Strong Eurozone Growth Shows Payoff of ECB Stimulus

As the European Central Bank moves toward phasing out its stimulus, evidence of a robust eurozone economy is emerging to suggest the program has achieved its aim.

Two-and-a-half years into the ECB's controversial bond-buying program, known as quantitative easing, the eurozone economy is the strongest it has been since before the global financial crisis. It has grown by 3.6% since the start of QE and created more than four million jobs, according to the ECB.

Data to be released over the coming weeks -- including second-quarter growth figures on Aug. 16 -- are likely to be "remarkable," said Ken Wattret, an economist with TS Lombard in London.

Against that backdrop, the ECB's aggressive stimulus, comprising subzero interest rates and bond purchases of EUR60 billion ($68.5 billion) a month, looks increasingly excessive.

"The news flow will be a strong reinforcement of the case that something needs to be done" by the ECB, Mr. Wattret said.

Nevertheless, investors appeared to be caught off-guard when ECB President Mario Draghi signaled last month that the central bank might respond to the improved economic outlook by reducing its monetary stimulus. Critics of such a move stress that the ECB targets not growth but inflation, which remains too weak. The ECB aims to keep inflation at just below 2%, but it was just 1.3% last month.

Even on that front, however, the ECB hasn't done a bad job. Inflation is roughly 2 percentage points higher than when QE was launched in early 2015, and approaching the ECB's target. Core inflation -- excluding volatile food and energy prices -- has risen to 1.1%, just off a four-year high. Many economists argue that central banks are bound to be unable to target inflation with a high degree of precision.

Crucially, central banks need to move early when the economy is heating up to ensure that inflation doesn't rise too quickly, because their policies act with a time lag of two or three years. Even if the ECB acts quickly to wind down QE, it is likely to keep adding to its stockpile of bonds until at least the middle of next year.

To be sure, policy makers don't fully understand why inflation hasn't picked up more. The ECB has repeatedly been forced to cut its inflation forecasts, most recently in June.

Economists have suggested a range of reasons for the weakness in global inflation, including poorly understood technological advances, aging populations and globalized supply chains that restrict workers' ability to press for higher wages.

Increasingly, though, major central banks have dismissed the importance of that weakness, and expressed confidence that normal economic relationships would reassert themselves as growth picks up around the world.

The global economy is likely to expand by 3.5% this year, up from 3.1% last year, according to the International Monetary Fund. That should spur higher prices for commodities and other products.

The U.S. Federal Reserve and the Bank of England both recently signaled that low inflation rates wouldn't deter them from moving toward higher interest rates.

In Portugal last month, Mr. Draghi listed a range of factors holding down eurozone inflation, including external price shocks, a large number of underemployed or discouraged workers, and recent low inflation.

"These effects, however, are on the whole temporary and should not cause inflation to deviate from its trend over the medium term," Mr. Draghi said.

That judgment has found echo elsewhere.

"Inflation can't be this way forever," said Stefan Gerlach, deputy governor of Ireland's central bank until 2015 and now chief economist at EFG Bank in Zurich. "With economic growth this strong, and global, the balance of evidence suggests this might start feeding into inflation."

Fed Chairwoman Janet Yellen signaled this week that the U.S. central bank is still anticipating further rate increases despite low inflation, which is also dogging the U.S. economy.

Ms. Yellen told Congress on Thursday that a stronger labor market and rising prices of imported goods supported her expectation that a recent downturn in inflation would prove transitory. Still, she said officials were watching inflation data "very carefully."

The Fed's preferred measure of core inflation was just 1.4% in May, and has languished below its 2% target for most of the past five years.

(END) Dow Jones Newswires

July 14, 2017 13:24 ET (17:24 GMT)