Macro View: Markets unsettled by fear of the Greeks' austerity plans

EUROPE has dominated the early weeks of 2015. Switzerland shocked the markets by allowing a huge revaluation of the franc, and the ECB’s long-expected decision to launch a new round of quantitative easing was announced only days before Syriza, the populist left-wing party, convincingly won the Greek elections.

In spite of German-led opposition to QE, ECB president Mario Draghi followed other central banks and launched a programme that involves purchasing some €1.1trn (£0.82trn) in bonds. Between March 2015 and September 2016, the ECB plans to buy each month bonds worth €60bn, adding large amounts of government bonds to its current €10bn-per-month purchases of private sector securities. The main aim is to counter threats of deflation, and boost the eurozone’s feeble economy. But success is not guaranteed. The US and the UK are growing more strongly than the eurozone, but it is not clear that this is due to QE. To grow faster, the eurozone must supplement QE with structural reforms.

Buying government bonds can raise asset prices, but the impact on the real economy is often limited. While QE can stimulate net exports by pushing down the exchange rate, it is difficult to sustain such policies without causing upheavals and inviting retaliation. The euro has already weakened by some 19% against the US dollar in the past nine months, and it is unlikely we will see further big falls that might benefit eurozone exports.

Swiss tumult

In anticipation of the QE launch, the euro’s decline accelerated, and the Swiss authorities were forced to abandon the currency peg against the euro that they maintained in recent years. The suddenness of the Swiss move caused huge turmoil, and eurozone institutions, including banks, incurred losses. It is clear that offsetting factors will limit the impact of QE. In order to overcome German objections, Draghi had to agree that future losses from buying bonds would be shared between the ECB and the central banks of individual members. This concession erodes benefits that might be provided by a common ECB umbrella. But the most serious risk to the euro’s future is the threat of a new crisis following the recent Greek elections.

Alexis Tsipras, the new Greek prime minister, and eurozone officials have made conciliatory comments to ease tensions. But it is difficult to mask the fact that the two sides hold fundamentally irreconcilable positions. There may be some room for compromise with regard to the speed at which Greece fulfils its obligations. But, unless Greece radically alters its demands for debts write-offs and for abandoning austerity, tensions will escalate. The forthcoming negotiations will be very tough, and both sides will engage in brinkmanship.

Though all concerned want to avoid a Greek default that may force it to leave the euro, uncertainties will continue to rattle the market. Greece hopes to find support for its stance in France and a few southern European countries. But the German-led core countries are likely to insist that Greece must fulfil all its obligations if it expects help with bond repayments totalling €6.7bn that are due in the next few months. The new Greek government may enjoy democratic legitimacy, but there is a danger that it exaggerates its strength. It underestimates the pressures facing the German government, which may preclude too many concessions.

Positive territory

It is ironic that the new eurozone tensions have erupted at the very moment when there are signs that its prospects are improving modestly, and its growth forecasts are being upgraded. Its economy will continue to underperform the US and the UK in the next year. But our 2015 GDP forecast, which was less than 1% only a few months ago, is being raised to 1.2% – still too low, but improving.

There is now growth across the eurozone. Every member, including weak economies such as Greece, is expected be in positive territory this year. Unemployment is falling, but only slightly, and at 11.4% is almost double US and UK rates, which are below 6%. Fears over deflation have worsened, as annual inflation became more negative, falling from -0.2% in December to -0.6% in January. These concerns have been a key factor persuading the ECB to launch its QE initiative. The key ECB rate is already virtually at zero. On present trends, ECB rate increases will not be considered until mid-2016 at the earliest.

In the US, there was a deceleration in the pace of growth. Real GDP rose at an annualised rate of 2.6% in Q4 of 2014, much less than the 5% increase recorded in Q3 and below market expectations. But the US economy remains relatively healthy, and is considerably stronger than the eurozone and Japan. Although house price rises have slowed over the past year, they are still rising by 4%-5% per annum, well above inflation.

The labour markets recovered impressively in January 2015, as the US created 257,000 jobs, more than expected. Revised figures also show that 147,000 more jobs than previously estimated were created in November and December 2014. The jobless rate rose slightly in January, to 5.7%, but the main reason for this was an increase in the participation rate, as discouraged workers rejoined the labour force. The upturn in wages is a further sign of strength. Growth in average hourly earnings accelerated in January to 2.2%, the highest increase seen since August 2014. The stronger labour market will increase pressure on the Fed to tighten policy early. But the mediocre GDP figures, and the slowdown in annual CPI inflation to 0.8%, well below the unofficial target, will persuade chairwoman Janet Yellen to wait. On balance, we expect the first rise in official rates in June 2015.

UK GDP growth in the fourth quarter of 2014 was 0.5%, confirming that the pace of expansion is slowing. Full-year 2014 growth was 2.6%, less than the 3% that was expected a few months ago, but still the strongest UK figure since 2007 and also higher than in most other G7 economies. The labour market remains robust and the unemployment rate is down to 5.8%, the lowest since 2008. But annual consumer price inflation fell to only 0.5%, and any thought of an early increase in official interest rates has faded. It now seems likely that official rates will stay at their current low levels at least until the early months of 2016.

David Kern of Kern Consulting is chief economist at the British Chambers of Commerce. He was formerly NatWest Group chief economist