Remember the stall speed phrase from the 2007 discussion on the US economy? “Stall speed” is a term borrowed from both cycling and aviation meaning that once an object becomes to slow, it will uncontrollably fall.
Stall speed is an important feature of the business cycle, too. Quite naturally, it is every central banker’s dream to slow down an economy just that wee bit below potential growth for inflationary pressures to subside, yet without eventually triggering recession. So far, alas, no monetary authority has ever been able to pull off that trick. And it is quite possible that setting interest rates at exactly such a level of of “slowing growth below but near potential” is monetary policy’s equivalent of the medieval alchemist’s longing to make gold.
But what is my intention behind those lines: Well, my guess is that EMU economy has already reached stall speed and the ensuing downward dynamics will force the ECB’s hand after its summer recess towards cutting rates. No matter the fact that Jean-Claude Trichet has recently been adamant about the ECB being “neutral”, i.e. neither for raising nor lowering rates, and some of his peers, e.g. Axel Weber from Germany’s Bundesbank, even hinting at higher rates.
What brings me to this conclusion? In my most recent postings I have argued time and again that a) there would be no European decoupling from a US recession, b) signs of a significant slowdown in southern Europe were already emerging, and c) rather sooner than later this weakness would also reach France and Germany. The latest readings of economic activity such as the INSEE, ifo and German labour market numbers have been in line with such a scenario.
Given the ECB’s rate stance since its inception in 1999, evidence suggests that, in fact, monetary easing is already quite close by. As a relatively simple measure that is available on a monthly basis and thus can also be empirically tested given the ECB’s relatively young history, one can take the readings of the composite PMI for the EMU aggregate. At levels below 51 points the central bank usually starts to cut rates. So with a reading of 51.9, the time has not quite come but is drawing neigh.
Another indicator would be that European central banks take a very close look at labour markets in general and the unemployment rate in particular. That’s quite sensible as unemployment is probably the best gauge of assessing the built-up of cost pressures in the overall economy. Generally, central banks in Europe have tended to embark on rate cuts once the trough in the unemployment rate has been past and rising unemployment is about to set in. Also on this yard-stick, the time has probably come for the ECB to cut rates. The overall EMU unemployment rate has levelled out at 7.1% in recent months. As with the economy, there are considerable divergences in labour market trends. Spain has seen a considerable rise in unemployment since the summer of 2007. In fact, this is happening at such a speed that the improvements still to be found in Germany and France have been completely cancelled out for the aggregate. Yet with signs of positive developments in Germany slowly petering out, we would also expect the European unemployment rates to start rising in the second half of 2008, giving the ECB a final thumps up for cutting rates.