Monetary policy in the eurozone seems to be facing a conundrum. Each time the European Central Bank signals its intention to ease its policy stance, market sentiment improves markedly, which attracts capital flows to the euro area. This in turn leads to a rise in asset prices, including the exchange rate.
The reason is that the eurozone, in particular some of its member countries, badly needs lower interest rates to achieve debt sustainability. If nominal interest rates remain above nominal gross domestic product growth, a higher primary surplus would be required to stabilise and reduce the debt, which means more austerity and a renewed risk of vicious circle of low growth and higher debt. If instead interest rates fall further, the current fiscal plans become more sustainable, which is good news for investors. Continue reading »