European central bankers have warned that risks including trade tensions and high government debt are piling up for the region’s economy, as they gathered for a meeting in Portugal this week.
Falling inflation and rebounding growth in the Eurozone were overshadowed by the victory of Marine Le Pen’s far-right eurosceptic party in the first round of France’s parliamentary election at the European Central Bank’s annual conference in a luxury hotel in Sintra, near Lisbon.
ECB governing council members told the Financial Times it was too early to speculate about whether they could be forced to intervene if France suffered a “Liz Truss moment” — referring to the debt crisis triggered by the former UK prime minister’s unfunded tax cuts in 2022.
However, most viewed the French elections as the sign of a broader shift in a more populist, protectionist and turbulent direction that is likely to hit Europe harder than most parts of the world.
Pierre Wunsch, the governor of Belgium’s central bank, warned that the US and China were stealing a march on Europe with subsidies and tariffs.
“We are moving to a world that is more disruptive as well as much more transactional and that is problematic for Europe,” he warned. “We don’t have a clear narrative to propose to people.”
The US has sharply increased tariffs on a range of imports from China, including electric vehicles and semiconductors, while the EU has followed suit to a lesser extent with higher levies on Chinese EV imports that are due to take effect from Thursday.
Beijing has threatened to retaliate against the moves. Trade tensions could intensify if Republican party nominee Donald Trump wins November’s election after promising to put an extra 10 per cent tariff on all imports from Europe. More than half the Eurozone’s gross domestic product is generated by exports, leaving it particularly vulnerable to a trade war.
Jan Hatzius, Goldman Sachs chief economist, said in a presentation at Sintra that Trump’s promise to increase tariffs on imports from the EU by 10 per cent would hit the Eurozone economy disproportionately hard — predicting it would knock 1 per cent off GDP in the bloc, while shaving only 0.1 per cent off US GDP.
Such a shock would be enough to more than wipe out the 0.9 per cent growth the ECB expects the Eurozone to generate this year.
“Europe is a legal construction that moves slowly on the basis of a level playing field,” said Wunsch. “In a transactional world where others are using tariffs or subsidies and don’t share our climate ambitions, it is challenging for us now.”
Gabriel Makhlouf, Ireland’s central bank governor, said: “I worry in particular about the geopolitical scene and economic fragmentation. All the signs are that it will go further.”
“I expect a supply shock of some kind,” he added. “It will have a price impact and accelerate moves to become more self-sufficient so we don’t rely on other countries as much. The biggest losers are going to be small countries.”
Bostjan Vasle, governor of Slovenia’s central bank, said the potential for governments to not bring budget deficits down as required under revamped EU debt rules was another risk for policymakers to grapple with. “Fiscal policy may also add to risks if current plans for fiscal consolidation will not materialise.”
Declining to comment specifically about the French elections, Vasle said: “It is very important to have stability in the euro area, politically, societally and financially. We do have instruments that would allow us to intervene to defend financial stability if there was an unwarranted and disorderly market dynamic. But we are not at that stage.”
Investors have speculated that the French election could trigger a bond market sell-off that forces the ECB to intervene with its new but untested debt-buying scheme, the transmission protection instrument. But Wunsch said it was “way too early to talk about the TPI”.
Several central bankers predicted the risk of a market meltdown would be enough to deter the next French government from going on a spending spree. “All governments in my experience realise there is a difference between the reality of governing and the reality of campaigning,” said Makhlouf. “You only need to look at Liz Truss to realise that.”
Rate-setters were broadly in agreement that inflation was heading in the right direction — supported by data released on Tuesday that showed Eurozone inflation had resumed its downward trajectory to 2.5 per cent in the year to June, following a brief pick-up to 2.6 per cent in May.
But they are almost certain to leave interest rates on hold at their meeting in two weeks — having cut them for the first time in nearly five years last month. ECB president Christine Lagarde said they could afford to “take time to gather new information” given how unemployment has remained at a record low in the Eurozone.
Vasle said the “surprisingly strong” labour market was pushing up wage growth and keeping inflation above 4 per cent in the labour-intensive services sector. “The anecdotal evidence is that it looks like being a very good tourist season in a lot of countries, including mine, as people are prepared to spend on services and that will not contribute to disinflation.”
Shortly before hosting a dinner to close the event on Wednesday night, Portugal’s central bank governor Mário Centeno expressed his frustration about the recent increase in support for populist, eurosceptic political parties opposing closer European integration.
He said this was “a paradox” given how governments and the ECB had taken unprecedented measures to protect jobs, stop companies going bust and avoid a European financial crisis after the pandemic.
“It is so hard to communicate a positive message to people when they are always being told about the massive challenges ahead and the sacrifices they must make — we should focus on the achievements,” Centeno said. “It is not that bad.”