IMF warns European Central Bank must cut interest rates again to kickstart eurozone out of recession
The European Central Bank may have to cut interest rates further and launch a fresh round of monetary easing to help boost the eurozone economy, the International Monetary Fund said today.
It warned the recession in the eurozone was likely to last two years in total before returning to growth sometime in 2014 as European governments continue to following the policy of austerity.
The Washington based organisation said the eurozone would contract a further 0.6 per cent before a return to 0.9 per cent growth in 2014.
Cut interest: The IMF warned the ECB to cut interest rates to boost growth or see the eurozone suffer another year of recession
The economic forecast is in stark contrast with the IMF’s recent revised forecast of economic growth in the UK earlier this month. It said the UK economy would grow by 0.9 per cent this year having previously revised its growth forecast for the economy down to 0.7 per cent for the year in April.
Today, official figures showed the UK economy had smashed that revised forecast growing 0.9 per cent in just six months.
The IMF’s assessment of the 17 country eurozone economy said government efforts to shore up public finances could cut growth by up to 1.25 percentage points this year. That was despite several purchase manager’s surveys suggesting the beginnings of the modest economic recovery in the currency bloc.
‘For the area as a whole, the negative growth impact of consolidation could reach as much as 1-1.25 percentage point this year,’ the IMF said. ‘Fiscal adjustment should be paced to avoid an excessive drag on growth.’
The IMF added there was a risk of stagnation in the euro zone while inflationary pressure was very weak and suggested the ECB should act to help growth with measures to reduce financial market ‘fragmentation’ - code for a North/South divide in the credit ratings of for companies and countries.
‘Additional unconventional monetary support could help reverse fragmentation,’ the IMF said.
‘Taking its current approach forward, the ECB should ensure term funding needs for weak but solvent banks through an additional LTRO of sufficient tenor,’ the report said, referring to the bank's ultra-cheap loans to banks, called Long-Term Refinancing Operations.
‘This would be most effective if accompanied by lower collateral haircuts, particularly on small and medium-sized enterprise loans,’ the report said.
‘To tackle fragmentation and repair monetary transmission more decisively, the ECB should consider further unconventional policies, including through a targeted LTRO (linked to new SME lending), or direct purchase of select private assets,’ it said.
The report praised the extra time European Union finance ministers gave several euro zone countries to reduce their budget deficits as a way to support demand, but said even longer deadlines for some governments may be needed.
‘Given weak growth prospects, these deadlines may still prove to be overly ambitious in some cases, and even more flexibility may be useful, particularly if countries use that fiscal space to implement ambitious structural reforms, or to recapitalize viable banks,’ the IMF said.
The IMF also added pressure on the German chancellor, Angela Merkel, who faces re-election in September - and who has been steadfast in her support of fiscal belt-tightening across Europe although some Germans believe she has not been steadfast enough - by calling on Germany to ease its stance.
‘If downside risks materialize, countries that are not under market pressure would benefit from a slower pace of fiscal adjustment,’ the IMF said.
To help stem the growing risk of stagnation, individual euro zone governments must continue with reforms and the euro zone as a whole must go ahead with its plans to create a banking union, the IMF added.
The banking union is seen as particularly important because it should help identify which of the 200 larger banks still have problems and hidden losses, recapitalise them and get money flowing to small and medium-sized firms once more.
The clean-up of the banking sector would follow a ‘bank asset quality review’ – better known as a ‘stress test’ - carried out by the ECB next year which would test what would happen to the value of a bank’s assets under various adverse economic scenarios.
Three such stress tests have already taken place over the last three years by the European Banking Authority but each test failed to show the full extent of the sector's problems.
The IMF called for third party involvement ‘preferably from the private sector’ in the stress tests in order to ensure ‘credibility and transparency.’
‘In the absence of such involvement, prospects for raising private capital would be jeopardized,’ the IMF added.
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