Europe Central Banks May Be Forced to Print More Money
Central banks in Europe are increasingly reluctant to pump more money into markets after already massive liquidity injections intended to kick-start economic growth but, according to analysts, they may have no choice.
The minutes of the Bank of England's Monetary Policy Committee (MPC), released on Wednesday, showed that the bank was worried about inflation in the medium term and that Adam Posen, a long-time dove, dropped his call for the bank to do more quantitative easing (QE).
"This 8-1 vote in favor of no additional QE in an environment where consumer price inflation has edged higher, business surveys are pointing to growth and today’s labor report shows employment rising 53,000 in the past three months and unemployment falling 35,000 suggest more QE is looking unlikely," ING Bank analyst James Knightley wrote immediately after the data was released.
Also on Wednesday, European Central Bank policymaker Jens Weidmann told Reuters that Spain should take the recent spike in its bond yields as a sign it must tackle the root cause of its problems, not wait for the central bank to boost liquidity further.
He also said that none of the ECB's policymakers were in favor of using the bank's bond-buying program to target specific interest rates on sovereign bonds and that he saw no reason to discuss a third long-term refinancing operation (LTRO).
The central bank injected over 1 trillion euros ($1.30 trillion) into the markets via two unlimited, two-year loans at its record-low interest rate of 1 percent and for a while, yields on the bonds of periphery countries fell.
But recently yields on Spanish bonds jumped back to the worrying 6-percent level, with some analysts calling on the ECB to do more to keep them in check.
However, inflation figures in the euro zone have given rise to new concerns, making the ECB's task even harder as the sole mandate written in its statute is maintaining price stability.
Data out on Tuesday showed euro zone inflation was revised up to 2.7 percent for March from a figure of 2.6 percent estimated by Eurostat and versus market expectations of a flat reading of 2.6 percent.
"Overall, we continue to think that inflation risks are skewed to the upside and that they mainly relate to higher-than-expected pass-through of energy commodity prices to consumer prices and also potential further increases in indirect taxes and administered prices amid the need to correct budget deficits across various euro area economies," Barclays Capital analyst Fabio Fois wrote in a research note.
Inflation is a problem for the UK as well, with the figure rising for the first time in six months in March, according to data released on Tuesday.
Vicky Redwood, chief UK economist at Capital Economics thinks that the Bank of England's minutes show that quantitative easing may be halted for now, but it is not out of the cards completely.
"We still think that more asset purchases are likely later this year as the economic recovery disappoints again. But the chances that the MPC will pause in May are increasing," Redwood said.
The weak economy but also the debt crisis showing no signs of abating as austerity brings worse recessions to euro zone periphery countries will likely make the ECB think again about its tough stance on fighting inflation and force it to loosen its purse strings once more, analysts said.
Euro Zone Not Out of the Woods
Portugal's prime minister wrote in an editorial in the Financial Times that the country may not return to capital markets in 2013 as previously expected.
Italy may delay by one year its plan to balance its budget and raised its budget deficit forecast.
In a worrying development that shows how deep Spain's predicament is, Spanish banks' bad loans in February rose to 8.2 percent of their portfolios, the highest level since October 1994, amid falling home prices, data released on Wednesday showed.
Even countries that are not in the eye of the storm are likely to suffer, analysts warned. In France, labor costs are the highest among the large euro zone economies and non-wage costs of employment – such as social security taxes – are "double those in Germany and since 2000 unit labor costs have risen by 20 percent relative to those in Germany," analysts at Credit Suisse wrote in a market note.
"France is the second most closed economy in the euro-area after Greece, and thus benefits less from a weaker euro or a global upturn," they added.
Barclays Capital's analyst Julian Callow noted that the International Monetary Fund, in its recent World Economic Outlook, saw the risk of "another acute crisis in Europe" and that it called for further easing from the ECB and a continuation of its LTROs and bond-buying program.
"In our view, such proposals (which echo some recommendations we have made previously) would be a sensible way to allay some risks in the euro area," Callow said.