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ECB policymakers try to keep a brave face

Validity of the resilience hypothesis will determine whether the ECB can stick to its path out of stimulus


THE euro-zone economy is testing the mettle of European Central Bank policymakers, who need to judge whether a multitude of uncertainties are crystallising into serious risks to growth.

Officials are putting faith in domestic resilience and say temporary factors that dragged on the third quarter should fade. The broad message: after a period of youthful exuberance, it's more a case of the expansion hitting middle age than moving into terminal decline.

But there's concern too, with President Mario Draghi warning on Friday of a rise in trade uncertainty. He also highlighted the potential for external risks to seep into the euro economy, damage sentiment and put the brakes on investment.

"We need to monitor these trade risks very carefully over the coming months," Mr Draghi said. "However, we still see the overall risks to the growth outlook as broadly balanced, in large part because the underlying drivers of domestic demand remain in place." Recent numbers paint a grim picture, with growth slowing and Germany, the euro area's biggest economy, shrinking for the first time since 2015.

Business confidence has weakened and there's reasons to fear for the outlook given the protectionist threats and ongoing budget battle in Italy. The euro fell to a 17-month low earlier this week.

The validity of the resilience hypothesis will determine whether the ECB can stick to its path out of stimulus. The next crunch call comes in December, when the bank will have new forecasts and a clearer view of how material the risks are, and whether "balanced" needs to be replaced by "downside." Previous cycles suggest the expansion may have the legs to power through the headwinds.

For now, policymakers are sticking to the glass-half-full view. This week, Bundesbank president Jens Weidmann said the recovery remains "intact" and ECB Executive Board member Peter Praet that demand is still "robust." The next step is raising interest rates. That's not expected until late 2019, though some economists are already questioning the timing of liftoff and the pace of any subsequent tightening.

Taken alone, the ECB is also sanguine about the potential for disruption. Brexit, whatever its form, will hurt the UK more than the Europe; direct trade tensions with the US have eased; and contagion from Italy has been limited.

Some businesses aren't so sure everything can be dealt with separately. For companies with a global reach, trade tensions between the US and China have already eaten into profits, reducing their capacity to bolster European operations.

"We must absolutely be aware of the necessity to find ways to de-escalate," BMW AG's chief financial officer told a Franco-German business forum in Paris last week. "Why? Because it's less money to invest in the future." BLOOMBERG

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