DGAP-News: Silvia Quandt&Cie. AG, Merchant&Investment Banking: Bernhard Eschweiler - In-between the lines
(firmenpresse) - DGAP-News: Silvia Quandt&Cie. AG, Merchant&Investment Banking /
Key word(s): Miscellaneous
Silvia Quandt&Cie. AG, Merchant&Investment Banking: Bernhard
Eschweiler - In-between the lines
05.05.2011 / 16:44
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- ECB has to find new 'normality' between inflation and unemployment
- Monetary aggregates and speed of fiscal consolidation are key factors
to watch
- Greek debt problem cannot be solved in isolation
As widely expected, the ECB left interest rates unchanged at today's
meeting. Yet, the tone of the press statement makes a rate hike in June a
high possibility. Inflation is above the comfort level and the ECB is
trying to contain inflation expectations. On the other hand, Euro area
economic and financial conditions remain fragile. Despite the tough
rhetoric, we believe the ECB will move cautiously and raise the policy rate
to just 2% by the first quarter of 2012 and then pause.
What would the old Bundesbank have done?
The ECB is caught between a rock and a hard place. What would be
appropriate for Germany would be lethal for the Euro-area periphery.
Indeed, the ECB cannot please everybody. Monetary purists, thus, demand
that it should focus on its primary mandate, which is maintaining price
stability and not full employment. This is, what many believe, the old
Bundesbank would have done. That is true, but would the old Bundesbank
have chosen a more aggressive policy response? Perhaps not!
An interesting comparison is 1994. The global economy had emerged from
recession and inflation pressures were again on the rise, driven as today
by oil and other commodity prices. The Fed responded aggressively,
doubling interest rates within a year. In Germany, inflation was well
above the Bundesbank's comfort level and the economy was showing some signs
of life. Unemployment, however, stayed stubbornly high and the Bundesbank
lowered rather than hiked interest rates. Did the Bundesbank get its
priorities mixed up? Some thought so at the time, but it was the right
course of action in hindsight. Inflation subsequently fell to 2% and even
lower, while the economy remained sluggish and unemployment moved higher.
To be sure, this is not a case for more monetary easing. Interest rates
were much higher back then. Still, one should ask what made the Bundesbank
so comfortable to risk its inflation-fighting credentials. Three factors
stand out with important lessons for the ECB today.
- First, Germany was in trouble and the Bundesbank knew that. Corporates
responded to the loss of competitiveness by cutting cost, especially
employment. While it took some time to materialize, the restructuring
was profoundly disinflationary. Much of the Euro area is in economic
trouble as well, not just the periphery. Only the German unemployment
rate is below the pre-crisis level and the pre-crisis cyclical average.
Devaluation is not an option for restoring competitiveness. The
disinflationary effects of the inevitable restructuring will
increasingly become visible, not just in actual price changes but also
in inflation expectations.
- Second, the Bundesbank knew that the government had exhausted its
fiscal means. The subsequent fiscal consolidation was a drag on growth
and inflation. The more the government tightened its belt, the more
the Bundesbank could relax. The fiscal situation in the Euro area is
worse than it was in post-unification Germany. Deficit and debt
figures still get revised up in many cases, yet the underlying policy
stance has become extremely restrictive for growth and employment.
Governments have to stick to the austerity course, as the new
Bundesbank President Weidmann demanded in his inaugural speech.
However, the more they do so, the more the ECB can relax.
- Third, the Bundesbank took comfort that the risk of excessive monetary
expansion fuelled by the unification boom and its implications for
inflation was declining. The ECB is carefully watching monetary and
credit growth. The latest figures showed a small pick-up, but from
moderate levels. Importantly, the expansion of the ECB balance sheet
has not boosted broad money supply. Thus, there is no imminent
inflation risk stemming from monetary developments.
An additional factor that argues for caution is the fragility of the
financial system. What would be an appropriate policy adjustment under
healthy financial conditions could have negative repercussions at the
moment. Mr. Weidmann is right that the return to monetary normality is
only a question of timing and not principal. Economic restructuring,
fiscal consolidation and financial fragility, however, mean that the
process may take more time and that the new normality may imply lower
interest rates than in the past cycles. For Germany, that could imply
higher than normal inflation. Mr. Weidmann demanded from the government to
use the economic tailwinds to accelerate the deficit reduction. This is
right, not only for fiscal reasons, but also for letting some steam out of
the economy and inflation.
Don't jeopardize Spain for Greek restructuring
The path to monetary normality is also tied to the resolution of the Euro
debt crisis. The market has zeroed in on Greece. Greece is bust and debt
restructuring is only a question of time. Thus, why not bite the bullet
now. Unfortunately, that is easier said than done. First, there is no
consensus what type of restructuring would work best. The proposals range
from voluntary exchanges (Brady-type bonds) with modest haircuts, maturity
extensions and lower interest rates to forced restructurings with steep
haircuts. Second, technical and legal aspects are not clear. Third, there
is no agreement among key players whether restructuring is the right thing
to do. ECB and EU Commission vehemently oppose a restructuring, fearing
more financial instability. And while some politicians are toying with the
idea, those who have the final say - including the IMF - have been quiet.
The key issue is that the Greek problem cannot be solved in isolation.
Action on Greece would immediately trigger pressure on other troubled
debtors. Most unfavorably, it could threaten the positive performance of
Spain. We have argued long ago for a Brady-type exchange, but that makes
only sense if there is consensus among all parties involved and the
restructuring is comprehensive, i.e. involves all insolvent debtors. If
that is not assured, politicians will opt for muddling through until they
hold enough Greek debt to manage a restructuring outside the market.
Disclaimer
This analysis was prepared by Bernhard Eschweiler, Senior Economic Advisor,
and was first published 5 May 2011, Silvia Quandt Research GmbH,
Grüneburgweg 18, 60322 Frankfurt is responsible for its preparation. German
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Number of recommendations Thereof recommendations for issuers to whichCompany disclosures
from Silvia Quandt Research investment banking services were provided
during
GmbH in 2011 the preceding twelve months
Buys: 94 36
Neutral: 40 1
Avoid: 4 0
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Datum: 05.05.2011 - 16:44 Uhr
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