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Central Bankers fear low incomes & high political volatility

Central Banks are not convinced the European economy is out in the clear, mostly because political risk overshadows strong economic fundamentals.

Sweden and the Eurozone

On Thursday, both Frankfurt and Stockholm held their policy steady on crisis mode. The European Central Bank kept the deposit interest rates at -0,4%, while Sweden’s Riksbank in the unconventional -0,5%.

Both Central Banks will also continue their bond-buying programme. The Eurozone’s Governing Council is stepping on a break, going from buying €80bn worth of government and corporate bonds a month to €60bn; Sweden holds steady with a monthly purchase of SEK 15bn (€1,56bn).

Political risk

The economists of both Central Banks are projecting present rate levels for an extended period, with Sweden explicitly citing political uncertainty in the rest of the world. In the short run, the most significant political risk factor remains the outcome of the French elections. In the medium turn, there is an ongoing political crisis in Italy and Greece. And that is without even spelling the word “Brexit.”

Italy’s banking system is overloaded by non-performing loans, stagnant growth, double-digit unemployment, and a government that cannot count on its parliamentary majority, while the anti-Euro opposition is surging in the polls. Greece and its creditors have yet to reach an agreement to release the next tranche of its third €86bn bailout programme, while the government needs to service a bond payment due in July.

Economic fundamentals

Fundamentally, Europe’s economic rebound is robust.

On Thursday, the European Commission published a report suggesting that both consumer confidence and business climate are in their best shape in over a decade.

The Eurozone’s economy has surged by 0,4% in the first three months of 2017 and business confidence in Germany – the Eurozone’s biggest economy – is buoyant. The German government on Wednesday raised its 2017 growth forecast to 1,5% (from 1,4%), which should be bolstered by domestic demand, as consumption and purchasing power are expected to surge by at least 1,4% within 2017.

That is good news as the enormous German trade surplus that is destabilising the Eurozone may begin to deflate. What remains weak in the Eurozone is purchasing power, as income is not catching up even in conditions of full employment. Inflation still averages 1,6% in the Eurozone and 1,3% in Sweden, that is, below the 2% target. And that inflation is surging more by external factors – such as the surge in oil prices and the dollar – rather than demand.

Pressure to normalise

Meanwhile, in Sweden, interest rate policy is feeding a real estate bubble, which must in time be addressed. The problem is not unknown to the Eurozone, including Austria, Belgium, Finland, Luxembourg, and the Netherlands. And that is not the only problem that comes hand-in-hand with negative interest rates. Fixed income funds that invest in bonds, like pension and insurance companies, are squeezed, not to mention the sincere rage of individual German pensioners.

If political circumstances allow, the EU’s economies could begin to “normalise” central banking policy by the first quarter of 2018. By that time, France and Germany will have a new government with a fresh mandate and will be able to address fundamental structural dilemmas… it is hoped. Raise interest rates too fast, and you lose Italy. Raise them too slow and deal with Europe’s creditor nations.

First Published by New Europe: