The European Central Bank has refused to take any further measures to lift the eurozone out of recession and curb rising unemployment, counting on spontaneous recovery later this year to do the job.
Mario Draghi, the ECB’s president, said the wild moves in currencies and global stock markets over the past two weeks do not change the fundamental picture, though the bank has downgraded its economic forecasts and expects a deeper contraction of 0.6pc this year. “It is not enough to justify immediate action,” he said.
“The ECB seems to have given up. It is as if they have decided that there is not much more they can do and will simply allow events to run their course,” said David Owen from Jefferies Fixed Income.
The Governing Council held interest rates steady at 0.5pc, and discussed a range of measures to alleviate the credit crunch across Southern Europe and boost lending to small business, without reaching any conclusion. “People don’t have definitive ideas yet,” said Mr Draghi.
The hawkish stance rattled European stock markets, with Italy’s MIB index off 2.6pc, the FTSE 100 down 1.3pc and Germany’s DAX off 1.2pc. Yields on 10-year Spanish bond jumped 24 basis points to 4.67pc, with spreads over German Bunds once again well above 3pc.
Mr Draghi said ECB policy “remains accommodative” but the eurozone is still stuck in its seventh consecutive quarter of economic contraction, with unemployment rising to a record 12.2pc. The youth jobless rate is above 40pc in Italy, Spain, Portugal and Greece.
The US Federal Reserve is pursuing a radically different strategy, targeting an unemployment rate of 6.5pc through calibrated bond purchases.
“What worries us is that the eurozone is moving ever closer to a Japanese deflation trap where animal spirits die and trend growth falls. It is something that a central bank should avoid at all costs,” said Mr Owen.
“Greece, Spain and Cyprus are already in deflation if you strip out tax rises, and Portugal will be soon, and that makes it even harder to stop the debt burden rising. The ECB should have launched quantitative easing a long time ago,” he added.
Eurozone core inflation has fallen to a post-EMU low of 0.6pc once adjusted for austerity levies, one shock away from outright deflation that could prove hard to reverse.
“The eurozone is already in a Japan-trap,” said Lars Christensen from Danske Bank. “What we are seeing in the money supply data and falling monetary velocity is exactly what happened in Japan in the 1990s, yet the ECB seems to think everything is fine.”
Mr Draghi said there is no sign of systemic deflation across a wide range of commodities and all sectors. “We don’t see it,” he said.
The German bank Berenberg said Mr Draghi is constrained from taking any action before a crucial decision next week by Germany’s constitutional court on the legality of the ECB’s rescue policies, including its pledge to back-stop the Italian and Spanish debt markets, known as Outright Monetary Transactions (OMT).
“This is now the most important risk to watch in the eurozone,” said Holger Schmeiding, the bank’s Europe economist. “We cannot fully rule out an awkward verdict in which the court may, for instance, attach conditions to any Bundesbank/German participation in ECB actions.”
While the court does not have jurisdiction over the ECB, the OMT would die instantly if judges ruled that Germany may not take part. This would knock away the central prop of EMU crisis strategy over the past year, leaving Italy and Spain once again at the mercy of skittish markets.
Bundesbank chief Jens Weidmann told the court last December that the debt pledge entails huge risks, breaches ECB independence, and violates fundamental principles. “It is not the duty of the ECB to rescue states in crisis,” he wrote, adding that the ECB has no mandate to uphold the “current composition of monetary union”.
Mr Draghi said yesterday that the OMT had been the “most successful monetary policy in recent times”, citing equity rallies and a reversal of capital flight from southern Europe. German exposure to crisis countries through the ECB’s internal Target2 payments system has fallen by ?160bn. “It brought stability to markets worldwide,” he said.
Marc Ostwald from Monument Securities said Mr Draghi’s hands are tied. He is being forced to bluff because he cannot secure backing for further stimulus from the Bundesbank or a bloc of northern hawks. “There is complete disagreement on the ECB council. Draghi’s policy of 'jawboning’ markets with platitudes is dead in the water,” he said.