Draghi Sees Signs of Stabilization Despite Tough Economy

european central bank

“The European Union is the new sick man of Europe,” began the overview of a recent Pew Research report. “The effort over the past half century to create a more united Europe is now the principal casualty of the euro crisis. The European project now stands in disrepute across much of Europe.” The term “sick man of Europe” was first used by Tsar Nicholas I of Russia in the 19th century to describe the Ottoman Empire because it was increasingly falling under financial control of the European powers. Now, with a headline unemployment rate of a record 12.1 percent in the 17-member euro area and International Monetary Fund projecting that euro area gross domestic product will contract 0.3 percent in 2013, the economy is clearly what is plaguing the European Union.

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All of this bad news has left many Europeans feeling as pessimistic as ever about their current situation and future prospects. But European Central Bank President Mario Draghi said at a speech in Shanghai on Monday that even though the economic outlook of the euro zone is “challenging,” he still believes the economic recovery will begin this year.

“There are a few signs of a possible stabilization,” Draghi said, according to the text of the speech provided by the Frankfurt-based central bank. “Our baseline scenario continues to be one of a very gradual recovery starting in the latter part of this year.” Still, after he dropped the ECB’s benchmark interest rate to a record low of 0.5 percent last month, the central bank’s president indicated that he will cut again if the economic data worsens. While unemployment did spike in April, most economists surveyed by Bloomberg said they did not expect the ECB’s Governing Council to lower borrowing costs at its upcoming June 6 meeting.

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“The drivers of such a gradual recovery are the highly accommodative monetary policy and export growth, caused by growing foreign demand,” Draghi said. Recent stock market gains are “benefiting virtually all economic agents, including corporations, banks and households,” he added.

Also on the central bank’s agenda is the asset-quality review of European banks. Before it takes over responsibility for supervision next year, any capital shortfalls will need to be made up by governments or the region’s bailout fund, said Draghi. Because the financial sector is the intermediary between the ECB’s monetary policy and the real economy, banks across the euro region must be open about the risk that remain on their balance sheets. That transparency is a prerequisite for restoring “lasting health” in the banking sector, he said, adding that the central bank can’t help lenders recapitalize.

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“It is –- first and foremost –- the responsibility of shareholders to ensure that their bank is solvent and able to sustain its core business,” Draghi said. “And if the private sector is unable or unwilling to provide the capital necessary to achieve solvency, it is for the fiscal and regulatory authorities to decide whether and how to act.”

During the speech, Draghi also defended the ECB’s bond-buying plan, dubbed Outright Monetary Transactions, which enables the central bank to purchase bonds of euro zone member countries to bring down their borrowing costs. The program, which as announced in mid-2012, has made the euro area a “more stable and resilient place to invest in than it was a year ago,” Draghi said. “This important improvement largely reflects the removal of unwarranted fears of a systemic collapse of monetary union that was previously priced in by markets.” But the German Constitutional Court is still determining whether the bond-buying plan is compatible with German primary law and a hearing will be held later this month.

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