‘Abenomics’ has taken Europe by storm. Don’t get me wrong, policymakers on the old continent expected the new Bank of Japan’s governor Haruhiko Kuroda to act, but they certainly did not think he would unleash a tsunami on financial markets. As we have argued here last week, the new unprecedented bond-buying program in Japan has the potential to force the European Central Bank into action.
For Europe, there is good and bad news, depending on the national vantage point. If you are watching from Berlin, the Japanese bold attack against deflation carries a lot of risks. Seen from other European capitals, Tokyo’s new approach could actually turn out to be a game changer.
The value of the yen has already dropped against all major currencies. If the fall continues, German products will suddenly be less competitive. Japanese and German companies make similar goods and compete for the same markets. A loss of German market share in countries within Asia and the Americas will not be offset by stronger imports from European countries or rising domestic demand, as Europe is still too weak. Even if the more rosy scenarios for the euro area materialized in the second half of this year, growth will remain anemic. According to recent polls, even Germans are actually turning more pessimistic of late. That leaves Germany’s economic strength almost entirely reliant on global demand. Therefore, denting the country’s record current account surpluses now would spell trouble for the European powerhouse’s economy. Given the electoral calendar, if the global effects of ‘Abenomics’ are left unchecked, things could get complicated for the German economy right in the middle of an election campaign.
Unfortunately, the potential pitfalls for Germany and Europe do not end there. Over the weekend, only 48 hours after the decision by the BoJ, President of the Bundesbank Jens Weidmann warned against the consequences of the recent developments and said they could lead to a currency war. He did not specify what that could entail. We can try.
Broadly speaking, the BoJ’s move could make it much easier for the ECB to announce new non-standard measures of its own, i.e. a further relaxation of monetary policies in the euro area. According to Mario Draghi, the ECB is already exploring a number of options. Even in Washington, expectations are growing that the ECB will soon address the financial fragmentation in the euro area by helping small- and medium-sized companies in the periphery to overcome their severe funding difficulties. However, any potential new injection of liquidity by the ECB is the very opposite of what the inflation weary Bundesbank would like to see. Weidmann would instead prefer a slow exit from the unconventional steps the ECB and other central banks have been forced to undertake in the last several years. The new Japanese twist risks pushing that very exit into a very distant future.
What is so unsettling to Germany’s Bundesbank could in fact be a welcome development for peripheral European countries, thus confirming that economic priorities among euro area members are currently diverging. In fact, the recent yen selloff has already pushed down yields for sovereign bonds in Italy, Spain, and France, as Japanese investors have started to look for higher yields outside of their country. This is good news for those European countries. The BoJ’s new stance could turn out to be a Japanese contribution to help ease the negative effects of financial fragmentation within the monetary union.
Any new easing of monetary policies by the ECB would have the unintended (at least officially) consequence of affecting foreign currency markets, i.e. weakening the euro. Hence, the paradox of the recent move by the BoJ is that while it addresses a specific Japanese problem (i.e. deflation and sluggish growth), it makes it somewhat easier for German export oriented companies and politicians of all stripes to tolerate additional unconventional measures by the ECB. After all, in order to preserve their competitiveness, Germans too have an interest in preventing global demand for German goods from softening. Reversing part of the gains of the euro vs. the yen on foreign exchange markets would certainly help.
It would be truly ironic if the unintended consequence of Japan’s bold action last week had made it easier for Europeans to address, and even partially reverse, their own political and financial fragmentation.