ECB battles demons as growth slows

The building of the European Central Bank (ECB) and a Euro-sculpture are seen in the western town of Frankfurt/Main, Germany. The ECB governing council meets March 7, 2013 to discuss interest rates in face of rising unemployment and falling inflation.

Story highlights

  • ECB unemployment rate hit 11.9% in January; youth rate even higher
  • Growing joblessness means less spending and falling inflation
  • ECB's governing council to meet Thursday to discuss interest rates
  • ECB expected to keep main refinancing rate on hold at 0.75% for ninth month in row

Since this time a year ago, another 1.9m people, equivalent to more than half the working-age population of Finland, have joined the already record-breaking unemployment queues in the eurozone.

The joblessness rate across the 17-nation bloc hit 11.9 per cent in January, an average that glosses over Spain's 26.2 per cent rate, more than five times that of Germany. Among the young, the statistics are even worse. If you are Spanish, under 25 and employed, you are in a minority. In Italy, close to 39 per cent of under-25s are jobless.

The economy is shrinking rather than growing and all these people without work are naturally spending less, so inflation is falling. Banks, at least in crisis-hit countries, are not on the whole lending to businesses and businesses are not investing.

All of which might sound like a list of symptoms demanding central bank action in the form of an interest rate cut or other measures to stimulate the economy.

When the 23 policy makers who form the European Central Bank's governing council sit down on Thursday morning to discuss interest rates, they will also look through the latest economic projections from the ECB's own staff.

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The last set of these, released in December, predicted that the eurozone would contract by 0.3 per cent this year and that inflation would slow to 1.6 per cent this year and 1.4 per cent in 2014. Anything other than a further downward revision of those forecasts would be a surprise.

And yet, the widely held expectation among ECB watchers and the tone of recent comments by its policy makers suggests that the bank will keep its main refinancing rate on hold at 0.75 per cent for the ninth consecutive month.

Unlike the US Federal Reserve, the ECB has no formal role in managing unemployment. Its one purpose in life is to guarantee price stability by keeping inflation "close to, but below" 2 per cent over a deliberately unspecified medium term.

So, job done then? Not quite. As the bank illustrates in an educational cartoon it made for schoolchildren, its aim is to keep both the blue inflation monster and the brown deflation monster safely restrained in small glass jars in its headquarters in downtown Frankfurt. With inflation at 1.8 per cent in February, the deflation monster is still clearly in its jar, but the downward trend, likely to be further exacerbated by the relative strength of the euro, could be used as an argument for further easing.

Instead, Mario Draghi, ECB president, and other board members have repeatedly stressed that the bank's stance is already "accommodative". (Too much so, would be the retort of some policy makers in Germany, where unemployment is low, the housing market is buoyant and growth is expected to return this quarter.)

A further argument against a cut is that it might not make much difference in the places it is needed most, given the financial fragmentation still besetting the bloc that makes it relatively harder for a Spanish or Italian company to borrow compared to a German one, irrespective of the ECB's rate.

In a speech in Munich a week ago , Mr Draghi chose to spell out some of the limits of ECB action. "We cannot repair unsound budgets. We cannot clean up struggling banks. We cannot solve deep-rooted problems in the structure of Europe's economies," he said.

Having offered banks cheap funding and put in place a bond-buying programme to prevent the break-up of the euro, ECB officials want to ensure that politicians make good use of the lull in financial market tensions.

The "positive contagion" from calmer financial markets to the real economy that Mr Draghi hoped for in January has yet to materialise, and the ECB chief has been careful to moderate his more optimistic comments with the caveat that risks to the economic outlook remain "on the downside".

What the bank wants is for eurozone governments to keep enforcing budgetary discipline and implementing structural reforms in the hope this will lay the groundwork for sustainable growth.

But as Italy's election has shown, what the people want, and vote for, may be something else.

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