Measured optimism in Washington
The World Bank and International Monetary Fund (IMF) spring meetings in Washington provide an occasion every year to bring together a varied group of actors and observers from the private, public and academic worlds. This is also when the IMF presents its macroeconomic scenario. On the whole, world growth is accelerating from 3% in 2013 to 3.6% in 2014 and 3.9% in 2015, but the recovery is too unequal, slow and fragile, according to Christine Lagarde, the IMF’s Managing Director. Asia is by far the fastest growing region (6.5% in 2013, 6.7% in 2014 and 6.8% in 2015), and is well positioned to take advantage of the recovery in the advanced economies and the rebound in external demand. In the United States, most of the economic hindrances have been removed (budget policy, household debt reduction, etc.), and growth is expected to reach 2.8% in 2014 before accelerating to 3.9% in 2015, after 1.9% in 2013.
In the eurozone, in contrast, a series of factors continue to hamper the recovery even though domestic demand has levelled off and foreign demand is providing extra support. The IMF is forecasting GDP growth of 1.2% in 2014 after the 0.5% contraction in 2013. In particular, the IMF is worried about low inflation, estimated at 0.9% in 2014, down from 1.3% in 2013. In March, inflation dropped to 0.5%, the lowest level since November 2009, and well below the ECB’s 2% target for price stability. Moreover, persistently low inflation could impact expectations and trigger wait-and-see stance, which in turn could both weigh on demand and increase the risk of deflation. Paradoxically, this situation would also further strengthen the euro (which gained 6% against the dollar and 9% against the yen in 2013), making real returns on euro-denominated investments particularly attractive, while eroding debt dynamics and jeopardising the current recovery.
The ECB opens up new possibilities
Mario Draghi, invited to the spring meetings in Washington, restated that the ECB still expects inflation to gradually return towards 2%. Yet he also insisted that the Governing Council is unanimously committed to using all tools at its disposal, including the least conventional ones, to avoid the risk of deflation. Several options are already being explored.
The first option is to cut key official rates, with the possibility that the interest rate on deposit facilities would be brought into negative territory. To date, only the Swedish and Danish central banks have made such a move, with contrasting results. In July 2009, when Swedish growth contracted for the sixth consecutive quarter and prices were declining, the Riksbank surprised the markets by announcing a 25bp cut in its three key rates. This brought the 1-week deposit rate, the lowest of its key rates, to -0.25%, and it held at this level through September 2010. Although the move was highly mediatised, its impact on the economy was very small: historically, Swedish banks have made very little use of this deposit facility. In contrast, the central bank of Denmark’s decision was a big success. Unlike the ECB, its final goal was not to stabilise prices but to shore up the foreign exchange rate1. In July 2012, the monetary authorities decided to lower their main two key rates by 25bp, bringing the 14-day deposit rate to -0.20%. This decision discouraged capital inflows from the eurozone, minimised the DKK’s safe haven status, and thus limited its appreciation. The DKK returned to its central rate against the euro (from DKK 7.43 in June 2012) and central bank reserves declined by nearly DKK 30bn at year-end 2013 after reaching a new record high in late 2012 of more than DKK500bn (27.5% of GDP).
As a second option, Mario Draghi mentioned the possibility of the ECB purchasing a wide range of securities on the market. Benoît Coeuré, also in Washington, said that such a move was designed to reduce the risk premiums on the long end of the yield curve and not the size of the central bank’s balance sheet. It would have to take into account three factors: vertical differentiation (the maturities targeted by the operation, a priori medium to long term); regional differentiation (benchmark assets likely to have an influence on household and corporate borrowing rates may vary from one national market to the next) and horizontal differentiation (i.e. segmentation of eurozone financial markets).
Lastly Mario Draghi and Mark Carney, governor of the Bank of England, presented a joint document in Washington laying out the actions that could be taken to stimulate securitisation in the European ABS market, which is now only a quarter the size of its US counterpart. Still stigmatized by the subprime crisis, the ABS market enables banks to obtain a better risk exposure and should provide indirect market access to groups of borrowers, such as small and mid-sized businesses, which were hard hit by the crisis, especially in the peripheral countries. This would mean easing capital requirements rules for ABS with low risk profile and giving them a special treatment when calculating short term liquidity ratios.
BY Caroline NEWHOUSE