Analysis: U.S. stimulus should be more boon than bane for struggling Europe

FILE PHOTO: The financial district with Germany's Deutsche Bank and Commerzbank is pictured in Frankfurt
FILE PHOTO: The financial district in Frankfurt, Germany, March 18, 2019. REUTERS/Ralph Orlowski

March 16, 2021

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) – The Biden administration’s $1.9 trillion pandemic recovery package should, on balance, prove a boon for Europe, far outweighing the short-term market turbulence that has already cornered the European Central Bank into printing even more money.

The stimulus is forecast to accelerate growth in the world’s biggest economy to 6.5% this year and transatlantic trade means the euro zone should enjoy a windfall from it well into next year.

But there is a major proviso: that Europe finally speeds up its vaccination programme, gets the pandemic under control, and translates its own fiscal response into rapid action.

Europe’s economic recovery is lagging that of the United States, and moves this week to suspend use of the AstraZeneca vaccine over as yet unproven safety concerns could increase vaccine hesitancy and possibly lengthen lockdowns.

PROS AND CONS

For investors, the bond market headaches have stolen the spotlight. Better U.S. prospects have pushed up borrowing costs on both sides of the Atlantic and risk choking off recovery in the euro area, which is still mostly in lockdown.

This forced the ECB to expand its stimulus measures last week and step up pressure on governments to hurry up with their budget response, specifically a 750 billion euro ($900 billion) joint EU fund awaiting disbursement.

It should be worth it, though, and could mean less rather than more work for the ECB over time.

Faster U.S. growth means more imports of European goods, and could also put upward pressure on the dollar, which functions as de facto monetary stimulus in Europe, supporting inflation and making European exports more competitive.

Stronger U.S. fundamentals also widen the spread between U.S. and European borrowing costs, which should depress the euro and push global commodity prices higher in euro terms.

This, in turn, should help the ECB in its long-term quest of reviving inflation.

FOREIGN EXCHANGE

The European Union’s exports equal around a fifth of the bloc’s GDP and, even after a big drop in activity last year, it still generated a 150 billion euro ($180 billion) trade surplus with the United States. The Biden recovery programme can only help.

“We get somewhere between 0.3 percentage points, and if you’re optimistic, 0.5 percentage points of additional GDP,” said Barclays economist Christian Keller.

The relative strength of the euro was expected to be a drag on growth this year but the new realities could turn this around.

“It’s very difficult to see an appreciation of the euro in this environment,” UniCredit economist Erik Nielsen said.

“It’s certainly a possibility that you get a situation in the next quarter or so that the U.S. takes off and Europe still can’t get vaccination going,” he said. “Then you could see $1.15-$1.16.”

Euro depreciation could also neutralise the impact of rising U.S. yields on the euro zone yield curve.

The euro now trades around $1.19, well off highs above $1.23 at the start of the year but still 10% stronger than before the pandemic.

INFLATION

Better U.S. growth could also help the ECB via higher global inflation, a relief for a central bank that has undershot its target for what it considers healthy annual price growth for a decade and now faces credibility questions.

Commodity prices are up 16% since the start of the year and now trade near 2-1/2-year highs on expectations of a surge in growth.

While the ECB tends to look past such cyclical increases, persistently high commodity prices will eventually seep into underlying inflation, raising overall annual price growth towards its target of just under 2.0%.

NOT TOO SLOW, NOT TOO FAST

For Europe to enjoy these benefits, it first needs to get the pandemic under control as lockdowns will throttle the economy, dulling the impact of any stimulus.

“If the reason for Europe’s slow growth is lack of control of the pandemic, it could very well do what happened in the U.S. when we had our fiscal stimulus last year – that it just led to an increase in savings or frustrated demand,” said Alan Auerbach, an economics professor at UC Berkeley.

U.S. overheating is also a real risk, which could hurt Europe just as its recovery gathers pace.

Various stimulus measures over the past year are equivalent in value to around a quarter of U.S. annual GDP. Once the economy fully reopens, that extra cash along with pent-up savings could push growth too high and force the Fed to tighten policy quickly.

But even that would offer a silver lining for the euro zone, through a much weaker euro and more exports.

“If that happens, it may not be good for U.S. policy, taking account of inflation and all that, but it should be very good for Europe in terms of spillover,” Auerbach said. ($1 = 0.8391 euros)

(Writing by Balazs Koranyi and Francesco Canepa; Editing by Mark John and Kevin Liffey)