Hamish McRae: Wanted - Confidence booster from ECB

Economic View

The focus shifts back to Europe. This week, it will be the turn of the European Central Bank to take over the baton of monetary easing, with a cut in interest rates widely expected after its governing council meeting on Thursday in Bratislava – one of the two monthly meetings it holds each year away from its headquarters in Frankfurt.

Nothing is certain but, given the hints and leaks, it would be a pretty big shock were the ECB not to do anything. So a cut of its main policy rate from 0.75 per cent to 0.5 per cent is overwhelmingly likely and the interesting issue will be what else it does to boost lending in Europe, particularly fringe Europe.

Something has to be done. Demand across a vast swathe of southern Europe has collapsed, as has been widely reported. But it has also weakened in the hitherto stronger parts of the eurozone, including even Germany. The German purchasing managers' index for April fell below 50, suggesting that the economy would contract in the second quarter of this year. The fact that inflation in the eurozone is now 1.7 per cent, comfortably below the 2 per cent ceiling, gives the ECB some leeway to act.

This leads to a narrow question and a wider one. The narrow is whether a cut in interest rates is going to boost lending in Europe; the wider is whether we are seeing the limits to monetary policy, or you might say, central bank power.

Part of the problem in Europe is that money supply is going up but lending to businesses is going down. You can see a snapshot of that divergence in the small graph. It is a familiar issue here in the UK. Here as there, it is hard to know to what extent weak lending is mainly the result of lack of demand for loans or lack of supply from the banks.

It must be a bit of both but if it were mainly lack of demand, then increasing the supply will have little impact. As for the price of loans, as opposed to their availability, when ECB interest rates are only 0.75 per cent, it strains belief that a 0.25 per cent cut – even if it fed through to a fall in the average interest rate on a loan – will affect demand.

Still, the ECB has to be seen to be doing something, and it is hard to see how a cut in rates, presumably associated with some other measures to increase loan flow, could do any harm. Indeed, given where Europe is now, with lending to the private sector having contracted for 11 months on the trot, even a modest boost would be more than welcome.

That leads to the wider issue, the power of central banks. The ECB has over the past 18 months demonstrated both how powerful and how weak a central bank can be.

We saw the power last year when a threat to buy the sovereign bonds of the distressed eurozone countries flipped round the markets and enabled Italy and Spain to start borrowing from them again. As it turned out, the ECB did not have to do anything; the threat was enough. The reason is simply that a central bank has almost infinite ability to print more of its own money, and so no one in the markets will want to bet against it. When Mario Draghi said that he would do "whatever it takes" to save the euro, market-makers took heed.

But we have also seen the limits of power. Central banks can print the money but, as we have seen, they cannot make the banks lend it on. We are only gradually learning both how quantitative easing affects the real economy, on the benefit side and on the cost side. Unprecedented monetary easing in the US (or at least unprecedented in peacetime) has not led to much of an increase in US employment, which is still below its previous peak. In the UK, it has not led to a strong economic recovery, even allowing for the official growth figures understating what has actually been happening. In Europe, it has not stopped the present dip back into recession. Of course, we cannot know what would have happened had the central banks not adopted QE – but I think it is pretty clear the situation would be far worse. So how bad is it for Europe?

In the large graph, you can see the official figures for growth in the UK and the eurozone, together with a "current activity indicator" developed by Goldman Sachs. The latter seeks to give a more timely and more accurate tally of economic activity. Activity in the UK has just managed to inch forward over the past two years, and now is consistent with growth running at about 0.5 per cent a year. That is not great, but remember that it is pulled down by the decline in North Sea output. Onshore activity is higher, with the Centre for Economics and Business Research estimating that it is running closer to 1 per cent a year, again not great.

Activity in the eurozone, as measured by the current activity indicator, has been negative since the beginning of last year, and remains so. The present consensus seems to be that growth overall will resume towards the end of this year but I think it will need some major shift in confidence, and I am not sure where that will come from.

That brings things back to the power of central banks. As far as Europe is concerned, in the absence of political union or even effective political co-operation, the ECB is really the only point of power. So the big question this week seems to me to be whether it can lift the confidence, particularly of the business community but also of consumers, towards the expectation of some growth. Can it do for confidence in the eurozone economy what it did last year for confidence in the survival of the euro?

It is a tall order, and the odds are stacked against it. But it is very much in UK self-interest that the ECB gets a good response to whatever it decides to do on Thursday.

