REPEAT-MNI POLICY: Draghi Economy On Course, Threats Persist

By Luke Heighton

     FRANKFURT (MNI) - The eurozone economy remains on course, despite the

recent slowdown in growth, boosted by domestic demand and rising wages, ECB

President Mario Draghi will said Friday.

     But changes in financial or liquidity conditions could force policymakers

to adjust their projected interest rate path, he said, while economic and

monetary union has become "As urgent as the first steps were in euro area crisis

management seven years ago [..] not only for the economic reasons, but also to

preserve our European construction".

     Here are the key points from the speech in Frankfurt:

     -- The underlying strength of domestic demand and wages continues to

support our view that the sustained convergence of inflation to our aim will

proceed. But in the light of the lags between wages and prices after a period of

low inflation, patience and persistence in our monetary policy is still needed.

Forward guidance is contingent on economic developments and therefore acts as an

automatic stabiliser. If financial or liquidity conditions should tighten unduly

or if the inflation outlook should deteriorate, our reaction function is well

defined. This should in turn be reflected in an adjustment in the expected path

of future interest rates.

     -- The euro area economy has now been growing for five years, and we expect

the expansion to continue in the coming years. Yet we have recently seen a loss

in growth momentum. There is certainly no reason why the expansion in the euro

area should abruptly come to an end. A gradual slowdown is normal as expansions

mature and growth converges towards its long-run potential. But the expansion in

the euro area is still relatively short in length and small in size.

     -- The slowdown can be attributed to two main factors: In the first half of

2018, weather, sickness and industrial action affected output in a number of

countries. And in the third quarter, we saw a significant disruption of car

production created by the introduction of new vehicle emissions standards on 1

September. But this effect should be temporary.

     -- We are witnessing a long-term slowdown in world trade. Some of the

factors that previously drove its rapid expansion, such as trade liberalisation

and the creation of global value chains, have waned since the financial crisis.

We are also witnessing a cyclical correction from the very strong trade growth

recorded last year. Trade dynamics are now normalising as global growth retreats

towards potential.

     -- There is some evidence that those euro area firms that are most likely

to be affected by proposed tariffs have reduced their rate of capital spending.

Moreover, the slowdown in imports has particularly affected capital and

intermediate goods, which might signal that firms are scaling back their

investment decisions. We need to monitor these trade risks very carefully over

the coming months. 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.

     -- Employment growth remains relatively strong, even though the latest data

suggest some slowdown, and appears to be resilient. However, the next leg of the

inflation process - the pass-through of wage growth to prices - remains

relatively muted. Measures of underlying inflation, such as core inflation,

continue to hover around 1% and have yet to show a convincing upward trend.

     --Insofar as world trade stabilises at a lower level, its drag on growth

could also be temporary. But there are two conditions that could make it

longer-lasting. The first is if trade uncertainty rises and dampens euro area

export performance, in particular owing to protectionism. The second condition

is if uncertainty about external demand spills over into domestic demand through

confidence and investment channels.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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