ECB's Draghi cuts again - Economics weekly

ECB's Draghi cuts again - Economics weekly

Over the last two and a half years the European Central Bank (ECB) has introduced all sorts of new policies to pull Europe’s economy out of its tailspin.

But last week it was back to basics. For the fourth time since he became ECB president, Mario Draghi cut the main interest rate. Getting the European economy to grow hasn’t got any easier.

The European Central Bank cuts interest rates...

The European Central Bank (ECB) cut its main rate by 0.25% to a record-low of 0.5% at its May meeting. While expectations of a rate cut gained strength in recent weeks, the vast majority of forecasters were not betting on it just two months ago.

But this week we learned that inflation dropped to 1.2% in April and unemployment edged up to a new euro-era high of 12.1%. Previous efforts from the ECB have been focused on helping out peripheral economies, but this rate cut was aimed squarely at relieving recession in the core.

…as well as trying to boost bank lending

ECB president Draghi cited low bank lending as a headwind to the European recovery and announced new policies in response. First, the current measures to provide euro area banks with funding will last at least until summer 2014. Second, the ECB will work closely with other European institutions to stimulate the market for lending to small and medium-sized enterprises (SME).

That will involve bundling together SME loans and selling them to investors, so-called asset backed securities. These measures won’t jump-start a recovery on their own, but they could remove an obstacle to future growth.

Is Funding for Lending working?

Mortgage approval rates rebounded in March, after falling for the first two months of the year. The number of mortgages approved for house purchase was up 3% m/m to 53,504, and for Q1 as a whole, up just over 1% on a year ago. The Bank of England’s Funding for Lending Scheme (FLS) seems to be feeding through to households, but its impact on business lending is less clear cut.

Borrowing by the UK corporate sector fell by £0.8bn in March, taking balances 19% lower than their 2008 peak.Outstanding loans dropped by 0.8% in the first quarter of 2013 which marks the 16th consecutive quarter of contraction in net borrowing. Demand for lending will remain subdued so long as the economic outlook continues to be challenging.

UK plc makes encouraging start to second quarter

Growth in the service sector hit an eight-month high, while the manufacturing and construction sectors showed signs of stabilisation, according to a leading survey of business activity. The purchasing managers' index (PMI) for services rose to 52.9 from 52.4 in March, and has increased in each month so far in 2013 (a reading above 50 indicates growth).

The survey suggested that the rise in new orders had taken some of the pressure off margins: profitability fell again, but at a slower rate. The manufacturing PMI edged up to 49.8 in April, from 48.6 in March. Companies benefitted from an increase in new export orders from just about everywhere - apart from the Eurozone. The construction PMI showed a large improvement in April but, at 49.4, pointed to a sixth successive monthly contraction. Civil engineering projects decreased markedly, while housing activity hit a 12-month high.

US labour market back on track

A month ago the US looked to be having a minor wobble, just as the automatic government spending cuts were being introduced and earlier tax hikes were starting to bite. But just 30 days later that wobble has been erased from history. The US economy added 165K jobs in April pushing the unemployment rate down to a four-year low of 7.5%.

Good news, but even stronger was the fact that jobs estimates for February and March were revised up by a total of 114k. That keeps job creation running at about two million positions a year and inspired celebration in the markets; the S&P 500 share index rose above 1,600 for the first time ever on the news.

US Fed happy to wait for recovery to strengthen

May’s meeting of the Federal Open Market Committee (FOMC) ended in no change to its quantitative easing purchases, or assessment of the economy. That decision was taken before the strong labour market data were released, but the committee has been cautious of reading too much into one indicator. Indeed, according to its purchasing managers, the rate of US expansion cooled a little in April.

The ISM index for the services industry fell 1.3 points to 53.1, while manufacturers reported a decline of 0.6 points to 50.7. In both cases, the growth of export orders weakened as did the jobs indicator. Interestingly, neither report mentioned that tighter fiscal policy has had any direct effects on firms. The Fed’s stated willingness to flex the pace of QE in response to a changing economy seems prudent.



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