The bright side is that China has opened the credit tap again, starting in the spring of 2018. We expect Chinese economic stabilisation by Q3 and a positive impact to Europe by Q4’19-Q1’20. Meanwhile, domestic measures to stimulate the economy need to be taken at the European level.
Monetary policy options
As it is so often the case, all eyes are on the European Central Bank. In a bid to win time and avoid a tightening squeeze hitting Eurozone banks, March saw the ECB announce a new round of TLTRO and a modification of forward guidance to extend its first rate hike into 2020. In our view, this is only a first step towards a more accommodative stance. As of today, discussions among ECB watchers are notably evolving around the idea of pushing the repo rate back to zero. The rationale behind this idea is that the benefit of negative rates is rather low; they are essentially a tax on banks that tends to further enfeeble the weakest banks. So far, the positive impact has been limited and has strongly depended on the structure of banks. The normalisation of the repo rate would be an easy move to reduce pressure on the banking sector if the risk of a tightening squeeze appears again.
Fiscal push in H2'19
These measures alone will not be enough to stimulate growth. They may help to push the credit impulse higher but other measures to support demand are also required. As economic data will continue to disappoint in the coming months, we believe that a new consensus for looser fiscal policy will emerge in European countries in H2’19. An accumulation of negative German data could be the perfect trigger to set off expansionary fiscal policy in Europe. If fiscal expansion is equivalent to 1% of GDP in Germany, it could lead to an average increase in the output of other European countries by 0.15% after two years, with the strongest impact on small, open economies sharing a land border with Germany to be around 0.4% according to Beetsma, Giuliodori and Klaassen1. Though the spillover effect of fiscal expansion usually tends to be small, it is largely positive and, coupled with the ECB’s accommodative monetary policy and China’s credit impulse, could be the right answer to ongoing headwinds.
1: SEE BEETSMA, R., GIULIODORI, M. AND KLAASSEN, F., “TRADE SPILL-OVERS OF FISCAL POLICY IN THE EUROPEAN UNION: A PANEL ANALYSIS”, ECONOMIC POLICY, VOL . 21, ISSUE 48, 2006, PP . 640–687
