‘Hands-off’ approach by ECB is bewildering

It was not wholly shocking that the ECB left its key interest rate unchanged at its record low level of 1% this week.

There had been some modest expectation that the ECB might move on rates as part of the alleged shift among EU policymakers towards more of a pro-growth strategy following the recent French election.

The ultra-conservative ECB board left rates unchanged and gave little indication that it is on the brink of cutting rates again. It was also somewhat reticent about committing further funding on a three-year basis to the banking system and further bond purchasing.

In the context of recent economic data releases for the eurozone, this very conservative approach is difficult to fathom at one level. The eurozone economy was flat in the first quarter and the influential Purchasing Managers’ Indices of manufacturing and service sector activity in May remained well below the key 50 level at 45.1 and 46.7 respectively.

These indices are leading indicators of future economic activity levels and a reading below 50 signifies that more companies are experiencing a contraction in activity levels rather than an expansion. The unemployment rate for the eurozone stood at an alarmingly high 11% in April.

Whatever way one looks at it, the eurozone economy is in a state of crisis and the incredibly serious and dangerous future of Greece and the escalating banking crisis in Spain are still posing a massive risk to the stability and sustainability of the whole euro project.

The more relaxed market assessment of the risks this week do not appear justified, but they reflect a belief that whatever is needed will be done to sort both of these crises.

The ECB appears to believe it is not up to it to provide the solutions, and that policymakers across the EU need to do more. There is certainly truth in this, but the ECB will have to play a much stronger role as well. This will have to include further interest rate cuts, further bond purchasing, and the provision of more long-term funding to the European banking system.

The ECB has also made it clear this week, as have the Germans, that debt relief for Ireland is not on the cards. There is nothing unexpected in that assertion and it is totally consistent with what one would expect from both parties.

However, I believe there is still a clear realisation at both IMF and European Commission level that what Ireland is being asked to do in terms of fiscal correction, the socialisation of massive bank debt, is probably not possible if the country is to maintain a functioning economy and society.

The Government will have to continue to argue the case as aggressively as possible and use every diplomatic skill it possesses. The yes vote in last week’s referendum can only help Ireland’s cause.

If we had voted no, we would now be grappling with a whole different range of problems and our negotiating position would be seriously undermined.

The exchequer returns for the first five months of the year provided further evidence that we are continuing to make progress in getting our unacceptably high level of borrowing down. The deficit of €6.5bn in the first five months indicates a gradual improvement in the borrowing situation, but one should not get carried away with the progress.

We are still borrowing far too much and taxpayers are still being forced to bear an unacceptable level of the adjustment burden. There is undoubtedly a limit to how many further increases the taxpayers will take.

The tax take in the first five months is running €386m ahead of target, but net current expenditure is running €365m higher than targeted. Hopefully, come December, the bias will shift further towards eliminating wasteful expenditure rather than squeezing taxpayers dry.