Economics Weekly - The time is now

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Economics Weekly - The time is now

Faced with high unemployment, very low inflation and faltering growth momentum, the ECB has decided to act.

Economic Analysis

08 September 2014

ECB decides now is the time for action

The European Central Bank cut its main interest rate from 0.15% to 0.05% last week. The cut from next to nothing to virtually nothing won't do much to stimulate the economy, but its quasi-quantitative easing programme is much more ambitious. The ECB plans to buy Asset Backed Securities (ABS), in much the same way as the Fed did as part of its latest round of QE in the US. ABS are bundles of loans that are typically sold by banks to investors. The most common loans to get bundled up are mortgages, but corporate debt is also securitised in this way.


The ECB hopes that by stimulating the ABS market it can encourage banks to issue more, and to lend more to households and businesses in the Eurozone. The ECB is also trying to boost lending by buying instruments called covered bonds, which banks use to raise funding. All very technical, but will it work? Probably not in the short run. Banks still have to negotiate the stress tests and associated investigations that the European Banking Authority is conducting. The ECB’s new policies may help some banks raise capital and funding faster than they otherwise would have, but they are less likely to prompt a big shift in attitudes to risk amongst Eurozone banks.


ECB President Draghi noted that the "growth recovery was losing momentum." The latest Purchasing Managers' Indices (PMI) lend weight to his argument. The composite reading for the Eurozone, covering both manufacturing and services, fell to 52.5 in August, the lowest level this year. Germany's reading is the lowest since last October while Italy's has gone back below 50, suggesting it is struggling to emerge from recession. France’s figures point to a stagnating economy, echoing the latest GDP data. The ECB will be hoping its policies can reverse this loss of momentum.


UK households are increasing their borrowings, but firms are not. This has been the message from the Bank of England's statistics all year. And so again in July, with household borrowings up 2.1%y/y. Two thirds of this rise was due to mortgages, the remainder was personal loans and credit cards. The story for firms is very different. Despite continued support from the Funding for Lending Scheme, there was no growth in lending to non-financial companies overall, despite increases in sectors like agriculture and manufacturing. But the winding down of borrowing was seen most in the financial sector. Financial intermediaries, insurance companies and pension funds' debts were more than 20% down on July 2013.


Help to Buy's shared equity loans and mortgage guarantee scheme have accounted for 6% of house purchases since April 2013, with two thirds of these happening outside of London and the South East. Figures released by the Treasury showed that although the South East itself had the highest number of Help to Buy purchases, the scheme is being used most intensively in the North East, where it has accounted for 12% of transactions. The scheme also looks like it (and the wider economic recovery) are helping housebuilding. The number of housing starts in the first half of 2014 was the highest since the first half of 2008.


Last Monday the United States marked Labor Day but fewer people than hoped were able to join in the celebrations. The economy added 142,000 jobs in August and the unemployment rate slipped a notch to 6.1%. But the pace of job creation, which has averaged over 200,000 per month in 2014, was the slowest this year. Wage growth remained modest, at 2.1%y/y. Like the Bank of England, the Fed is looking for signs that slack in the market is being used up quickly. There is little in these numbers to encourage it to think about raising rates soon.


The PMIs give more evidence of a slowing Chinese economy with the manufacturing PMI falling to a level just above the 50-mark. Another sign of weakening Chinese demand is that South Korean exports to China are declining when compared to last year. In contrast, exports to the US are growing at a healthy pace while even shipments to the EU's largest five economies (UK, France, Germany, Italy and Spain) are growing.

“When the facts change, I change my mind. What do you do Sir?”

At the end of this month, the ONS will publish a new record of GDP. This week we saw the changes to the figures up to 2012. What’s changed? The Great Recession was not so great, with a peak to trough fall of 7.2% revised to 6%. The recovery since then has also been stronger, leaving GDP 2.4% higher at the end of 2012 than we previously thought. But some things stay the same, like the UK's unusually poor productivity growth. We await the end of the month for the ONS to bring the story up to date.


This material is published by The Royal Bank of Scotland plc (“RBS”), for information purposes only and should not be regarded as providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution in any jurisdiction in which this would be prohibited. Whilst this information is believed to be reliable, it has not been independently verified by RBS and RBS makes no representation or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of the RBS Economics Department, as of this date and are subject to change without notice.

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