As G-20 leaders gathered in St. Petersburg and grappled with the question of what to do about Syria, the head of the European Central Bank (ECB), Mario Draghi, tried to lower expectations about the nascent European recovery. “These shoots are still very, very green,” he said during the press conference, following the meeting of the governing council. The ECB raised its outlook for 2013 slightly. However, it lowered its forecast for 2014. Draghi was intentionally cautious.
The biggest danger for a number of struggling European economies would be a sudden, steep rise in interest rates. This move would make it even harder for companies and consumers to access credit, and high interest rates could very well choke off the nascent recovery. In fact, although it is positive that the cycle is slowly turning into Europe’s favor, structural challenges remain in a number of countries, including Italy or France.
Furthermore, the shape of the future banking union is still very much up in the air. Negotiations on the Single Supervisor Mechanism (SSM) are close to their conclusion. The European Parliament could vote in the next few weeks, but establishing the SSM is only one step towards a full banking union.
We can expect the ECB to take its new responsibility very seriously. If managed with political skill, the new role could give the central bank just enough leverage to push politicians to be more ambitious in other areas, such as establishing a credible resolution mechanism and fund. Ultimately, a negative assessment by the ECB about any given financial institution could force one or more governments to act. Yet, one of the strengths of the current ECB president is the fact that ― so far ― he has avoided open clashes with politicians. Will Merkel ― if reelected ― choose Draghi’s stance on the banking union over widespread domestic concerns? I am rather doubtful.
From a negotiating point of view, the recovery ― be it a very weak one ― could become the excuse for politicians to slow down or halt any significant progress towards a full banking union. Draghi knows how quickly politicians can become complacent, which is a danger that the ECB is very well aware of.
For now, all Draghi can do is to assure investors that the ECB will keep money cheap for a very long period of time and warn politicians that things could get ugly once again. When asked why the Netherlands had not yet profited from the general lift in sentiment, he provided the questioner with a detailed macroeconomic assessment of the country, its housing bubble, and private household debt overhang. He concluded by saying that, under such circumstances, the process of deleveraging is inescapable and takes time. When asked to give his assessment of the state of the Italian economy, he declined to answer. It’s not hard to see that many hurdles remain on the road to recovery.
However, Draghi is more optimistic than he might want you to believe. In response to a question about the potential spillover effects of current turmoil in emerging economies ― arguably one of the greatest dangers to the world economy ― he said that the pickup in growth in the euro area was not only driven by exports, but also by rising domestic demand. He seemed to imply that Europe’s growth could be self-sustaining and the euro zone could even weather some turbulence. I find such a statement hard to reconcile with an overly cautious assessment of the euro area economy.