Start your day with The Independent, sign up for daily news emails
Arts and Entertainment
Joe Cocker performing on the Stravinski hall stage during the Montreux Jazz Festival, in Montreux, Switzerland in 2002
musicHe 'turned my song into an anthem', says former Beatle
News
Clarke Carlisle
sport
Sport
footballStoke City vs Chelsea match report
Arts and Entertainment
theatreThe US stars who've taken to UK panto, from Hasselhoff to Hall
PROMOTED VIDEO
ebooks
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
Life and Style
Approaching sale shopping in a smart way means that you’ll get the most out of your money
life + styleSales shopping tips and tricks from the experts
News
newsIt was due to be auctioned off for charity
News
Coca-Cola has become one of the largest companies in the world to push staff towards switching off their voicemails, in a move intended to streamline operations and boost productivity
peopleCoca-Cola staff urged to switch it off to boost productivity
Environment
Sir David Attenborough
environment... as well as a plant and a spider
Voices
'That's the legal bit done. Now on to the ceremony!'
voicesThe fight for marriage equality isn't over yet, says Siobhan Fenton
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

The Jenrick Group: Night Shift Operations Manager

£43500 per annum + pension + holidays: The Jenrick Group: Night Shift Operatio...

SThree: Trainee Recruitment Consultant - LONDON

£20000 - £25000 per annum + OTE £40,000 + Car + Pension: SThree: SThree are a ...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE £35K: SThree: We consistently strive to be the...

SThree: Graduate Recruitment Consultant

£20000 - £25000 per annum + OTE £35000: SThree: SThree are a global FTSE 250 b...

Day In a Page

Isis in Iraq: Yazidi girls killing themselves to escape rape and imprisonment by militants

'Jilan killed herself in the bathroom. She cut her wrists and hanged herself'

Yazidi girls killing themselves to escape rape and imprisonment
Ed Balls interview: 'If I think about the deficit when I'm playing the piano, it all goes wrong'

Ed Balls interview

'If I think about the deficit when I'm playing the piano, it all goes wrong'
He's behind you, dude!

US stars in UK panto

From David Hasselhoff to Jerry Hall
Grace Dent's Christmas Quiz: What are you – a festive curmudgeon or top of the tree?

Grace Dent's Christmas Quiz

What are you – a festive curmudgeon or top of the tree?
Nasa planning to build cloud cities in airships above Venus

Nasa planning to build cloud cities in airships above Venus

Planet’s surface is inhospitable to humans but 30 miles above it is almost perfect
Surrounded by high-rise flats is a little house filled with Lebanon’s history - clocks, rifles, frogmen’s uniforms and colonial helmets

Clocks, rifles, swords, frogmen’s uniforms

Surrounded by high-rise flats is a little house filled with Lebanon’s history
Return to Gaza: Four months on, the wounds left by Israel's bombardment have not yet healed

Four months after the bombardment, Gaza’s wounds are yet to heal

Kim Sengupta is reunited with a man whose plight mirrors the suffering of the Palestinian people
Gastric surgery: Is it really the answer to the UK's obesity epidemic?

Is gastric surgery really the answer to the UK's obesity epidemic?

Critics argue that it’s crazy to operate on healthy people just to stop them eating
Homeless Veterans appeal: Christmas charity auction Part 2 - now LIVE

Homeless Veterans appeal: Christmas charity auction

Bid on original art, or trips of a lifetime to Africa or the 'Corrie' set, and help Homeless Veterans
Pantomime rings the changes to welcome autistic theatre-goers

Autism-friendly theatre

Pantomime leads the pack in quest to welcome all
The week Hollywood got scared and had to grow up a bit

The week Hollywood got scared and had to grow up a bit

Sony suffered a chorus of disapproval after it withdrew 'The Interview', but it's not too late for it to take a stand, says Joan Smith
From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?

Panto dames: before and after

From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?
Thirties murder mystery novel is surprise runaway Christmas hit

Thirties murder mystery novel is surprise runaway Christmas hit

Booksellers say readers are turning away from dark modern thrillers and back to the golden age of crime writing
Anne-Marie Huby: 'Charities deserve the best,' says founder of JustGiving

Anne-Marie Huby: 'Charities deserve the best'

Ten million of us have used the JustGiving website to donate to good causes. Its co-founder says that being dynamic is as important as being kind
The botanist who hunts for giant trees at Kew Gardens

The man who hunts giants

A Kew Gardens botanist has found 25 new large tree species - and he's sure there are more out there