The ECB and the Germans
The initial German reaction to the rate cut was muted, as we reported on Friday morning. We were particularly surprised by Bild, which appeared to endorse the decision. But the reactions have since become fiercer when it became clear that both Jens Weidmann and Jorg Asmussen had opposed the rate cut – plus four other central bankers. The FT quotes another anonymous central banker as saying that the German opposition could become a problem for the difficult decisions has yet to make. The ECB was losing trust in Germany. The article says there were also signs of a growing anti-Italian sentiment in German policy circles, quoting a vicious attack by Wirtschaftswoche, which says that the eurozone was now run by the Bank of Italy. Hans Werner Sinn is quoted as saying: “Draghi abused the euro system by giving cheap loans to the southern countries, of the kind that they would not get on the capital market.”
Roger Bootle writes in the Daily Telegraph that there is a chance of outright deflation in the eurozone. He is pointing to number of recent data, wage growth, fall in producer price, exchange rate trends. If in addition, the eurozone imports deflation through falling commodity prices, the descent into deflation would come sooner. He expresses doubt whether the ECB would indeed be able to deploy whatever it takes to fight deflation, given the split on the governing council. And as we know from Japan, a hesitant central bank becomes part of the problem. The only way out for the eurozone crisis is higher inflation. But Germany will not agree to this. The risk of default and euro exit is thus still present.
In his FT column, Wolfgang Munchau writes that the only surprise about last week’s rate cut was that so few people expected it. By Mario Draghi’s own admission, the ECB is now expecting to miss its medium-term inflation target for the first time. Munchau says the ECB has all the tools available to fight deflation, though without the support of appropriate fiscal policies, the instruments would have to become progressively extreme. He does, however, not think that outright deflation is likely, but he sees a longish period of extremely low inflation, and low nominal GDP growth. The consequence of that is that governments will switch to run large and persistent primary surpluses to contain the debt, which in turn will act as a break on demand.