IMF downgrades eurozone growth post-Brexit

Posted on July 8, 2016

ECB announces surprise rate cut to historic low to spur growth...epa04383668 (FILE) A file photo dated 07 August 2014 showing a over-sized barbed wire, part of an installation, seen in front of the European Central Bank (ECB) in Frankfurt Main, Germany. The European Central Bank (ECB) announced surprise interest rates cuts on 04 September 2014 as it steps up its efforts to spur economic growth in the eurozone and to fight the threat of deflation. The Frankfurt-based ECB said it had trimmed its benchmark refinancing rate for the second time in three months, lowering to a historic low of 0.05 per cent. The bank also lowered its deposit rate, which is the rate charged for banks depositing funds at the ECB, deeper into negative territory, cutting it by 10 basis points to minus 0.2 per cent. The move sent the euro down to 1.3 dollars, while shares climbed on markets across Europe. EPA/BORIS ROESSLER©EPA

The International Monetary Fund has downgraded its projections for growth in the euro area, arguing the UK’s decision to leave the EU will dent the region’s economic recovery over the next two years.

The IMF said on Friday that it expected the eurozone’s economy to grow by 1.6 per cent this year and 1.4 per cent in 2017, down from earlier estimates of an 1.7 per cent expansion for this year and next. Those earlier estimates were made just ahead of the Brexit vote.

    Mahmood Pradhan, deputy director of the IMF’s European department, said the numbers had been marginally reduced, with a “strong caveat that this is an early assessment”.

    “We are worried about investment and confidence . . . There is a substantial rise in risk aversion which is raising the cost of capital. That’s not across the board at the moment, but it’s quite widespread,” Mr Pradhan said. “If risk aversion is protracted, it will weigh on investment and it will weigh on confidence.”

    The IMF’s estimates are based on the UK and the EU reaching a favourable deal on Brexit close to the so-called Norway model, in which Britain continues to have access to the EU single market. While such a scenario would limit the economic damage from Brexit, a deal may be politically problematic because it could leave the UK unable to impose limits on immigration from within the EU.

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    Another scenario would be for the UK to quit the single market and negotiate trade deals through its membership of the World Trade Organisation.

    “The UK and the EU are big trading partners. If you went to the WTO option, just getting there would take a very long time — and that itself will be very damaging,” Mr Pradhan said. “It’s also a very significant change from the current arrangement.”

    The revised forecasts came as the IMF published its annual review of the euro-area’s economy, which raised concerns over political uncertainty.

    “We worry that the euro area is in a difficult situation,” Mr Pradhan said. “There are a whole range of risks stemming from Euroscepticism and populism. Brexit was one but there are other risks. Risks manifest themselves in a lack of compliance and governance in the euro area.”

    If the damage from Brexit turned out to be worse than expected, the IMF said the European Central Bank should unveil more stimulus, preferably by adding to its current quantitative easing programme instead of cutting interest rates deeper into negative territory.

    In depth

    Eurozone economy

    An employee shows fifty-euro notes in a bank in Sarajevo in this March 19, 2012 file photo. The European Central Bank took the ultimate policy leap on on January 22, 2015 launching a government bond-buying programme which will pump hundreds of billions of new money into a sagging euro zone economy. The Europen Central Bank (ECB) said it would buy government bonds from this March until the end of September 2016 despite opposition from Germany's Bundesbank and concerns in Berlin that it could allow spendthrift countries to slacken economic reforms. Together with existing schemes to buy private debt and funnel hundreds of billions of euros in cheap loans to banks, the new quantitative easing programme will pump 60 billion euros a month into the economy, ECB President Mario Draghi said. Picture taken March 19, 2012. REUTERS/Dado Ruvic (BOSNIA AND HERZEGOVINA - Tags: BUSINESS)

    News and analysis of the single currency bloc’s fragile recovery as it attempts to regain competitiveness in the wake of the sovereign debt crisis and its struggles with austerity

    “We would prefer more asset purchases,” Mr Pradhan said. “We see limits to moving interest rates much further.” The ECB is buying €80bn of mostly government bonds a month and has said it will continue to do at least until March 2017.

    There are fears some national central banks could run out of assets to buy, but the IMF said policymakers could expand the universe of bonds available for purchase. Options include scrapping limits on central bankers buying bonds with yields lower than the ECB’s deposit rate of minus 0.4 per cent, as well as the amount of one particular type of bond that the ECB can own.

    The IMF ramped up its calls for eurozone leaders to join forces and unveil a package of spending measures and tax breaks to boost the region’s economic prospects.

    It also criticised European banks for their failure to write-off bad loans, saying the amount of non-performing loans remained too high and lenders had been too slow to tackle such problems.

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