Mario Draghi famously promised to “do whatever it takes” to save the euro. Although the European Central Bank president has averted the currency’s collapse, the massive bond buying that the ECB has embarked upon won’t be enough to jump-start the euro zone economy, predicts Karen Ward, chief European economist at HSBC Holdings.
In December Draghi announced that the ECB would extend its quantitative easing program until at least March 2017. And last month he boosted the rate of purchases by a third, to €80 billion ($91 billion) a month, and said the central bank would buy nonfinancial corporate debt as well as government paper. But without fiscal stimulus from countries like Germany that can afford it and structural reform in countries like France that need it, the 19-nation euro area will remain stuck in slow-growth mode, Ward says.
“I’m relatively new in this world,” says London-based Ward, 35, who took up her current post in December after spending five years as the bank’s senior global economist, devoting much of her time to studying China. Although she is new to the territory, her subdued forecast for the European economy echoes a 2011 HSBC report she wrote called “The World in 2050,” which contended that the economic center of gravity was shifting toward emerging markets. Those countries “are going to power global growth over the next four decades,” she wrote, citing their growing populations, particularly in Africa, and greater attention to improving fundamentals such as per capita income, rule of law and education levels. In a sign that developing economies are bouncing back from their recent slump, the MSCI Emerging Markets index has gained 9.07 percent this year through April 1.
Ward, who holds a master’s in economics from University College London, joined HSBC as its U.K. economist in 2006 after having worked at the Bank of England, where she provided supporting analysis for the Monetary Policy Committee. She spoke recently with Institutional Investor Assistant Editor Jen Werner about the euro zone’s prospects.
What is the biggest challenge that the European economy faces?
A lack of inflation. That is the main story. Although there are some domestic drivers of growth through consumption and government spending, external demand remains weak. We’re still looking for growth in the region of 1.5 percent, which just isn’t fast enough, given the depth and length of the recession, and so the economy isn’t generating enough inflation.
I think this is one of the main things that we’ve been trying to point out to our institutional clients. We’re still a little bit too focused on real numbers such as real GDP, but in fact what investors care about are nominal things such as profits. Things are really weak when you look at nominal GDP, and so the underlying problems in the economy aren’t going away. Whether that’s a question of government debt sustainability in the euro zone or income inequality, it’s just not a rapid enough pace of growth to really address those big problems that have haunted European markets for some years.
How can Europe reinvigorate its economy?
We’ve seen a big improvement in real disposable income for households, and on the whole they went out and spent it. So we saw a solid pace of consumption last year, and that should follow through into this year as well. That’s one of the engines of growth.
The other engine of growth is government spending. I know there’s a lot of cynicism that monetary policy and quantitative easing haven’t done much, but I would disagree. The main area where they have worked in the euro zone, particularly over the past six to nine months, is the impact they are having on government spending.
These supports will ensure that the economy keeps muddling through, but to really reinvigorate and provide sustainable growth we need more structural reform. For example, France is stuck in a rut with firms not employing because they’re too worried about the economic outlook, and then households are worried about job prospects and so are not increasing spending. Reforms to the labor market might break this impasse, but there is simply too much opposition.
Is any country or politician in a position to drive structural reform?
Germany! During the whole European crisis, everyone’s been looking to Germany, saying, “Come on, you’ve got the capacity to drive growth.” Usually, we’re talking about the fiscal capacity that Germany has, because the recovery has been stronger there, which has translated into much higher tax receipts, and the government debt level is comparatively low. Moreover, the sovereign markets are crying out for the German government to take their money. Yet Germany remains focused on its balanced budget.
There’s been an extra 1 million people arriving in Germany, which has been an enormous increase in cost for the government, but the Finance minister is still focused on balancing the books. German fiscal prudence has therefore been a source of frustration for the rest of the region, which you can glean from the minutes to the December ECB meeting.
How have politics been affecting economic issues in Europe?
Everywhere, we’ve seen a sort of electorate discontent, which has manifested itself in support for a whole range of different parties. It’s not far right; it’s not far left. It’s an alternative to the mainstream that people are going to, and that shows the broad desire for change. There needs to be some really difficult structural reform. But ultimately, as [European Commission President] Jean-Claude Juncker once said, “We know what we have to do; we just don’t know how to get reelected after we’ve done it.” That’s the political challenge in Europe.
It really stems from the sense of entitlement that we have in Europe — whether that’s being paid for a considerable period of time after we’ve been made unemployed or being able to retire at 60 and have decades of retirement benefits. These just aren’t realistic in today’s aging societies with global competition.
So even though the recovery is ongoing, we just aren’t seeing the underlying fixes to the structural problems in Europe that can really make you confident that Europe is on the right track. Debt sustainability and income inequality, and what that means for the political environment, aren’t going away, regardless of the modest recovery.
And so Mario Draghi has engineered a very precarious calm. On the surface, it all looks like it’s going in the right direction, and the data looks okay, but we’re facing a summer where we’ve got the question of the U.K. referendum, potentially new elections in Spain, Greece trying to meet the conditions of last summer’s bailout and the ongoing migrant crisis.
I’m worried that the markets have euro zone politics fatigue and have become complacent about some of these issues. As we saw last summer, they tend to flare up very quickly and reach people’s attention but then recede again.
What is your outlook for the European economy?
There are some reasons to be fairly optimistic. The first is that the big fall in oil prices over the course of the past few years has really helped the euro zone consumer. The euro zone is a big importer of energy.
But one of the big questions is how much resilience we have regarding domestic demand. Some people think that there’s been such a lack of business investment, and that the capital stock is so aged, that businesses will be forced to expand. If you have that, you could be looking at a pretty robust European recovery. Personally, I think we need to have a much stronger global backdrop for that. I think the recovery is going to remain pretty modest, particularly lacking inflation.
It will also be important to see if the new package of measures that Mario Draghi gave us in March can really improve terms and conditions in order to spur new lending to small and medium-size companies. The broader question of whether the ECB has done enough and whether Draghi alone has what it takes to fix the euro zone — well, I think the jury is still out. He’s certainly doing everything he possibly can, but he needs the politicians to get behind him, and at the moment they are perhaps not helping as much as they could.
