European Central Bank presidents meeting in Portugal this week warned that risks, including trade tensions and rising government debt, are building up for the region's economy.
At the European Central Bank's annual meeting in a luxury hotel in Sintra, near Lisbon, falling inflation and a recovery in growth in the euro zone were overshadowed by the victory of Marine Le Pen's far-right euroskeptic party in the first round of French parliamentary elections.
ECB Governing Council members told the Financial Times that it was too early to speculate whether they would be forced to intervene if France were to suffer a “Liz Truss incident” – a debt crisis triggered in 2022 by the former British prime minister's unfunded tax cuts.
But most see the French election as a sign of a broader shift toward a more populist, protectionist and destabilizing direction that is likely to hit Europe harder than most of the world.
Belgian central bank governor Pierre Wunsch warned that the United States and China were getting ahead of Europe with subsidies and tariffs.
“We are moving towards a more chaotic and much more traded world and that's a problem for Europe,” he warned. “We don't have a clear narrative to offer our citizens.”
The United States has significantly increased tariffs on a range of imports from China, including electric vehicles and semiconductors, and the EU has followed suit, increasing tariffs on electric vehicle imports from China, due to come into effect on Thursday.
China has warned it would retaliate against such moves. Trade tensions could escalate if Republican candidate Donald Trump wins the November election pledging to impose an additional 10% tariff on all European imports. The euro zone is particularly vulnerable to a trade war because exports generate more than half of its gross domestic product.
Speaking in Sintra, Goldman Sachs chief economist Jan Hatzius said Trump's pledge to raise tariffs on EU imports by 10% would hit the euro zone economy disproportionately hard, predicting that EU GDP would fall 1% while U.S. GDP would fall just 0.1%.
Such a shock would be enough to wipe out the ECB's forecast for euro zone growth of 0.9% this year.
“Europe is a legal structure that moves slowly on a level playing field,” Wunsch said. “It's difficult for us now in a trading world where other countries use tariffs and subsidies and don't share our climate ambition.”
“We are particularly concerned about the geopolitical situation and the fragmentation of our economies, and all the signs point to more of that to come,” said Gabriel Makhlouf, governor of the Central Bank of Ireland.
“We expect there will be some kind of supply shock,” he added. “It will impact prices and will lead to a faster move towards self-sufficiency and less reliance on other countries. The biggest losers will be smaller countries.”
Slovenia's central bank governor, Vosjan Vasle, said the government's failure to reduce the budget deficit as required by revised EU debt rules was another risk policymakers had to contend with. “Fiscal policy could also increase risks if the current fiscal consolidation plans do not materialize.”
While avoiding specific comments on the French election, Basr said: “Political, social and financial stability in the euro area is very important. There are certainly tools available to intervene to protect financial stability if market movements become irrational and disorderly. But we are not at that stage yet.”
Investors have speculated that the French election could trigger a bond-market selloff, forcing the ECB to step in with a new but untested bond-buying tool, the Transmission Protection Instrument (TPI).But Wunsch said, “It's too early to talk about TPI.”
Several central bankers predicted the risk of a market collapse would be enough to deter the next French government from rushing to spend.“In my experience, all governments recognise that there is a difference between the reality of governing and the reality of campaigning,” Mr. Makhlouf said.“You only need to look at Liz Truss to see that.”
Rate-setters are broadly in agreement that inflation is heading in the right direction, a view borne out by data released on Tuesday that showed euro zone inflation briefly rising to 2.6% in May before reverting to a downward trend to 2.5% in the 12 months to June.
But the ECB, which cut interest rates last month for the first time in five years, is almost certain to keep them on hold when it meets in two weeks, and ECB President Christine Lagarde said the central bank could afford to take “time to gather new information” given that euro zone unemployment remains at a record low.
Vasl said a “surprisingly strong” labour market was driving wage growth and keeping inflation in the labour-intensive services sector above 4%. “Anecdotal evidence suggests that we're going to have a very good tourist season in many countries, including my own, because people are willing to spend money on services and that won't lead to deinflation.”
Speaking shortly before hosting the event's concluding dinner on Wednesday night, Portugal's central bank governor, Mário Centeno, expressed frustration at the recent surge in support for populist eurosceptic parties that oppose greater European integration.
He said this was a “contradiction” given the unprecedented measures governments and the European Central Bank have taken to protect jobs, prevent business failures and avert a European financial crisis in the wake of the pandemic.
“It's very hard to convey a positive message when people are constantly hearing about the huge challenges that lie ahead and the sacrifices that will have to be made. We should focus on the accomplishments,” Centeno said. “It's not such a bad thing.”
