Economy

Draghi’s interest rate dilemma as euro zone hits a soft spot

Reasons for anaemic growth under scrutiny in Frankfurt and London

Central banker dilemma: Governors Mario Draghi of the European Central Bank and Mark Carney of the Bank of England have tough choices ahead. Photograph: Reuters

Wed May 2 2018 - 11:35

Is it a soft spot or a slowdown? Evidence is building that growth in the euro zone economy slowed in the first quarter of this year. Eurostat, the EU statistical agency, estimated on Wednesday that euro zone GDP growth was 0.4 per cent in the first quarter, down from 0.7 per cent in the final quarter of last year and the slowest growth rate since the middle of 2016.

Separately, the latest purchasing managers index – a measure of activity expectations in the manufacturing sector – fell to a 13-month low of 56.2 in April. The sector is still expanding, but the growth rate seems to have lost its momentum.

The “beast from the east” – the bouts of bad weather that hit Europe – has taken some of the blame for slow growth in the first quarter and there may also be a pause for breath after a surprisingly strong 2017. Euro zone growth was 2.5 per cent last year, the fastest since 2007,

But there are also fears that more fundamental factors may be at play, with signs of consumer and business spending easing. Is the ECB’s massive monetary stimulus, now being slowly reduced, having less of an impact? Are fears of a trade war and Brexit affecting sentiment? Or do structural factors mean that the euro zone economy can’t sustain a fast growth rate?

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Nobody is quite sure. But what is clear is that this is posing a dilemma for central banks. The Bank of England had been expected to increase interest rates again next week from their current level of 0.5 per cent, but weak manufacturing and credit figures there mean analysts now feel this is unlikely.

ECB dilemma

The ECB also faces a dilemma. It has pledged to continue its bond-buying programme until September, at least. It had been expected to phase it out by the end of the year and to start to increase interest rates around the middle of next year.

Commenting on recent data, ECB president Mario Draghi (left) has said he still believes growth is solid and has played down the risks. However further weakness in the months ahead could leave the ECB’s governing council in a bind.

Draghi’s term ends in October 2019 and there is still a chance he will complete eight years in office without ever increasing interest rates.

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