Email of the day on Eurozone monetary policy and the outlook for Japan's bonds as deflation ends
Comment of the Day

December 23 2013

Commentary by David Fuller

Email of the day on Eurozone monetary policy and the outlook for Japan's bonds as deflation ends


“I love your daily comments, however I do not see how you can affirm that monetary policy in the Eurozone is stimulative. Monetary policy here is very tight in fact the monetary base and credit is continuously down, we need a low euro or debt restructuring, instead they have chosen deflation. We are in deflation so I [Ed: do not] see monetary policy as very accommodative at all, also employment is not going down so the situation is critical. Could you please comment? Also, if Japan really gets inflation up they will have to print ever more money to keep their bonds from crashing, isn't this dangerous?

David Fuller's view

Many thanks for your interesting email and challenging questions..

Europe has had a much more difficult recession than the USA and I do not feel that signs of recovery began to emerge until the extremely capable Mario Draghi took over as ECB President in November 2011.  He did not have Ben Bernanke’s freedom to introduce quantitative easing, even if he had wanted to, but he prevented a collapse of the commercial banking sector by immediately introducing a long-term refinancing operation (LTRO) by issuing over €1 trillion of three-year low-cost loans to hundreds of European banks.  Crucially, this reflationary step also reduced government bond yields as banks used their cheap loans to buy higher yielding government securities.  It is very likely that the ECB will issue further long-term loans to prevent European rates from rising.

Europe has been in a deflationary depression but there are signs of recovery in the Northern European economies, including rising wages in some of Germany’s industries.  I would say European monetary policy is very accommodative but it takes time for these policies to work.  The UK economy is now recovering and hopefully we will see signs of improvement in all European economies in 2014-2015.  I believe European share indices such as the DJ Euro Stoxx (Cap Weighted) (SXXE Index) are a lead indicator for this recovery although it is likely to be gradual because of the problems mentioned in the email above.

Regarding Japan, it may only be a matter of emphasis but I would say that Japan is seriously trying to halt the deflation which had been hollowing out its economy for over twenty years.  However, if all they succeed in doing is raising inflation without generating GDP growth, then I would expect Japan’s bond market to be in trouble.  Fortunately, the economy is showing signs of recovery although this reflationary effort is barely a year old.  I hope Japan’s economy will be strong enough in April 2014 to survive the planned Consumption Tax increase from 5 to 8 percent.  If so, a further increase to 10 percent is planned for 2015 as part of the effort to stabilise Japan’s debt burden by 2020.  Meanwhile, I regard Japan’s stock market as a lead indicator for its economic recovery prospects. 

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