US and Europe

2015 a year of note for the Eurozone?

Saturday January 31, 2015 Hugh Dixon

european union flag

 

Coming into 2015 the 19 nation Eurozone has been experiencing several years of low growth (currently 1.3 percent), high unemployment (currently 11.5 percent) and low annual inflation (currently -0.2 percent).

 

Already in 2015 two events have occurred that may dictate the course of Eurozone for the coming year, if not the next few years.  The first is a large expansion by the European Central Bank (ECB) of its bond buying program, and the second is the Greek election which has been won by the anti-austerity Syriza party.

 

Fearing that the Eurozone may end up in experiencing a prolonged period of deflation, the ECB has announced a large scale expansion of its bond purchasing programs to make loans and exports cheaper, to encourage businesses to hire and expand.  Given the weak growth currently occurring in the Eurozone, allowing the Eurozone to continue with deflation could paralyse the Eurozone and severely limit the potential for future economic growth, an issue that has plagued Japan for the last two decades. 

 

In March this year the ECB will start its new single large scale bond purchasing program that will purchase €60 billion a month from Eurozone governments, banks and financial institutions.  The program is intended to last until September 2016 or until inflation rates for the Eurozone close in on the ECB’s two percent target.  In total €1.1 trillion may be spent by the ECB in order to rejuvenate the Eurozone economy.

 

The bond purchasing program will help to ease monetary and financial conditions in the Eurozone, making access to finance cheaper for both businesses and households.  Cheaper finance usually leads to higher levels of investment and consumption occurring within an economy and could contribute to returning the Eurozone inflation rate to around two percent.

 

Banks are the main source of credit and financing for Eurozone businesses and will get a much needed cash injection from the bond purchasing program. However, any economic growth coming from this cash injection will depend on businesses deciding to borrow off the banks in order to expand.

 

The main danger with the ECB bond purchasing program is that it may encourage Eurozone Governments to use the program as a rationale to increase their spending and create new Government debt.  This could impact harshly on the Eurozone given it is still trying to work its way through the last Government debt crisis involving Greece, Portugal, Spain, Italy and Ireland. 

 

The second main event is the Greek election which has been won by the anti-austerity Syriza party.  The Syriza party campaigned on renegotiating the bailout deal agreed in 2010 and cancelling austerity measures introduced in 2010 as part of the bailout deal with the ECB, the European Union and the International Monetary Fund (IMF).

 

The bailout deal provided Greece with €240 billion, allowing Greece to meet its debt and government funding commitments, in exchange for Greece cutting its government spending, increasing taxes and increasing deregulation of Greece’s goods, labour, energy and service markets, to allow more competition and therefore more efficient use of Greece’s resources.

     

The actions by the new Syriza controlled Greek Government in terms of policy and the reaction from the ECB, the European Union and the IMF will be closely watched by investors and other anti-austerity parties in other countries affected by austerity measures introduced to lowered Government debt.

 

What happens next will depend largely on the willingness of the European Union, the ECB and the IMF to renegotiate the bailout, or their willingness to force Greece into an uncontrolled default and possible expulsion from the Eurozone.

 

As a result of these two events, by the end of 2015, the Eurozone maybe safely on its way to a strong economic recovery or on its way back into the midst of an economic recession, only time will tell.