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Stephanie Flanders: The ECB is not the only show in town

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Never fear, Super Mario is here. That is the conclusion  investors in European markets seem to have come to.

The economic news from the eurozone has not been good at all. But bond and equity prices have rallied, on the perception that the European Central Bank and its president, Mario Draghi, are on the case.

That is an understandable reaction. It may even turn out to have been justified. But it is also disappointing for two reasons.

The first reason is that, nearly five years since the eurozone crisis first erupted, you might have hoped that the real economy would now be setting the pace for markets, not the central banks.

It is a sad reflection of just how long it has taken countries to get moving again that central banks are still front and centre in every major developed economy. The exact timing of the first rise in interest rates in the UK and the US is a constant subject of debate.

That gradual tightening of policy is now firmly on the horizon in Britain and America shows it is at least on the path to less extreme levels of central bank support. There is also a general understanding that tightening in these economies need not be bad for stock prices in the medium term if it comes in response to accelerating growth.

We are still a long way from that in the eurozone. Financial markets have been rising as well but it is not because of any improvement in the economic data. It is because Draghi seemed to suggest at the Jackson Hole meeting of central bank governors in Wyoming last month that the situation was bad enough to warrant further ECB action.

That expectation was rewarded earlier this month, with the surprise cut in the ECB’s key interest rates and the symbolically significant decision to start buying private asset-backed securities outright. That is a form of quantitative easing although by limiting the purchases to certain kinds of private assets rather than government IOUs, the  ECB is ensuring the programme will start out relatively small.

If they help to support lending to European businesses, at the margin, these steps will do more good to the eurozone economy than harm. But helpful though they may be, these measures cannot transform the outlook on their own. That is the second reason to worry. Pushing down the value of the currency is a good start and will help European companies start to deliver the faster growth in corporate profits that investors have been waiting for. 

But no amount of new credit will induce businesses to borrow if they do not believe there is demand for their goods out in the broader economy – or if a mountain of red tape and regulation is standing in their way.

This was one of Draghi’s central points in Wyoming. In that speech he made a pointed reference to needing more growth-friendly budget policies across the eurozone. That contained an implicit suggestion that Germany could be doing more in its fiscal policy to support European growth. He also endorsed a plan by the European Commission president for a big fund to invest in European public infrastructure. But Draghi also said, forcefully, that no amount of stimulus would have a lasting effect on growth in Europe without structural reforms to raise the eurozone’s underlying potential.

Many in the markets seemed to hear only the first part of his message – that the outlook for the recovery was worrying and  the eurozone needed growth to stage a lasting recovery. 

They did not listen so closely to the second part – that economic growth could not come from the ECB alone. Not for the first time, the central bank is being painted as the only show in town. Draghi is supposed to be the master of managing market expectations. But now the expectations around the ECB are high and so are the risks of disappointment.

Stephanie Flanders is chief market strategist at JP Morgan Asset Management 

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