ECB’s current programme of stimulus. It is now hard to believe that less than 12 months since the last European QE programme was announced that the markets are already pricing in QE2.
The ECB is probably right to worry. It only needs to look to Japan. A country that has suffered a chronic and disastrous recession. The fear amongst the ECB governing council is that the plight of Japan could turn out to be the story of the Euro-Area.
There are of course differences between the Japan and the Euro-Zone. Japan is a much smaller economy that is heavily focused on manufacturing, whereas the Euro-Zone brings together a much more diverse economy.
For a better comparison, we really need to look across to the United States. What becomes evident when one compares the US and Euro-Area is the how out of kilt the economic cycles are.
Although a low inflation environment does continue to persist in the USA, there are signs that this picture is beginning to change. Furthermore, over the past few months there has been real signs that the US jobs market is beginning to show positive gains.
By contrast, the Euro-Area has shown patchy employment growth and an anaemic inflation outlook. There is talk that the Euro-Area is some 24 to 36 months behind the United States. This is probably a correct assumption. However, the structural and political problems continue to persist in the Euro-Area.
Although QE2 should eventually push the Euro-Area towards recovery, the main beneficiaries will be the core nations such as Germany, Netherlands, Austria and France. For the periphery such as Greece, Italy, Portugal and Spain, the road back to recovery will continue to be a long and painful journey.