Recovery in Europe Best News for Spain

December 2nd, 2009

Once a star performer in Europe’s 11-year old monetary union, Spain has become the wayward laggard. Growth data last week showed the Spanish economy – hit badly by a property market collapse and soaring unemployment – stuck firmly in recession in the third quarter, while the eurozone as a whole grew 0.4 per cent. The rollercoaster ride might suggest the European Central Bank would have difficulty calibrating policy steps to suit Spain and the other 15 eurozone countries.

During the economic crisis, Miguel Fernández Ordóñez, Spain’s central bank governor since 2006, has rarely given interviews. Talking to the Financial Times in the library of the bank’s plush Madrid headquarters, he strikes a distinctly cautious tone, but his messages are not so different from those of his colleagues in Frankfurt.

After the collapse of Lehman Brothers investment bank last year, the ECB cut its main interest rate farther and faster than ever before, to a record low of 1 per cent. He hints this monetary policy stance will remain for some time. “It is clear that any increase in [interest] rates is off the screen. The markets do not expect any change before the second half of next year,” he says.

He agrees, however, that with financial markets normalising, the ECB’s governing council should plan to remove emergency support, such as offers of unlimited liquidity for up to one year. “My reasoning is that those measures were exceptional because the markets did not work well. When the markets are working well, we should take them away because otherwise the markets will never work perfectly, ever. Support should be exceptional.”

Jean-Claude Trichet, the ECB’s president, indicated this month that the “exit strategy” would start in December, with the ending of one-year liquidity offers.

But is Spain ready for the start of such an ECB strategy, given its weak growth prospects? “Well, it’s ready for recovery,” Mr Fernández Ordóñez replies, “because recovery in Europe is the best news for Spain.” Some 70 per cent of Spain’s exports go to the eurozone, he points out. His biggest concern is that Spain pushes harder to bring public finances under control and increase labour market flexibility.

From one perspective, eurozone membership acts as a straitjacket in a downturn because devaluation is not an option. Worse, the euro is strengthening. Mr Fernández Ordóñez does not see things that way, however. “Of course you are right that we cannot devalue, and what does it mean? This means that we have to do more structural reforms so that you have the advantages [similar to those] of devaluing.”

As such, he is happy to see Spanish consumer prices falling faster than elsewhere. “Deflation in the euro area would be a disaster. But if you don’t have deflation in the euro area and we have a negative inflation differential in Spain compared with the rest of the eurozone, that would be the best thing. Reducing prices and regaining competitiveness is what we have to do.”

Story from FT.com

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