Speaking at the annual gathering of the world’s central bankers in Jackson Hole, Wyoming, European Central Bank President Mario Draghi expressed his increasing concerns about continuing high levels of unemployment, stuck close to 11.5%, and very low inflation in the Eurozone. In a speech presenting the ECB’s analysis of unemployment in the euro area, Draghi summed up the current economic situation as follows:
The most recent GDP data confirm that the recovery in the euro area remains uniformly weak, with subdued wage growth even in non-stressed countries suggesting lackluster demand. In these circumstances, it seems likely that uncertainty over the strength of the recovery is weighing on business investment and slowing the rate at which workers are being rehired.
Moreover, he added, “In some countries, at least, a significant share of unemployment is also structural.”
Growth-Friendly Stance
The European Central Bank is ready to do more to strengthen the recovery: “We stand ready to adjust our policy stance further.” However, Draghi stressed that monetary policy alone would be inadequate to address this situation. The euro area governments need to step up to the plate with more flexible fiscal policies where there is room to do so within the Eurozone’s fiscal rules, he said – a comment aimed directly at Germany – and move forward with needed structural reforms (France, Italy). His call for a “more growth-friendly overall fiscal stance for the euro area” has been widely seen as a “softer tone on austerity,” bringing the ECB closer to the views being urged by Italy and France and further from the strict position on fiscal restraint pressed by Germany. Draghi also stressed that structural reform in two areas – policies that allow workers to redeploy quickly to new job opportunities and policies to raise the skill intensity of the workforce – “can no longer be delayed.”
Draghi’s comments on monetary policy basically repeated and stressed the measures the ECB announced in June. He continues to see the need for “an accommodative monetary policy for an extended period of time.” The Targeted Long-Term Refinancing Operation aimed at supporting increased bank lending to business will be launched next month. Preparations for outright purchases by the ECB in asset-backed security (ABS) markets are “fast moving forward.” His reference to being “ready to adjust our policy stance further” suggests that large-scale quantitative easing remains an option, but his other remarks imply that cooperation on the part of Eurozone governments will need to accompany any such action by the central bank.
These remarks appear to us to be right on target in view of the current economic situation in Europe. If Draghi’s recommendations are followed by the Eurozone governments, there will be good reasons for optimism about the European economy. But there is considerable risk that Germany, with the largest economy in the Eurozone by far, will not heed Draghi’s call for increased “flexibility” with regard to fiscal policy, and the weak recovery will continue to limp along. Moreover, my former colleague at the OECD, John Llewellyn, now of Llewellyn Consulting, notes that even if the ECB undertakes QE after having left it so long, it “may well have missed the boat.”
Portfolio Composition
For the time being, we will continue to underweight the Eurozone in our International and Global Equity ETF Portfolios, which are fully invested. The Eurozone as a whole has underperformed so far this year. The iShares MSCI EMU ETF, (NYSE:EZU), which tracks the Eurozone markets, is down 4.08% year-to-date, whereas the iShares MSCI ACWI ex-US Index Fund ETF, (NASDAQ:ACWX), which tracks our ex-US benchmark, is up 2.21%. We are, however, maintaining our position in Spain, where economic reforms have permitted the economy to sustain a strong recovery, in contrast to the second-quarter declines in Germany and Italy and zero growth in France. The iShares MSCI Spain ETF, (ARCA:EWP), is up 4.33% year-to-date and over 27% for the past 12 months. We have also added a position in Belgium, where the iShares MSCI Belgium ETF, (NYSE:EWK), has gained 4.09% year-to-date.
Bill Witherell, Chief Global Economist