Be Careful What You Wish For, Europe
12/08/2011 4:28 pm EST
Mario Draghi and the European Central Bank today delivered everything that financial markets could have reasonably hoped for—and still financial markets tumbled.
The German Dax Index finished the day down 2%, and the S&P 500 was down 1.5% as of 3:30 p.m. New York time.
I think that the market action amounts to a great, big vote of no confidence in European political leaders, who have just begun a summit meeting that wraps up on Friday.
At today’s meeting in Frankfurt, the European Central Bank cut its benchmark interest rate by 0.25 percentage points to 1%, extended the term of its credit facility for banks to three years from the current one-year term, and loosened its standards on the kinds of collateral that it will accept from banks.
That’s pretty much the entire wish list that investors were looking for from the bank. (Anybody who thinks the bank was going to cut rates to 0.75% is delusional, I think. Even at the worst of the 2008 global financial crisis, the European Central Bank never went below 1%. This isn’t the Fed, you know.)
If you want to see why the bank moved so forcefully, just take a look at the revised projections for Eurozone growth the bank’s economists released this morning.
According to the new forecast, growth in the Eurozone economy for 2012 will range between a contraction of 0.4% and expansion of 1%. That’s a serious downgrade from the forecast just three months ago, which said the low bound was expansion of 0.4% (not contraction, but actual growth) and the high bound was expansion of 2.2%.
The bank’s economists left their forecast for 2011 growth essentially unchanged, going from projections of 1.4% to 1.8% growth to projections of 1.5% to 1.7% growth.
Politically, what’s most interesting about the bank’s decision to go for a rate cut, looser collateral, and a three-year term is the implication that the economic situation has deteriorated enough to worry even some of the inflation hawks at the bank.
Until very recently, those inflation hawks—the German, Austrian, Finnish, and Dutch contingent at the bank—were arguing that the bank needed to do less, because inflation in the Eurozone was running at a 3% annual rate, well above the bank’s target of near but below 2%.
I’m sure those voices were still heard at today’s meeting, but the danger that the Eurozone will slip into actual recession in 2012 has muted their opposition—for the moment.
The new economic projections might produce a similar sense of urgency at the Euro summit, due to end tomorrow with, everyone hopes, a plan to end the euro crisis.
But the financial markets sure don’t seem convinced. And with good reason, beyond the dismal record at crisis solving that Eurozone leaders have established.
Yesterday, for example, was filled with what seemed to be hardening of positions, with the Germans insisting on comprehensive treaty change, and the French warning that the Eurozone didn’t have time to go down that route.
German officials, for example, went out of their way to criticize a suggestion by European Council president Herman Van Rompuy that tighter fiscal discipline could be enforced without treaty change. An unnamed but senior German official disdainfully told the Financial Times that “A number of actors have not understood the seriousness of the situation.”
There’s hope that yesterday’s verbiage was just the usual posturing at the beginning of negotiations and that the Eurozone’s political leaders will have read the forecasts from the economists at the European Central Bank.
But even if it was, the summit faces a huge challenge. Not only do Eurozone leaders have to come up with some plan to move the Eurozone countries toward closer fiscal integration over the next 12 to 24 months, but they have put forward a credible plan for bridging the gap between the current crisis and that long-term solution.
What the markets fear most today, in my opinion, is that once again the Eurozone leaders will come up with their own version of a bridge to nowhere.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of September, see the fund’s portfolio here.