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Deepening EU slump may force Draghi to pull QE trigger

Europe's foundering economy sprung new leaks Thursday – and they're serious enough to turn up the heat on the European Central Bank to get off its hands and deliver a quantitative-easing lifeline.

New data showed that the euro zone's economy stalled utterly in the second quarter, with gross domestic product unchanged from the first quarter – short of even the puny 0.1-per-cent quarter-over-quarter gain that economists had anticipated. On a year-over-year basis, euro zone growth is now a tepid 0.7 per cent.

Most worrisome was that Germany, the economic powerhouse of the region that has been a critical source of strength up until now, saw its GDP shrink by 0.2 per cent in the quarter, its first contraction in five quarters. France, the currency group's second-biggest economy, was flat.

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At the same time, the euro zone's inflation has now slumped to financial-crisis levels. The July inflation rate came in at 0.4 per cent, the lowest since October, 2009.

The numbers point to a couple of unpleasant conclusions: That Europe's economic struggles are broadening from the long-standing weakness of its periphery to increasingly infect its core, and that despite the ECB's efforts to date, the deflation threat looms larger than ever.

Certainly, the Russian trade sanctions over Ukraine have dropped an anvil on the euro zone's best-laid recovery plans. Russia is the European Union's third-biggest trading partner; Germany, the EU's biggest economy and a massive exporter, has particularly close trade ties to Russia, stemming in part from the relationships between the Soviet Union and East Germany forged in the old Communist-era days.

Since the recession, Russia has been one of the EU's fastest-growing markets, with an average export growth of better than 16 per cent a year. In short, Russia had been an important source for growth as the euro zone struggled to get its economic head above water; now, Russia may be the thing to dunk it back under again.

Not that it has ever really surfaced anyway. National Bank senior economist Krishen Rangasamy points out that the euro zone's GDP, in real (i.e. inflation-adjusted) terms, is still 2.4 per cent below its pre-recession peak, in the first quarter of 2008. Excluding Germany, the GDP in the rest of the euro zone is 4.8 per cent below the pre-recession peak.

Even by the tepid standards of other advanced economies, Europe has been a massive laggard in the post-recession recovery. And with conditions now showing further erosion, the threat of the euro zone slipping into a deflationary spiral is inching closer – an event that would have serious ramifications for not just European but global economic and financial stability. It simply can't be allowed to happen.

The ECB acted last June to try to stimulate the euro zone economy and reverse the inflation's slide into dangerously low territory – cutting interest rates to the bone and making cheap loans available to banks. At the time, ECB boss Mario Draghi indicated that the central bank was prepared to pull out even more ammunition if necessary. He may have little choice than to do so now.

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Mr. Draghi may be tempted to give his June actions more time to take hold and create the desired spark, but it's hard to overlook the fact that since he implemented them, things haven't just not improved, they have gotten worse. Mr. Draghi's wiggle room is shrinking to an uncomfortable squeeze.

Just last week, the ECB stood pat on its monetary policy, but Mr. Draghi and his colleagues will be under intense pressure ahead of next month's policy meeting to haul out the big guns to halt the deterioration. That means, finally, pulling the trigger on quantitative easing – asset purchases by the bank aimed at directly injecting monetary stimulus into the market.

Mr. Draghi has so far resisted this extraordinary action – which, while similar to what the U.S. Federal Reserve has been doing for years now, would be unprecedented for the euro zone, and it's not altogether clear how it could be implemented under the laws governing the 18-country monetary partnership. However, the ECB earlier this year opened the door to using QE if necessary. There had been some hope that the mere talk of QE would shift market sentiment enough to give Europe the desired lift (through a lower euro and more attractive lending rates), but it clearly hasn't been enough. It may be time for the ECB to put its money where its mouth is.

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About the Author
Economics Reporter

David Parkinson has been covering business and financial markets since 1990, and has been with The Globe and Mail since 2000. A Calgary native, he received a Southam Fellowship from the University of Toronto in 1999-2000, studying international political economics. More


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