European Economic Recovery? ECB Cuts Interest Rates

The mainstream has been adamantly insisting about a supposed economic recovery in Europe. 

But if true, then why the need for the European Central Bank (ECB) to cut rates?

ECB President Mario Draghi was quoted by the CNBC at last night’s press conference saying that “risks to the outlook remain weighted to the downside”

In addition, Mr. Draghi raised the issue of the risks of deflation to justify such actions.

From Bloomberg

The European Central Bank unexpectedly cut its benchmark interest rate to a record low in a bid to prevent slowing inflation from taking hold in a still-fragile euro-area economy.

With inflation at the weakest level in four years and less than half the ECB’s target, the Frankfurt-based bank halved its key refinancing rate to 0.25 percent in a shift anticipated by just three of 70 economists in a Bloomberg News survey.

“Our monetary-policy stance will remain accommodative for as long as necessary,” ECB President Mario Draghi told reporters in Frankfurt. “We may experience a prolonged period of low inflation…

Euro-area inflation surprisingly deteriorated in October to 0.7 percent, below the ECB’s goal of “close to but below” 2 percent, sparking fears of a deflationary cycle. Unemployment of 12.2 percent is the highest level since the currency bloc was formed in 1999, while the euro’s almost 4 percent rise against its major peers this year is challenging exporters. The ECB will better detail its economic outlook when it releases forecasts next month.

While it is true that the Euro zone’s CPI has been falling which reflects on the declining monetary aggregate M3, that’s only half of the picture.

The other half of what the mainstream doesn’t tell you when discussing central bank policies: Financial markets in the Eurozone has been booming. 

Europe’s crisis stricken economies (Portugal-PSI 20, Spain’s IBEX and the Irish ISEQ) has produced returns of significantly more than 20% over a one year window. Greece’s Athens Index has generated more than 40%!

Even Europe’s blue chip index the Stoxx 50 has strongly risen year-to-date.

And it’s not just stocks…

European sovereign bonds has had a robust performance. The spread of PIGS relative to the German bond has significantly narrowed* after peaking in early 2012.

In other words, the ECB and the mainstream sees TWO different self-contradicting worlds: risks of “deflation” in the economy—based on CPI inflation measures, while alleged “recovery” in the economy based on rising markets.

Or differently put, the mainstream sees financial markets as seemingly irrelevant or unrelated to the real economy unless it serves as convenient alibi to justify rising asset prices.

Yet zero bound rates function as a one size fits all policy that would have different impact on distinct European economies. 

As one would note, bank credit to core Europe has been in the positive (although stagnant) while crisis stricken periphery remains in negative territory*.

Of course, looking at the aggregates can be deceiving. While it may be true that general bank lending has been falling, in breaking down the details we find the Eurozone’s banking system credit to the government has exploded even as credit to the private sector has weakened.

In short, government borrowing has taken the slack from the private sector.

The complex maneuvering by the troika, the ECB, the banking system and the government to keep rates low has resulted to a massive expansion of debt.

The Eurozone’s debt as % to the GDP has been skyrocketing

Yet banks have not been the only source of lending.

 

Europe’s High Yield corporate bond issuance is at record highs*!

Europe’s corporate debt has also been ballooning*.

Corporate debt in core Europe has modestly increased from 2007…

While corporate debt at the periphery has been robust over the same period

Bottom line: Contra policymakers and the mainstream, the risks of deflation remains a popular bogeyman used to justify the “euthanasia of the rentier” via zero bound rates and QE.

While the Eurozone’s banking system remains clogged or the transmission mechanism broken due to impaired balance sheets, substantial credit growth has been taking place at the bond markets.

And credit growth in the bond markets fired up by ECB and government policies has been redistributing resources or has been benefiting the asset markets (via asset inflation) at the expense of the real economy (revealed by CPI disinflation). 

The real intent of the ECB’s rate cut has been to keep interest payments low for the rapidly swelling the Eurozone’s government debts since the Eurozone government’s refusal to reform, France should serve as an example. 

A second unstated goal has been to boost asset markets in order to keep their 'broken' banking system afloat. 

European politicians, bureaucrats and their mainstream lackeys have been pulling a wool over everyone’s eyes.

And it seems that for the first time this year, the unexpected credit easing by a major central bank has hardly been welcomed warmly by the global equity markets. Europe’s markets appear jaded as US stocks fell considerably. Asian markets are down as of this writing.

Has the global financial markets seen ECB’s actions as insufficient? Or has the positive impact on financial markets from credit easing policies reached a tipping point in terms of diminishing returns?

We surely live in interesting times

* charts from the Institute of International Finance November 2013 Capital Markets Monitor and Teleconference