One of our six European chief economists’ views, from BNP Paribas Investment Partners’ William De Vijlder, sums up a theme of this month’s special report: “Depending how one looks at it, a lot or very little has changed in the last nine months.”
Our lead article tells the story of how ECB president Mario Draghi calmed – indeed galvanized – financial markets with his “whatever it takes” promise. But it also reflects the view that the ECB is limited to providing a window of opportunity to address deeper problems of divergent growth and competitiveness, and that the euro-zone is slipping deeper into recession.
A number of commentators question the appropriateness of fiscal austerity but the greater focus is on the limits to monetary policy imposed by the continent’s broken transmission mechanism. Our lead article outlines the halting progress towards European banking union. A number of our chief economists’ viewpoints emphasise the importance of this progress for enabling bank recapitalisation via the European Stability Mechanism (ESM) and this is at the heart of the commentary by Michael Howell of CrossBorder Capital on euro-zone flows.
Opinion is split as to whether the resolution of the Cypriot banking crisis was a step towards or away from establishing the resolution pillar of European banking union – or indeed whether it has any relevance to wider European questions at all. The response of bank-capital markets suggests that it might – a subject we explore in ‘The Cyprus syndrome’.
But if a broken banking system is at least partly to blame for Europe’s lack of growth, there is no doubt that Draghi’s intervention took the pressure off of its sovereigns. Credit is also extended to the Fed, the Bank of England and, especially, the Bank of Japan.
Is this a good thing? If turning on the liquidity is meant to open a window of opportunity in which to get fundamental things done, governments defeat the object if they use it to procrastinate. And we are not just, or even primarily, talking about the periphery, here. As Lorenzo Naranjo and Carmen Stefanescu of ESSEC Business School suggest in their commentary, much European bond market price action of the past five years has to be explained, not in terms of flight-to-quality but rather flight-to-liquidity. They conclude that this is the only way to explain the remarkably low spreads in French bonds.
We tackle this question in our article looking specifically at French and Dutch bond markets, and find that their size and liquidity accounts for their combination of falling yields and declining credit quality.
For some, like Poul Thybo of Austrian pension fund APK, this is destined to end in tears: “Investors will wake up one day and say, ‘Why should I buy all this risk without getting paid?’” For others, it indicates that the market feels we have moved into a new phase: from imminent catastrophe in the periphery to a ‘normal’ euro zone-wide recession that just happens to go on for quarter after quarter after quarter.
Is that progress? We hope that our report might help you make up your mind.