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Global economic slowdown looms, exposing outgunned central banks

The European Central Bank, based in Frankfurt, Germany, has cut its 2019 growth forecast in light of concerns about the global economy.
The European Central Bank, based in Frankfurt, Germany, has cut its 2019 growth forecast in light of concerns about the global economy. (Thomas Lohnes/Getty Images)

The European Central Bank on Thursday unveiled a new economic rescue package, citing a darkening outlook driven by a slowdown in China, fears that the United Kingdom will make a chaotic exit from the European Union and aftershocks from President Trump’s tariff wars.

The mounting worries prompted the bank to cut its growth forecast for 2019 by nearly one-third to just above 1 percent. ECB President Mario Draghi also said he would maintain rock-bottom interest rates through the end of this year, several months longer than previously planned, and funnel more credit to banks in hopes of spurring business lending.

The move came less than three months after European authorities said the 19-nation euro zone economy no longer needed unusual help, capping more than a decade-long $3 trillion stimulus following the global financial crisis.

Thursday’s about-face sounded alarms about a global slowdown that caught officials off guard.

“It’s a highly significant move,” said Adam Tooze, a Columbia University historian and author of “Crashed,” a history of recent financial crises. “It’s a testament to the anemic quality of Europe’s recovery and the [failures] of the ECB that we’ve had to go through this roller coaster.”

For now, the United States remains an island of relative stability, though Federal Reserve officials in recent days have voiced concerns that the economic expansion could be fraying. The Dow Jones industrial average fell more than 200 points or nearly 1 percent on the European announcement.

Despite the accumulation of bad news, the global economy is still likely to grow this year. The bigger concern is that central banks like the ECB have little ammunition to fight a deeper downturn, whether triggered by events in Europe or elsewhere.

European interest rates are already negative, meaning that banks actually pay authorities in Frankfurt to hold their deposits.

In the United States, the Fed’s benchmark lending rate is less than one-half what it was on the eve of the global financial crisis. So Chair Jerome H. Powell would have little room to cut rates to spur growth if a recession occurs.

“What’s scary is this is the ECB signaling they are running out of ammo,” said Adam Posen, a former member of the Bank of England’s monetary policy committee. “If we overshoot into a genuine recession, that’s why I get genuinely freaked out.”

If that happens, European monetary authorities will have the greatest difficulty. The Federal Reserve and the People’s Bank of China are in relatively better shape, he added.

Fed officials have changed their thinking about how high interest rates should be when the economy is purring at an ideal pace, one that doesn’t need to be accelerated or cooled down.

Before the financial crisis, the Fed believed that inflation-adjusted “neutral” rate was 3 percent. Today, it’s probably around 1 percent.

The likelihood that rates will often be lower than in the past — even when the economy is growing at its potential — “limits the amount of space available for cutting the federal fund rate to buffer the economy from adverse developments,” Lael Brainard, a member of the Fed’s Board of Governors, said Thursday in a speech at Princeton University.

If needed, the Fed could resume its bond purchases, known as quantitative easing.

Along with such monetary tools, the United States could raise spending or cut taxes to fight rising unemployment. The Trump administration already cut taxes by $1.5 trillion in 2017, helping drive the national debt to nearly $22 trillion.

So far, even as the public debt swells, financial markets have been willing to lend the government as much as it wants. Borrowing costs, measured by the 2.6 percent yield on the 10-year Treasury security, are less than one-half the 50-year average.

Investors may not remain so sanguine indefinitely.

For now, the economy is humming. Job growth in the United States remains robust, with employers hiring nearly 240,000 workers each month over the past year. Small businesses broke a 45-year-old record for job creation in February, according to the National Federation of Independent Business.

Brainard cited recent statistics on retail sales, consumer confidence and residential construction that suggested a “softening” of economic activity. The economy in the first quarter has all but stalled, growing at an annual rate of just 0.5 percent, according to the Federal Reserve Bank of Atlanta’s GDPNow forecast.

Weakness abroad reverberates in the United States through lower orders for American exports and financial market volatility, she added. More than 40 percent of sales by companies in the Standard & Poor’s 500-stock index, a key stock market benchmark, come from overseas.

“We are more vulnerable than what people are suggesting,” said Torsten Slok, chief international economist for Deutsche Bank.

Indeed, in Paris on Wednesday, Laurence Boone, chief economist for the 36-nation Organization for Economic Cooperation and Development, gave a downbeat assessment of the global outlook before cutting her forecasts for the global economy and every advanced nation.

“It does not look very good,” Boone said. “Global growth looked really good in 2017 but it has slowed markedly since then.”

Her formal presentation carried a stark warning: “Vulnerabilities in China, Europe and financial markets could derail the global economy.”

Tensions from the trade war between the United States and China, along with uncertainty over the U.K.’s planned Brexit, have sapped consumer and business confidence. China, where government leaders have been trying to wean the economy from its addiction to debt-fueled growth, also is slowing more sharply than had been anticipated.

In the fourth quarter, world trade volume fell by 0.9 percent, its worst performance since 2009, according to the CPB Netherlands Bureau for Economic Policy Analysis.

The ECB’s actions indicate that the authorities expect economic weakness to persist for at least a year, according to Carl Weinberg, chief international economist at High Frequency Economics. “They’re a little bit more worried than Dr. Draghi has let on,” Weinberg told clients on a Thursday webinar.

The global downturn reflects a buildup in business inventories and should be “short and shallow,” Weinberg said. “All recessions do not have to result in a financial crisis.”

Still, Dan Alpert, managing partner of Westwood Capital, said Europe’s weakness will inevitably spill over into the United States and China. As the euro weakens, European customers won’t be able to afford as many American or Chinese exports.

“This is no way to run a global economy,” Alpert said.