Could a Bubble in German be Forming?
The ECB’s latest round of easing measures address the risk of deflation, rather than the risk of a long period of low inflation. The measures will help in particular countries with high levels of private debt, such as the former bailout countries, but they also create the risk of bubbles emerging in countries such as Germany, where property markets are starting to heat up.
Implementing further easing when economic activity is picking up and broadening carries the risk that exit steps will also be taken too late and Draghi’s challenge will come when bubbles start to emerge in some countries, while others remain stuck in the re-adjustment process following the crisis.
Low returns on savings have already started to fuel demand for property, especially in Germany’s larger cities and there is the risk that the extended period of low interest rates in the Eurozone will create a similar bubble in the housing market that led to the crisis in countries such as Italy, Spain, Ireland, Greece and Portugal. The fallout from a burst bubble in Germany for the rest of the Eurozone would be very negative. So not an easy task for the ECB, which took the risk into account by excluding lending for property purchases from the new TLTRO program.
For now the measures announced last week may be appropriate, although with economic activity are already stabilising and the recovery broadening the risk is that the ECB once again is behind the curve. The real challenge for Draghi will come when there are really signs of a bubble in Germany. The crisis countries will continue to lag behind in terms of economic activity and labor market developments and pressure on Draghi to maintain the very accommodative policy will remain high. This means there is a real risk that the ECB will miss the right time to implement exit steps.
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