A very special year for Europe

By Aurel Schubert

2014 posed great challenges to the insurance industry. Aurel Schubert, chief statistician of the European Central Bank, gives an explanation of how monetary policy reacted to economic influences and why he is looking to the future with confidence.

2014 has now been the seventh year of the global economic and financial crisis, in particular in Europe and in the eurozone. In addition, the European real economy is still marked by a significant underutilisation of capacity. The inflation rate, and even the expectations of inflation over all time horizons, have not only sharply declined, they have reached historic lows. The inflation rate in the eurozone in December 2014 and subsequently at the beginning of 2015 even lay in the negative range. Lending also continued to decline, while development of the money supply was restrained.

Innovative monetary policy

Monetary policy reacted resolutely. The European Central Bank (ECB) took full advantage of the conventional tools, even including targeted longer-term refinancing transactions and negative interest rates on deposits. In June 2014, the interest rate on deposits, which had already hit zero in the middle of 2012, fell to –0.1 per cent, and then in September even to –0.2 per cent. At the same time, the main refinancing rate, which at the beginning of the crisis was still at 4.25 per cent, had dropped to the historic low of 0.05 per cent. The interest channel was thus fully exhausted. In order to achieve an even looser monetary policy, these interest-rate measures were supplemented by a series of unconventional expansionary steps, some of them quite innovative. They culminated in March 2015 with the beginning of the purchase of eurozone government bonds on the secondary market (in addition to private asset-backed securities and covered bonds). All these measures, some of which entered new territory for central banks, pursue the same objective: to allow the ECB to fulfil its mandate. This means a correction of the course of inflation, which at the beginning of 2015 had even brought a reduction of consumer prices of 0.6 per cent, and bringing it back to the ECB target, namely close to but under 2 per cent. This should combat the dangers of deflation and continue to push the market expectations of inflation in the direction of the target value. The transmission mechanism of monetary policy is to be restored, thereby further improving the financing conditions for companies and private households in the eurozone. As a result, domestic demand should be strengthened, as well as foreign demand through the effects of exchange rates. At the same time, the positive effects of purging bad assets from many European bank balance sheets, which has meanwhile been completed – in connection with the start of the banking union and the related “asset quality review” – should be supported.

Side effects of the monetary policy

However, this situation and the measures that were taken also created completely new and unprecedented challenges in the form of “side effects” for many financial market actors, in particular insurance companies and pension funds. Negative yields on the money market and for government bonds – sometimes even for corporate bonds – with the best credit ratings in Europe, are symptoms that present an entirely new situation for investment policy for which there is no prior experience to fall back on. Simultaneously, the risk premiums for entities with lower credit ratings have declined, not least due to the purchase programmes of the central banks, while repayments and sales have created a need for reinvestment in this difficult market environment.

Asynchronous economic development

Economic trends in 2014 varied greatly among the major economic zones of the world, but also within the eurozone. Recovery in the eurozone, at least up to the beginning of 2015, remained restrained, being marked by significant unused capacity, ongoing high unemployment and an annual growth rate of under one per cent. At the same time, the economic recovery in the US made significant progress; the country is said to have achieved growth of around 2.5 per cent. This has been reflected in growing differences in the monetary policy cycle on either side of the Atlantic. While in the US the markets and analysts were beginning to consider the question of reducing the expansive monetary policy measures (“tapering”), in the eurozone the focus was on possible new expansive monetary policy decisions (“quantitative easing”).

Structural reforms as a motor of growth?

Now that the possibilities of monetary policy in the eurozone have been essentially exhausted, the long-standing pending structural reforms have taken on increased significance. Here policy is challenged to embrace measures that will bring about or at least support a long-term, sustainable increase of the growth path. The banking sector plays an outstanding role in the financing of the European real economy, in some ways different than in the US. Consequently, the health of the European banking sector is also of special significance for strengthening the European economy. A historical milestone was put in place in November 2014 with the establishment of the common European banking supervision by the ECB. With this supervisory approach, trust in the banking sector should be clearly strengthened and the normal transmission mechanism of monetary policy will be back in motion. 2014 brought a number of innovations for the finance market in Europe and in the eurozone, both in monetary policy and in institutions. These innovations emphasise the fact that Europe, when challenged, can act in a forceful manner. They will – if they are accompanied by structural reforms of similar strength – form a solid basis for a sustained economic upswing in Europe. That gives us hope in the face of future challenges.

Aurel Schubert has been Director General Statistics at the European Central Bank since 2010. Previously, he was the chief economist at Oesterreichische Nationalbank. He directs the Statistical Committee of the European System of the central banks; he is a member of the European Statistical Advisory Committee (ESAC) and sits on the management board of the Irving Fisher Committee on Central Bank Statistics.

Note: This commentary gives the opinion of the author. It does not necessarily represent the official policy of the European Central Bank.

© UNIQA Group 2015