Eurozone (EZ)
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Eurozone has made significant progress in its twin deficit. The improvement in current account is largely driven by periphery, while fiscal development is primarily attributable to core region. Notably, government debt in EZ also posted its first decline in six years in Q3 2013.
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Notwithstanding these improvements, stronger Euro, driven by persistent contraction in balance sheet of European Central Bank (ECB), and deflationary pressures, driven by continued banks' de-leveraging, could affect the region adversely.
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These developments demand further monetary easing by ECB, which must take actions to reverse shrinking balance sheet along with cutting policy rates further this year.
Eurozone has made considerable progress in twin deficit...
In the first three quarters of 2013, EZ current account has posted a surplus of 1.8% of GDP, almost double of that in the corresponding period in 2012. Similarly, EZ fiscal deficit (in seasonally adjusted terms), as % of GDP, has eased in 2013, falling to its lowest level in five years. What is more important is that the progress is shared by core as well as most of the periphery nations. Not only did the troubled periphery group-Greece, Ireland, Italy, Portugal and Spain (GIIPS)-moved in surplus territory on external account in 2013, fiscal deficit also narrowed considerably in Greece, Ireland and Portugal.
...and government debt also posted its first decline in Q3 2013
More importantly, government debt in EZ fell (in absolute terms) for the first time in six years in Q3 2013. Although it remains high, the fall is encouraging. What concerns us though is that region's government debt has fallen due to core nations rather than the periphery, as the latter's debt posted a fresh high in the third quarter of 2013. Within periphery, while Debt-to-GDP ratio fell in Ireland, Italy and Portugal, it moved up for Greece & Spain.
However, strong Euro & deflationary forces could undermine these efforts...
All these favourable developments in EZ fundamentals, nevertheless, are threatened by strong Euro and deflationary forces, which could reduce periphery's competitiveness and increase their debt burden in real terms. At the end of 2013, ten euro members had an inflation of less than 1%, of which two are already in deflation. In fact, core inflation in December 2013 was the lowest ever level, which picked up marginally in January 2014.
...which need to be addressed with further monetary easing
This is what makes us believe that the European Central Bank (ECB) will have to ease monetary policy further in 2014. As we had discussed in one of our earlier reports, ECB must reverse the contraction in its balance sheet in order to help weaken common currency. Besides, while negative deposit rate or a cut in main refinancing rate could send strong signal, these steps must be complemented with some form of targeted LTRO-3 (longer-term refinancing operations) or other measures to stop the contraction in ECB's balance sheet.
Please refer to the attached document for the detailed report.
Regards,
ICICI Bank : Treasury Research
Contact:
Nikhil Gupta
+91-22-4259-2180
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