EU Economic Update – 29 September 2014

Economic data and holes in policy approach continue to highlight challenges facing the ECB

While the second half of 2013 heralded positive signs of a nascent recovery on the continent, the first half of 2014 has cast a shadow over the sustainability of this.

Although some previously troubled nations (Portugal, Ireland and Spain) have continued make progress toward fiscal consolidation and growth; these triumphs have been replaced by increasingly heightened concerns over growth at the very core of Europe.

This is as both Germany and France have experienced a marked deceleration in growth during the first half of the year while bloc wide inflation has plummeted, to the point where the prospect of deflation now threatens to undermine attempts at fiscal reform.

In contrast, both the UK and US economies have enjoyed robust stimulus driven recoveries since mid 2013 and are now each on the verge of beginning a gradual tightening of monetary policy. As this scenario of divergent economic health has developed it has made the challenges faced by the continental economies ever clearer; leading to increasing pressure upon the ECB to act.

Despite the bleaker outlook for growth and reforms the ECB has, by any measure, been slow to act and now faces accusations of having been behind the curve every step of the way.

More importantly, a large question mark remains over whether or not the current measures put forward by the ECB will be sufficient to halt the threat of deflation and renewed financial instability. The current proposals see the ECB expanding its balance sheet by almost 1 trillion euros through the purchase of asset backed securities and covered bonds.  

The key points of criticism in relation to this plan are that the European market for securitisations is remarkably small when compare with that of the US. In addition to this, the ECB already has cold feet over whether or not it would be willing to purchase the riskier and lower rated types of ABS that are available.

This reluctance effectively castrates the central bank’s rescue plan as it does nothing to relieve the balance sheets of Europe’s banks of any real risk. Consequently, the plans are unlikely to result in a notable increase in credit availability within the European economies.

As a result, we continue to expect that the current policy approach will prove to be insufficient and that this will more than likely see the ECB forced to embark upon an outright asset purchase program during the opening stages of 2015, one which is targeted at sovereign debt markets.

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