FEELING BETTER AFTER THE BUDGET? DON’T COUNT ON IT

GEORGE KEREVAN

HERE is the real news: George Osborne’s Budget is small beer in global economic terms, even if he does knock 2p of a pint on Wednesday. Our immediate economic future lies rather with decisions now being made by Janet Yellen at US Federal Reserve in Washington, and by Mario Draghi at the European Central Bank in Frankfurt.

Pay attention.

Last week Mr Draghi, at long last, got to launch his own version of Quantitative Easing, after persuading the German Constitutional Court to ignore this flouting of the ECB’s ultra-conservative constitution – rules specifically designed by the Bundesbank to preclude such frivolities.

Faithful readers will know I have long supported QE in the rapidly deflating Eurozone, as a counterweight to Berlin’s mad insistence on forcing debt-laden members to engage in fiscal suicide, in the forlorn hope it will provoke an entrepreneurial revolution.

In fact, the said entrepreneurial revolution is happening in China, where they are printing money like confetti in order to invest underpin manufacturing investment.

Unfortunately, Mr Draghi’s resort to the printing presses is possibly a mite too late. I realise my pessimistic view is not shared on the Continent, where they view QE as the antidote to deflation. The ECB and its 19 constituent national central banks plan to spend 60bn euros (£42.7bn) every month, mostly on sovereign bonds, until at least September 2016. In theory, this will keep market interest rates low, encouraging investors to move into riskier assets that will spur growth. At the same time, it will push down the euro in value, boosting exports.

One week in and the plan seems to be having an impact. The euro has plummeted faster than expected, to a record low. There is more confidence about in the Eurozone, than for ages – possibly because something is being done – even if it is the wrong thing.

Uprated forecasts by the ECB claim the QE programme will raise growth rates, and lift inflation from below zero up to 1.8 per cent by 2017. Had QE been launched last year when European growth was stagnant and banks were reining in credit, the new money would have had a hard time finding its way into the economy – meaning any stimulus would have been neutered. But now the ECB detects some stirrings in the Eurozone economies, so QE arrives with a wind behind it.

Or does it?

Here is my worry. The bit of the Eurozone that is doing OK is Germany. QE is arriving in time to keep German borrowing costs at rock bottom just as inflation-beating wage deals are warming up domestic industrial costs.

Certainly, higher wages will increase demand for imports and rebalance Germany’s irrational budget surplus. But will these exports come from southern Europe or France? I doubt it. My guess is that if the Bundesbank starts panicking about domestic inflation and eroding German productivity, it will put the brakes on more QE. Meanwhile, southern Europe still lacks an expanding export market inside the EU, even if the euro is ultra-cheap.

Conclusion #1: the Eurozone is as fragile and dysfunctional as ever. QE might improve matters. Or it might be the dynamite that explodes the whole common currency, if Berlin finally decides its material interests are threatened.  And I haven’t mentioned Greece.

The game is also afoot across the Atlantic, where strong US growth and employment data suggests the Fed will raise interest rates for the very first time since the great banking fiasco. The markets are already pricing in not one but three marginal adjustments this year – starting as early as June. That spells very bad news for the rest of the world, especially Asia.

US Quantitative Easing has flooded the world with cheap debt denominated in greenbacks. Since 2000, non-American companies have borrowed around $7 trillion in US currency to fund investments. Crucially, this debt is outside American jurisdiction and so without the protection of a lender-of-last-resort like the Federal Reserve.  In other words, we have precisely the same inherent weakness as the Eurozone: there’s no one there to pick up the pieces if debtors fail and illiquidity grips the global banking system.

Which is precisely what could happen when the Fed starts raising rates.

Optimists are hoping that there has been some fundamental readjustment internationally, since the markets had a mini-stroke last year, on the back of premature fears the Fed would abandon QE too quickly. Pessimists think we are heading for global capital flight and tit-for-tat currency devaluations. I side more with the latter sad sacks.

Conclusion #2: imminent higher interest rates will cool growth prospects while resulting market disruptions will harm confidence – the UK included. Even the impact of cheaper oil will not help very much.

Ponder that as you tot up how much you have received in pre-election goodies from sunny Mr Osborne.

 

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