Published October 03, 2012
FRANKFURT, Germany – The European Central Bank managed to ease investors' fears that the euro might break up when it said in September that help was at hand for countries struggling with their debts. But the good mood in the markets has yet to be felt in Europe's wider economy.
Sagging growth and low confidence are plaguing efforts by the ECB's President, Mario Draghi, and other European leaders to put the 17-country group that uses the euro on the road to recovery.
The eurozone's economy shrank 0.2 percent in the second quarter on an annualized basis and is in danger of shrinking again in the third. A recession is typically defined as two straight quarters of economic traction. Unemployment is at 11.4 percent, the highest since the shared euro currency was introduced by the European Union in 1999.
Even so, many analysts say the bank is unlikely to give the eurozone's economy a shot in the arm and cut its benchmark interest rate when its governing council meets Thursday in Ljubljana, Slovenia.
Inflation in the eurozone is running at 2.7 percent on an annualized basis, above the bank's goal of just under 2 percent, and that is making it difficult for the ECB to further reduce its rates, analysts believe.
"The latest developments have been a rude reminder that preventing the eurozone from falling apart will not necessarily restore growth quickly," ING analyst Carsten Brzeski wrote in a note to investors.
The ECB's benchmark rate is already at a record low of 0.75 percent. Lower rates tend to boost growth by encouraging businesses and consumers to borrow and spend.
At its last policy meeting on September 6, the ECB said it would buy unlimited amounts of government bonds to help lower borrowing costs for countries struggling to manage their debts. To get help from the ECB, a country must first ask for assistance from the rest of the eurozone by approaching the bloc's emergency fund, the European Stability Mechanism.
Large-scale purchases of short-term government bonds would drive up their price and push down their interest rate, making it less expensive financially stressed governments such as Spain to borrow money. The ECB bond purchase program is designed to keep these countries from defaulting on their debts or requesting a bailout so expensive that it would strain the finances of the other euro member governments.
The ECB hasn't bought any bonds yet under the program because no government has asked for help yet. Many economists say it is only a matter of time before Spain will be forced — by high borrowing rates — to apply for financial support
Analysts say the ECB's program has succeeded — for the moment — in removing risk of an extreme event such as a government default. Stock markets have recovered and Spain has seen its borrowing costs fall from highs that prompted fears of a default. Spain's interest rate on its 10-year bond was 5.75 percent on Wednesday compared with over 7 percent before the ECB plan was announced.
The bond-buying program follows other attempts to calm the debt crisis — such as loaning €1 trillion to banks at low interest in December and February to shore up the financial system, and accepting more kinds of securities as collateral for those loans.
But while the markets may feel safer, businesses and consumers are still unwilling to risk more borrowing to spend and expand so the economy can grow. And ultimately it is more growth that is needed to shrink the debt loads of burdened countries such as Italy and Spain over the long term.
Yet the usual medicine — an interest rate cut — may not offer much help. Too many people are unwilling to borrow at any rate due to ongoing worries about how secure their future. Additionally, the still-elevated borrowing costs for governments tend push up borrowing costs for companies as well, blunting the effect of low ECB rates in countries such as Italy. Bond purchases would be one way to tackle that problem — instead of rate cuts.