August 28, 2014 / 9:15 PM / 3 years ago

COLUMN-Russia tensions may help cut knot on euro zone policy: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own.)

By James Saft

Aug 28 (Reuters) - New tensions in Ukraine, which has accused Russia of further incursions, may serve to light a fire under efforts to bring looser monetary and fiscal policies to the euro zone.

While Russia has denied the allegations, NATO on Thursday said that well over 1,000 Russian troops were now inside Ukraine in what would represent a large increase.

This makes more likely some interruption of Russian energy shipments this winter and will exacerbate the economic effects of sanctions both sides are imposing on one another.

The net result is clearly not good for the euro zone economy, which is already struggling with outbreaks of recession in Italy, dangerously low inflation and high rates of unemployment.

“In August, economic sentiment in the Eurozone already dropped by the biggest margin since the heyday of the euro crisis in mid-2012. A further escalation would pose a serious risk of a renewed recession in the still-fragile economy,” Christian Schulz, senior economist at Berenberg Bank, wrote in a note to clients.

“The likelihood that governments and the ECB would then react with stimulus programmes, including full-scale quantitative easing, is rising.”

Already, German German Chancellor Angela Merkel has said that further sanctions will be discussed at a meeting of the European Council this weekend. That may well be called for, but will do little to encourage households or businesses to hire and spend.

Even before these developments, the euro zone economy was in need of fiscal and monetary help, a case laid out by European Central Bank President Mario Draghi last Friday in a speech at Jackson Hole, Wyoming. He called for more stimulative government spending, though without being overly specific about by whom or under what circumstances.

Draghi also acknowledged that market prices were demonstrating how very low inflation was quite possibly undermining future inflation expectations. That, rightly, has led markets to export more from the ECB by way of extraordinary monetary policy, both in the form of buying up asset-backed bonds and possibly an eventual move to buy government bonds on secondary markets.

Bond markets certainly are pricing in the risks of slow or negative growth, dangerously low inflation and economic fallout from Russia/Ukraine. The Eonia rate, a euro overnight index gauge of borrowing costs, fell to negative territory for the first time ever on Thursday, at minus 0.004 percent. Meanwhile German two-year government bunds have a negative 0.02 percent yield and 10-year German yields are at a record low 0.87 percent.


The problem, which the Russia/Ukraine situation may help to loosen, is that both main avenues for relief - monetary and fiscal policy - face substantial roadblocks.

The asset-backed bond market which the ECB is exploring supporting is relatively small, and there are both political and legal issues which may complicate large-scale outright government bond QE. Those issues won’t go away quickly, but it would not be at all surprising if the political atmosphere for ECB movement suddenly became a lot more supportive.

The ECB meets to set policy next week, and while bond buying isn’t likely, a cut in the refi and deposit rates is a possibility. I would also look to Draghi next week at the post-decision press conference to take note of the potential damage from Russia tensions and to make noises about being mindful of this in making policy.

At the very least that will drive the euro lower, which is of some help.

Similarly to QE, expansionary fiscal spending will be far from easy. The Stability and Growth Pact presents obstacles, as does the deteriorating budget situation in recessionary Italy and elsewhere.

But remember, Russia/Ukraine is an unexpected and uncontrollable outside shock of the kind to which sensible governments make some economic response. It will be far easier today for Germany to do something stimulative to protect its good farmers and savers from suffering due to Russian aggression than it would have been three months ago, when it could have been portrayed as a sop to the supposedly feckless governments of southern Europe.

All of this is a bit of a nonsense, in that 95 percent of the issue has nothing to do with Russia. But, as is so often the case, nonsense often gets things done.

To see the potential for movement on fiscal issues look at Germany’s newfound willingness to countenance a loosening of French austerity. German Finance Minister Wolfgang Schaeuble went out of his way on Thursday in Paris to say he agreed with French President Francois Hollande that public and private investment is needed to stimulate growth.

Europe’s instiutional arrangments are just as confining and difficult as they were a month ago, but Russia/Ukraine has probably made cutting the knot a bit more likely.

At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at and find more columns at Editing by Jonathan Oatis

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