European Central Bank: Risks, risks everywhere

Mario Draghi, the European Central Bank President did his best to sound positive in his press conference following the bank's policy announcement but economic reality kept intruding.  

His cheerful attitude gave the euro an initial boost pushing it up more than a figure against the dollar to 1.1381. But the substance of his presentation and the bank's assessment in which risks have “moved to the down side" brought the euro low, dropping it to a six week trough at 1.1289 before recovering to just over 1.1300 in New York afternoon trading.

The new caution came just six weeks after the ECB ended the last element of its financial crises supports, the bond purchase program that the bank began in 2015 to fight deflation and kept running longer than any other central bank.  The Federal Reserve’s asset purchase programs, knows as quantitative easing or QE ended in October 2014.

Initially the ECB bought only sovereign bonds of the various nations in the European Monetary Union, up to 33% of the outstanding stock. But three years ago the governors decided to include corporate issues, partially because they were running out of eligible national debt.

Although the ECB has ended bond purchases it will continue, Mr. Draghi said, to roll-over existing bonds which will keep the bank’s balance sheet expansive but prevent the implied rate tightening by withdrawing the roll-over purchases.

The ECB’s concerns come as European economies are showing increasing signs of distress.  The Markit manufacturing purchasing managers’ index, a measure of business sentiment and activity, fell to 50.5 in January and the services sector came in at 50.7, both just above the 50 division between expansion and contraction. 

Eurozone annual industrial production fell to -3.3% in November from 1.2% the prior month and is expected to have fallen further in December. The Economic Sentiment Index from the EU’s Directorate General for Economic and Financial Affairs has slipped from 115.20 in December 2017 to 107.3 a year later. The industrial sentiment index has declined from 9.7 in January to 1.1 in December.

Chart: FXStreet

In Germany the Union’s largest economy the Ifo business climate index was at 101.0 in December its lowest in two years. The Markit manufacturing PMI index registered 49.9 in January far short of the 51.3 expectation and the 51.5 December reading.

Euro zone growth over the year dropped to 1.6% in the third quarter its lowest level in four years. It is forecast to have fallen further to 1.2% in the fourth quarter. The preliminary figures will be released on January 31^st.

The worsening domestic conditions come against a raft of global economic tensions that are lowering sentiment and darkening the economic outlook around the world.

Specific to the EU is the unresolved dilemma of the British exit from the EU.  Although the possibility of an extension of the March 29^th departure date is becoming increasing likely, the relief will be transitory. Uncertainty over the final outcome will continue to plague economic and business planning and to cloud consumer and industry sentiment.

The US-China trade dispute, in temporary abeyance through the truce called between Presidents’ Trump and Xi which expires at the end of March, has the potential to either cause problems for Europe or support its weak economy.

If the parties do not come to an agreement and the trade argument escalates the impact will be global, particularly on business sentiment.  If Washington and Beijing can find mutual terms the boost to the world economy and outlook will go a long way to easing the ECB’s purely European concerns.

Perhaps Mr. Draghi’s good cheer was because the economic outcome is largely out of his hands. Or maybe it is because his tenure is up in October.