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Macroeconomics

07 June 2019

THE ECB VALIDATES THE SECULAR STAGNATION CASE 

The ECB’s message yesterday was clear, rates are going to remain low for longer. In fact, one should not expect any rate hike before 2021. And possibly even beyond.

The markets are increasingly looking for a cut, not a hike. The ECB tried to talk dovish, but markets understood the central bank continues to buy time. It had to admit however that its efforts to spur inflation are not really successful. Add sluggish growth to the picture and the mix of low growth, low interest rates and low inflation all point to secular stagnation in Europe.

Some have called it Japanification. Thats perhaps because like Japan, Europe is facing falling inflation and extremely low interest rates, which today are even lower than the Japanese ones. In fact, with Europes ageing population and relatively high government debt levels, the savings rate for most Eurozone countries remains at very lofty levels. People set aside more money as they feel uncertain about their pension. The result is a savings glut which by its total amount clearly outstrips private investment demand. And any economic handbook will tell you that the result of this is pressure on interest rates. Normally, interest rates tend to balance supply and demand for money.

The result is that Ms. Watanabe has moved to Europe. The archetypical Japanese housewife that tried to earn a little extra in the currency markets because domestic rates were too low, might now find a replicate in Europe. And indeed, there has been steady outflow of investments out of Europe towards other continents, mainly the US. Higher bond yields and better growth are difficult to resist. Anything that provides some yield and has bond-like features is and will be hunted in Europe. And as growth is scarce, the premium for growth stocks, while already very high, might increase further. Cyclicals will be shunned and defensive sectors will remain the prime target.

A new Marshall plan for Europe may be needed, one aimed at infrastructure. The savings glut could be mopped up if set to work for such a purpose. Fiscal stimulus could be the carrot to lure savings into financing infrastructure works. And could it not be linked to a pension plan? Vision is needed to bring about the huge change required to break the savings interest rate loop. Where that may come from is anyones guess.

Food for thought ahead of the weekend