European central bankers warned that risks to the region’s economy, including trade tensions and high government debt, are growing. They met in Portugal this week.
Falling inflation and improving growth in the eurozone were overshadowed by the victory of Marine Le Pen’s far-right Eurosceptic party in the first round of France’s parliamentary elections at the European Central Bank’s annual conference in a luxury hotel in Sintra, near Lisbon.
ECB governing council members told the Financial Times it was too early to speculate on whether they could be forced to intervene if France suffered a “Liz Truss moment”, referring to the debt crisis triggered by the former British prime minister’s unfunded tax cuts in 2022.
Most, however, saw the French elections as a sign of a broader shift in a more populist, protectionist and turbulent direction, one that is likely to hit Europe harder than most parts of the world.
Pierre Wunsch, governor of the Belgian central bank, warned that the US and China are outdoing Europe with subsidies and tariffs.
“We are moving into a world that is more disruptive and much more transactional and that is problematic for Europe,” he warned. “We don’t have a clear story to present to people.”
The US has significantly increased tariffs on several imports from China, including electric vehicles and semiconductors. The EU has followed suit to a lesser extent, imposing higher duties on Chinese imports of electric vehicles. These duties will take effect on Thursday.
Beijing has threatened to retaliate against the measures. Trade tensions could rise if Republican candidate Donald Trump wins the November election after he pledged to slap an extra 10 percent tariff on all imports from Europe. More than half of the eurozone’s gross domestic product is generated by exports, making it particularly vulnerable to a trade war.
Jan Hatzius, chief economist at Goldman Sachs, said in a presentation in Sintra that Trump’s pledge to raise tariffs on EU imports by 10 percent would hit the eurozone economy disproportionately hard. He predicted that EU GDP would fall by 1 percent, while US GDP would fall by just 0.1 percent.
Such a shock would be enough to more than wipe out the 0.9 percent growth the ECB expects for the eurozone this year.
“Europe is a legal construct that moves slowly on a level playing field,” Wunsch said. “In a transactional world where others use tariffs or subsidies and don’t share our climate ambitions, it’s now a challenge for us.”
Gabriel Makhlouf, governor of the Irish central bank, said: “I am particularly concerned about the geopolitical scene and economic fragmentation. All indications are that it will go further.”
“I expect some kind of supply shock,” he added. “It will have a price impact and accelerate the steps to become more self-sufficient, so that we are less dependent on other countries. The biggest losers will be the small countries.”
Bostjan Vasle, governor of Slovenia’s central bank, said the possibility that governments will not reduce their budget deficits as required under revised EU debt rules is another risk policymakers face. “Fiscal policy could also add risks if current fiscal consolidation plans are not realised.”
Vasle declined to comment specifically on the French election, but said: “It is very important to have stability in the eurozone, politically, socially and financially. We have instruments that allow us to intervene to defend financial stability if there is an unjustified and disorderly market dynamic. But we are not at that stage yet.”
Investors speculated that the French election could trigger a bond market sell-off that would force the ECB to intervene with its new but untested debt-buying program, the transmission protection instrument. But Wunsch said it was “far too early to talk about the TPI.”
Several central bankers predicted that the risk of a market collapse would be enough to deter the next French government from spending. “All governments in my experience realize that there is a difference between the reality of governing and the reality of campaigning,” Makhlouf said. “You only have to look at Liz Truss to realize that.”
Ratemakers were broadly in agreement that inflation was heading in the right direction. This was supported by figures released on Tuesday showing that eurozone inflation had resumed its downward trend to 2.5 percent in the year to June, after a brief rebound to 2.6 percent in May.
But they will almost certainly leave interest rates unchanged at their meeting in two weeks’ time, after cutting them last month for the first time in almost five years. ECB President Christine Lagarde said they could afford to “take time to gather new information” given how unemployment in the euro zone has remained at record lows.
Vasle said the “surprisingly strong” labor market was boosting wage growth and keeping inflation above 4 percent in the labor-intensive services sector. “The anecdotal evidence is that in many countries, including mine, it looks like it’s going to be a very good tourist season because people are willing to spend money on services and that’s not going to help disinflation.”
Shortly before hosting a closing dinner on Wednesday evening, the governor of the Portuguese central bank, Mário Centeno, expressed frustration over the recent surge in support for populist, Eurosceptic political parties opposed to closer European integration.
He called this “a paradox” given the way governments and the ECB had taken unprecedented measures to protect jobs, prevent businesses from going bust and avoid a European financial crisis after the pandemic.
“It’s so hard to get a positive message across to people when they’re always hearing about the huge challenges ahead of them and the sacrifices they have to make — we have to focus on the accomplishments,” Centeno said. “It’s not that bad.”