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Germany seen keeping wallet closed as Draghi rails against inaction

Outgoing European Central Bank President Mario Draghi famously said the ECB would do "whatever it takes" to save the euro, but made it very clear at his last press conference who needs to take the baton from here.

"Almost all the things that you see in Europe, the creation of more than 11 million jobs over a short period of time, the recovery, the sustained growth for several quarters were by and large produced by our monetary policy," he said after announcing a reactivation of quantitative easing and a further reduction of rates into negative territory.

"So now it’s high time I think for the fiscal policy to take charge," he said.

His pleas are likely to fall on deaf ears.

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While Draghi suggested that any country with room to increase spending should do so, the biggest wallet by far belongs to Germany, the largest economy in Europe and warden of one of the lowest debt-to-GDP ratios in the region. It also has highly restrictive fiscal rules.

Finance Minister Olaf Scholz used a Sept. 10 address to the Bundestag, Germany's parliament, to reiterate the country's commitment to a balanced federal budget.

Scholz stressed the government is prepared to release "many, many billions of euros" in order to tackle an economic crisis, but the terms of the German constitution place strict limits on spending.

There may be extra funding for environmental spending such as subsidies for cleaner cars and heating systems, but Berenberg Economics expects a fiscal expansion in 2020 and 2021 in the order of 0.4%-0.5% of GDP, only slightly higher than the 0.3%-0.4% in 2019.

"Any additional German stimulus will likely be reactive and gradual, rather than proactive and immediately growth enhancing," said Mark Haefele, global chief investment officer at UBS, while Berenberg's Holger Schmieding said, "the German stimulus will not be a European — let alone a global — game changer."

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The fiscal room for maneuver differs broadly across the eurozone. Greece, Italy and Portugal ended 2018 with government debt as a percentage of GDP at 183.3%, 132.1% and 121.4%, according to the IMF, while France and Spain are also stretched at 99.2% and 96%.

That leaves the burden of fiscal loosening on less indebted countries such as Germany, which has debt-to-GDP of 59.8%, and the Netherlands with just 54.4%.

The latter is trailing an investment fund and a €3 billion tax cut for households to help bolster sluggish growth, but it is Germany that economists would really like to see open its spigots.

In fact, fund managers from around the world polled by Bank of America Merrill Lynch this month said that a German fiscal stimulus is the number one policy they want to see to spur global growth, ahead of a 50 basis point rate cut by the Federal Reserve or Chinese infrastructure spending.

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"The eurozone is experiencing a lack of aggregate demand relative to supply," Andrew Bosomworth, head of portfolio management at Pimco in Germany, wrote in a research note. "[The] monetary policy decisions will help spur demand, but fiscal policy — such as government stimulus packages — could have a more direct and larger effect."

Headline inflation in the eurozone slowed to just 1% in August, well short of the ECB's 2% target, while the region's growth was just 0.2% in the second quarter, down from 0.5% in the January-March period.

To tackle that, the ECB cut 10 basis points off the deposit rate to negative 0.5% and indicated further cuts are possible. More importantly though, it said it will restart monthly bond purchases on Nov. 1 on an open-ended basis with the intention of lowering government borrowing costs and supporting fiscal policy.

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But the additional stimulus is unlikely to boost growth or inflation significantly, according to Marion Amiot, senior economist at S&P Global Ratings. "Risks to growth stem from weak external demand and geopolitical uncertainty, which is not something the ECB package will change," Amiot said.

Draghi's call for fiscal stimulus comes at a potentially crucial time for the eurozone economy, with some saying that it has already showing signs of being stuck in the low growth, low inflation, low rates rut known as Japanification.

To markedly improve the eurozone economic and inflation outlook, a region wide fiscal stimulus of 1%-1.5% would be required, according to Dutch bank ABN Amro. However, that prospect is not likely, according to Nick Kounis, head financial markets research. "The ECB may rightly wish that central bank stimulus was not "the only game in town," but that looks likely to remain the case."

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