Eurozone policymakers returning from the summer break will take succour from better economic data, but the fragile recovery might be derailed if there is no political agreement on issues such as European banking union.
Michala Marcussen, global head of economics at Société Générale CIB, says that for the recent green shoots of recovery to prove durable, sustainable and implemented political agreement on debt, austerity, structural reform and banking union are needed.
The jury will be out until after the German election [on September 22], but failure to reach agreement will entail a prolonged period of sub-par growth for the euro area, says Marcussen. For now, this still seems the most likely scenario.
There has been movement on some of these issues over the summer, but not always in a positive direction. German chancellor Angela Merkel, for example, has already warned that there will be no debt forgiveness for Greece.
On banking union, the European Commission published its proposals for a single resolution mechanism in July.
However, although EC president José Manuel Barroso hoped that this would put the banking sector on a sounder footing, restore confidence and overcome fragmentation in financial markets, investors are taking a different view.
According to a Fitch Ratings quarterly European investor survey in August, most of the respondents in total managing an estimated 5.6 trillion of fixed-income assets said they did not believe the banking union would reduce default risk for banks.
Only 28% of investors surveyed said they were optimistic that the regulation shift would reduce default risk; the balance cited incomplete implementation (39%), the insufficiency of the proposed measures (6%) and the consequence of independent resolution being that banks are less likely to be supported (27%).
An additional worry is that, according to Bank of America Merrill Lynchs benchmark fund manager survey in August, most investors said they believed that the implementation of a banking union was the sole factor dictating whether or not there would be a full revival of European risk appetite.
In Fitchs view, the different pillars of the banking union have different impacts on the risks for European bank creditors, which might have conflicting implications for default risk.
We expect the first pillar, the single supervisory mechanism (SSM) centred on the European Central Bank, to be in place by end-2014. The SRM is the second and probably final pillar now that some form of depositor preference will be built into the final bank recovery and resolution directive, said Monica Insoll, managing director, credit market research, at Fitch Ratings in London.
She added: A single supervisor should bring consistency and comparability of risk measurement and reporting. Many national regulators have already reviewed asset valuations and required banks to strengthen capital ahead of the SSMs balance-sheet assessment, which may be combined with the European Banking Authoritys EU-wide stress test. This should help reduce bank failure risk.
However, Fitchs expectations on having the SSM in place by the end of the year might be ambitious.
|Yves Mersch, member of the executive board of the European Central Bank|
During his speech on the single market and banking union at the European Forum Alpbach in Austria, Mersch said: If as we hope the parliament adopts the regulation at its plenary session on September 9-11, the supervisory board should be established as soon as possible, and we have to overcome bureaucratic hurdles.
He added: If it takes until the first quarter of next year to have the full-fledged supervisory board in place, it will be quite challenging to have the SSM itself operational one year after the entry into force of the legal act, the earliest date foreseen by the regulation.
A force for good
Mersch believes there are three specific channels where banking union can be a force for good in creating a single European capital market: by encouraging greater cross-border banking integration; by increasing confidence in banks balance sheets; and by helping to break the bank-sovereign nexus.
He said: We already have some new rules in place, for instance on capital requirements. We are on the verge of agreeing to a new mechanism for supervision. But now we need to make sure that we have a strong authority for resolution, and that it has proper instruments to do its job, like the bail-in tool from 2015.
He added: It is my conviction that banking union is one of the clearest examples of where elevating powers to the European level is common sense: it brings benefits for citizens, who have a safer banking sector; for banks, which have a more consistent environment; and for governments, which are less liable for bailing-out.
Mersch might be correct on all of this, but it seems investors still need to be convinced that banks will be safer as a result of the banking union.