Against the tide: Too soon to talk of eurozone recovery
Despite recent positive GDP figures, there is still depressed consumer demand and tight credit in large parts of the single-currency area.
The data for real GDP in the second quarter of the year for the eurozone indicated that the longest economic recession the single-currency area had faced since it was formed had finally ended. The eurozone grew 0.3% after shrinking exactly that much in the first quarter. So in the first half of 2013, GDP growth was flat. Nevertheless, the European Commission claimed that things were on the up at last. And investors, desperate for a bit of good news in Europe, have now turned bullish on European equities.
But I remain deeply sceptical about sustained economic recovery. If you look closely at the last-quarter recovery, it’s built on a one-off weather-related rebound (German and French construction picked up after a long, cold winter), as well as a boost in export demand from outside Europe. Credit is still tight and, while consumer spending has picked up a bit, French and German expansion might not be enough to make up for continued depressed consumer demand in Spain, Italy and now the Netherlands. Some 20 million people in the eurozone are still unemployed — a record 12.1%. That’s unlikely to change any time soon.
The truth is that although the recession might be over, Europe’s deep-seated economic problems – its slow-burn debt crisis and the underlying weakness of many of its banks – are not. The eurozone banking union is beginning to take shape. If executed correctly, the programme will bring numerous benefits. The banking sector would become international, not national, in structure. This would mean banks become similar in terms of their risk profiles, reducing financial fragmentation across the single-currency area.
This would also pay dividends from a monetary policy perspective, improving transmission and allowing interest rate differentials to decline. Similarly, the umbilical cord between banks and sovereigns would be cut, reducing the risk of the negative feedback loops that have caused problems from Greece to Spain to Cyprus. It would also reduce the risk of deposit flight in the case of a new crisis. By outlining a clear resolution mechanism for troubled banks, the risk of moral hazard is further reduced. Such rules also erode political interference, which often picks up in times of economic stress and can delay prompt resolution. The internationalization of the sector should also generate efficiency savings, allowing the emergence of pan-European banks competing against each other from a single platform with harmonized regulation.
However, being Europe, the structure to achieve these goals is complex and progress is painfully slow. There are numerous institutions to be established that will be responsible for the various stages of bank monitoring. All must strike a balance between national and pan-European interests. If trouble arises, there must also be a clear path for resolution, which requires further compromises between the periphery and core.
There is an added risk emanating from the European Central Bank’s asset-quality review, which will subject the region’s banks to a more robust stress test. Any capital shortfall identified will then need to be plugged.
And eurozone banks are still tightening credit conditions, if at a slower pace. Liquidity is plentiful but it is all due to ECB action and not rising deposits or banks’ own capital. Credit demand remains slack and is principally down to firms not investing.
The eurozone periphery is still paying back excess liquidity generated from cuts to domestic lending rather than improved interbank borrowing. The ECB is struggling to fix the broken transmission of monetary policy to peripheral economies. So, although Target2 imbalances are narrowing, it remains a symptom of the problem not a sign of recovery.
So I am deeply cynical about the much-touted eurozone economic recovery in the second half of this year as there is little sign of the earnings power at either the corporate or the consumer level, and bank credit certainly won’t help.