Macroscope | Why Europe’s success could prove to be its undoing

For once, the European Central Bank has been doing the right thing. Regularly blamed for not doing enough, or being too late with policy solutions, the ECB’s monetary super-stimulus is finally paying dividends. Euro-zone growth is outpacing its Group of Seven (G7) partners and the bloc’s unemployment rate has fallen dramatically. Understandably it is building hopes for sustainable recovery ahead.

Things are clearly looking up after years of economic poor health and crisis in Europe. Thanks to the first quarter’s 0.6 per cent GDP gain, the euro-zone economy grew at its fastest pace in five years, driven by unlikely stars such as France and Spain. Critically, the euro-zone economy has risen above its pre-crisis peak, with growth surging past the US and the UK.

Sadly, the euro zone’s success could easily prove to be its undoing. The more euro-zone growth gets onto a stronger footing, the more it strengthens the case for Germany’s hawkish central bank to put a future block on open-ended ECB easing. Unfortunately, the recovery still needs more careful nurturing to deal with major economic headwinds coming the euro zone’s way.

External risks and internal frictions still pose serious pitfalls for the economy. Slowing global growth, entrenched deflation pressures and deepening financial market uncertainty have enough potential to derail the euro zone’s nascent recovery. The euro zone also needs to chart its way through dangerous political waters. Threatened exits by Britain and Greece out of the European Union could trigger deeply troubling shocks to the euro zone economy up ahead.

While the recovery in growth is clearly welcomed, it is raising concerns in Germany that the ECB is going over the top with too much stimulus. Negative interest rates and vast infusions of quantitative easing (QE) money might have put the euro zone back on track to recovery, but German policymakers are worried that too lax policy will open up the floodgates to overheating and inflation risks down the line. The economy may be getting too much of a good thing.