Europe is once again in the news as a cause of fear in the financial markets. This time it’s not due to Greece or any of the Club Med countries but more due to the EU economy and the Euro as a whole.
The value of the euro fell to its lowest level in years this week, hitting $1.19 a 15% fall from May and the lowest level since 2005, In response European stocks fell sharply amid uneasiness about whether the region is on the verge of a new economic and financial crisis.
Stock markets were already under pressure from falling oil stocks as Brent crude hit a 5-year low, interpreted by many as a sign that global demand has collapsed resulting in a glut of oil driving prices down. The markets are betting on the European Central Bank (ECB) introducing sovereign and corporate debt purchases at their next meeting on January 22, a form of “Quantitative Easing.”
Indeed, in the New York Times Jean Pisani-Ferry, an economist who serves as a policy adviser to the French government, is quoted as saying the markets have already priced in the introduction of QE and if the ECB fail to act, the consequences could be dire.
“Disappointing those expectations would bring an abrupt and damaging unwinding of positions: Long-term interest rates would rise, stock markets would sink, and the exchange rate would appreciate,” he wrote.
Yet dire as Europe’s ongoing position seems to be – slowing growth, a falling Euro and weakening export markets, particularly to Asia and petro dollar markets – there is much to be positive about, too. The oil price has collapsed but it is more from deliberate overproduction than from a collapse in demand.
For a region that is a net importer of oil and natural gas that is a positive development. Pump prices have already fallen 9% in Germany with the resulting windfall allowing consumers to spend more in other areas. True, the weak Euro will negate some of that benefit as oil is usually priced in dollars and so the falling price will be partially offset by the EU having to pay more for imported oil and natural gas in Euros than at the corresponding exchange rate 6 months ago, but on balance it is still a net benefit.
The falling currency will have two benefits. First, it will make European exports more competitive, even in a cooling global economy international trade continues and a lower currency will be a boost to European companies competing with US, UK or Asian competitors. The other benefit is it will increase inflationary pressures as imports become more expensive in Euro terms. It seem strange, suggesting a rise in inflation could be beneficial but in Europe they are on the verge of deflation with consumer prices falling to a rate of just 0.1% in December prompting real fears of a deflationary spiral. Policy makers are desperate to boost inflation, particularly in wages, to allow consumption to recover.
It is to be hoped the combination of weak currency and falling oil prices provides the boost the region needs because expectations of the ECB introducing QE this month may be misplaced. Germany is set against it fearing they will have to pick up the tab for default or eventual losses. They are more likely to want to see how the combination of currency and energy prices translates into growth before agreeing to a program of QE, possibly in March. Meanwhile, not to be forgotten, Greece has elected a left wing anti-austerity party in recent elections, creating a potentially explosive tinderbox to ensure the tiny state remains on investors’ radar in the first quarter.