- Fears of military escalation built on Friday, but ceasefire talks a ray of light
- Ukraine tensions hit markets but this week’s August PMIs will tell us more about impact on economy
- QE can have benefits for the eurozone, but the ECB’s focus is on bank lending, for now
Ukraine truce discussions a positive following drama on Friday
While developments remain highly in flux, there have been some relatively positive developments in the Ukraine/ Russia crisis over the weekend. Indeed, yesterday, in Berlin, Ukrainian Foreign Minister Pavlo Klimkin and his Russian counterpart Sergei Lavros began talks with their German and French colleagues about a possible cease-fire in Ukraine. While, at the time of writing, it was unclear whether an agreement was achieved, there were also positive developments relating to the Russian aid convey. 16 of the roughly 275 trucks had driven to the Ukrainian border in order to await inspection, while talks between Russian, Ukrainian and rebel officials about the passage of the convey looked set to continue today. Meanwhile, Red Cross workers had arrived at the convoy to take part in the inspections. These developments followed a flaring up of tensions on Friday, due to the alleged partial destruction of a Russian column of armed vehicles by Ukrainian forces. These reports had led to a deterioration of investor risk appetite on Friday, but the background looks a little more positive now.
This week’s PMIs should tell us more about the fall-out of the Ukraine crisis for the eurozone economy
Financial markets have been fretting about the possible fall-out from the Ukraine crisis for the eurozone economy over recent weeks. The direct trade and financial linkages between the eurozone and Russia are not very impressive. For instance, exports to Russia make up only around 4% of the eurozone total. The exports impacted by sanctions are of course only a small subset of that. However, the risks stemming from the Ukraine crisis cannot be dismissed completely. There is a possibility that confidence among businesses and consumers is negatively impacted, which can then have real economic effects as they adjust their investment and spending decisions. We do not expect such effects to be significant or long last lasting, but it is important to watch the upcoming survey data for August (the PMIs for the eurozone are published this week). Another risk is that the Ukraine crisis becomes much worse, which could then have bigger effects. The worst case scenario is that there is a disruption in energy supply, though fortunately the chances of that look small.
QE: is there a point?
Market speculation that the ECB will launch a QE programme given recent weak growth data and risks related to the Ukraine crisis has reached fever pitch. One of the questions we are often asked is whether there would be any point of QE in the eurozone context. The differences with the US are often mentioned, which is a market-based financial system, in contrast to the eurozone’s bank-based system. A second argument against QE is that core government bond yields are so very low in any case, setting up a large scale government bond purchase programme would have little additional effects on rates in any case. We see a number of potential advantages. First of all, core government bond yields have fallen partly in anticipation of QE, while it will also likely lead to sharper falls in peripheral bond yields. Second, QE could help to turn financial market sentiment and could also give a boost to confidence more widely in the economy. Finally, QE could put further downward pressure of the euro, which could spur exports. Our base case is that economic growth will pick up in the second half, while inflation will bottom out. In addition, the ECB is still rolling out the monetary easing package, which it announced in June. Against this background, we think the ECB will focus on rolling out the TLTROs, and possibly supplement these with an ABS purchase programme. If these policies fail to gain traction, or if growth and inflation look to be falling further, the central bank should stand ready to put in place QE in the shape of a broad-based asset purchase programme.