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Another dove in the flock

Dutch central bank governor Klaas Knot found himself amidst some media attention last Tuesday, the 12th February, as he went through a metamorphosis of being a monetary hawk to becoming a dove.

The ornithological reference is taken from Anglo-Saxon expressions, where monetary hawks represent the tight monetary policy. In the decision-making governing council at the European Central Bank (ECB), there is only one prominent hawk- Jens Weidmann. He is also the governor of the German central bank, Bundesbank, where one also finds for example, Finland and Austria in his fraction. Until a few days ago, this monetary hawkish fraction also included the Netherlands, but is now history, as governor Klaas Knot has moved his position from hawk to dove.

I can imagine a few reasons behind the jump, which may also include a personal aspect. ECB’s current president Mario Draghi is expected to step down in October, where the broad group candidates for the vacant post includes Klaas Knot. Since Germany very well could get the presidency of the European Commission after the EU elections in May, it makes it very certain that Jens Weidmann does not take over from Draghi at the ECB, and it seems unlikely that the German government will fight for the presidency at the Eurozone central bank. This automatically gives France a huge say in the choice of the next person to lead the ECB – and in that election race, it surely is a disadvantage to be a monetary hawk.

However, Klaas Knot’s changed position, I trust, is primarily based on a professional assessment of the current macroeconomic situation in the Eurozone. As graphic one shows, GDP growth rate has fallen since the third quarter of 2017. Though the decline in the second half of 2018 has accelerated in speed, which has surprised many.

It’s no secret that Italy is currently is in a recession, as the country has experienced negative GDP growth both in the third and fourth quarter last year. But my assessment is that the financial market was surprised about Germany lowering its growth expectations to maximum 1 pct. this year. The speed of decline in the GDP growth means that Germany’s economic activity during this first quarter has a risk of falling into negative territory. Should it happen, I expect it to be temporary, as the German government already adopted a stimulus package for this year, which increases public spending and supports private household consumption.

Over the past year, my own expectation has been that certain countries in the Eurozone could most likely end in a recession. However, Germany will still add a plus in the equation, which means that overall, the Eurozone will show some kind of economic growth, though far from bubbly.

It remains my general assessment, but if I look at how I have increasingly focused on the Eurozone during the past 12 months, including my written contributions, then it is a signal of my growing concern about the development. China’s economy is growing less than it has done, but the Eurozone is entering a regular economic crisis of severe size, and at the same time, the most worrying at global level. Despite the fact that I think the warning signs have been clear, I am honestly also surprised about the speed in the downwards momentum in the Eurozone.

Naturally, the question arises on how to deal with that challenge. I am convinced that the German government will suggest even more fiscal stimulus. Otherwise, if I look across the European economic/political landscape, there is not a lot of fantasy and interesting solutions that impresses, and a few thoughts might even worry the financial markets.

The world’s third largest gold reserve is held by Italy. Based on the comments from the government in Rome, they do not plan a sale of the reserves, but conversely, the government seems to flirt with that thought. The financial market is already nervous about the development in Italy and these kinds of comments add fuel to the fire. The gold reserves belong to the country’s central bank, which means that the Ministry of Finance would have to force a transfer of the gold from the central bank to the Ministry of Finance. Such a move is not expected, though the financial market would react very sharply against it, also just if somebody thinks out loud about it. But it underlines the lack of fantasy among European politicians when it comes to solutions about getting a sparkling momentum back in the Eurozone economy.

I maintain my long-term view of the growth in the Eurozone as overall positive, but at a very low level, for a very long time. A country like Italy now has a lower credit rating than after the global financial crisis 10 years ago. I expect the trend to continue, so within the next three years, the country drops to the so-called “junk status” for the first time.

Of course, it will have an impact on the return that investors can expect from the stock market. Several banks in the US now predict an annual return from the American stock market of 5 pct. Over the next 10 years though, the Eurozone surely does not offer better macroeconomic conditions.

If I judge the reaction of Klaas Knot, my belief is that senior executives at the ECB fear exactly the same, and in that regard, it is obvious to look at whether the ECB has any solutions.

According to his comments in the press, Klass Knot argues that the best attitude right now is to wait and see. To be fair, it must be said that he now no longer argues that the ECB should raise interest rates this year. His argument is the dropping inflation (graphic two) that moves further away from the central bank’s inflation target of approximately 2 pct. In addition, Klaas Knot sees himself as a major supporter of the quantitative monetary policy, where he argues that it has helped the economic growth to return again. This is similar to many other statements from the doves at the ECB that in my ears sounds like more of the same in the years to come – but it is hardly enough to push the economy into growth again, nor attract investors.

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