After the new interest rates decided by the European Central Bank (ECB) – 0.25%, in line with expectations – we are approaching the threshold where the inherent risks of the monetary weapon will intensify. As in the period before the Great Recession, the impact of adjustments appears benign in the early stages of a tightening cycle, but they accelerate later with the appearance of an episode of financial instability. Of course, money managers are aware of this “non-linearity”, however it is…
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After the new interest rates decided by the European Central Bank (ECB) – 0.25%, in line with expectations – we are approaching the threshold where the inherent risks of the monetary weapon will intensify. As in the period before the Great Recession, the impact of adjustments appears benign in the early stages of a tightening cycle, but they accelerate later with the appearance of an episode of financial instability. Of course, those responsible for monetary policy are aware of this “non-linearity”, although in the case of the ECB the semi-exclusive objective of eliminating inflation in the short term complicates the task.
The main argument put forward to support the turning of the screw is that inflation has persisted: despite lower energy prices, core inflation is still high. On the other hand, the European economy – particularly the Spanish economy – is performing better than expected despite rising interest rates, with a brief but positive growth of 0.1% in the first quarter. The extraordinary resilience of the labor market acts as a buffer against loss of purchasing power, while mitigating the default risk of indebted households. However, private debt levels are much lower than seen before the Great Recession. In Spain, households were able to reduce their liabilities by more than a third in relation to their disposable income. In the case of non-financial corporations, the cut reaches 40%, a result of an unending deleveraging process.
According to this view, the succession of failures of regional banks in the US and the collapse of Credit Suisse in Europe can be interpreted as a single episode with a specific impact given the impossibility and traction under the regulatory umbrella prevailing in the Eurozone. Economy. While the hawks have agreed to ease the rate of interest rate adjustment, they have also secured an important decision for Spain: the end of the summer of reinvestment of all maturing government bonds by the ECB. It is like an order sent to the states so that they lend their shoulders in the fight against inflation and correct their budgetary imbalances. From July, all the loans written off at the central bank must be placed in the market, in addition to the already anticipated financing needs according to the deficit and bond maturities in the hands of the private sector.
Facing this scenario of deflating inflation with a soft landing in the economy, there is another less friendly one. First, the economy’s resilience is largely based on the phenomenon of accumulated savings, a factor that is losing strength in light of the decline in household consumption recorded in the last two quarters. A similar trend followed in the euro area, according to poor retail sales data (-1.2% in March). Wages continue to lose purchasing power, while financial costs skyrocket. On the other hand, past experience has shown that inflation responds late to monetary tightening, so it is not easy for the ECB to calibrate its policy. It can pass if the underlying trend is already converging towards the target.
As for the immunity of the European Financial System, the supervisor itself recognizes vulnerabilities such as its regulations and potential interactions between entities operating under shadow banking. Another focus of attention concerns latent losses created by depreciation of assets acquired at a fixed rate. All this without taking into account the impact of financial stress on isolation at the end. A quick withdrawal of both price stability and sustained growth is a devilish dilemma.
The manufacturing output index registered a 2.6% monthly growth in March. However, given the weakness at the start of the year, the index showed stagnation for the overall quarter. In terms of outlook, the manufacturing purchasing managers’ PMI indicator for April fell below the 50 level, pointing to a contraction in activity – albeit to a lesser extent than in other major European economies. Likewise, production capacity utilization is expected to decline in the second quarter.
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