Germany close to recession as ECB admits recovery is weak

The debt markets are pricing in 0.5pc inflation in Germany and Italy over the next five years through so-called “break-even” rates, evidence that investors think the ECB is falling far behind the curve. Mr Draghi insisted that a string of measures unveiled in June were starting to work and should be enough to stave off deflation.

The ECB ignored pleas from leading economists for pre-emptive action to bolster the eurozone’s defences before an external shock hit and before the US Federal Reserve tightened monetary policy, an inflection point that risks sending tremors through the global system, according to a paper by the Chicago Fed.

Hopes for a swift rebound in Germany are fading. The economics ministry said new orders in manufacturing fell 3.2pc in June, with orders from the rest of the eurozone collapsing by 10.4pc. “What this shows is that Europe is nowhere close to recovery. Monetary policy has run out of traction,” said Steen Jakobsen from Saxo Bank.

The worry is what will happen over coming months as sanctions against Russia bite in earnest. The European Commission said the measures were likely to shave 0.3pc off the eurozone’s GDP this year, with most of the effect concentrated in the second half.

This was before Russia retaliated with a sweeping ban on all imports of meat, fish, dairy products, fruit and vegetables from the EU and the US.

The euro fell to a nine-month low of $1.3347 against the dollar after Mr Draghi said the “fundamentals for a weaker exchange rate are much better than they were two or three months ago”, a clear attempt to drive down the currency by verbal means. “Mr Draghi could barely hide his enthusiasm for the weaker euro,” said Ken Wattret ,from BNP Paribas.

A weaker euro should prove a buffer against deflation but the damage already runs deep. Italy has fallen back into a triple-dip recession, with GDP returning to levels last seen 14 years ago. The toxic mix of recession and very low inflation is a grave threat to Italy’s debt trajectory.

The public debt ratio jumped from 130.2pc to 135.6pc of GDP in the first quarter from a year earlier and will now rise again, despite austerity measures and a primary budget surplus.

“The picture is getting worse rather than better. We are going to get to 140pc for sure next year. Nobody knows when the markets will react,” said a senior Italian banker.

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