I’ve long thought that it was going to take the the European crisis to begin to genuinely infect Italy or Germany before we saw any real action from the Europeans. Italy because of its size , both debt and GDP, and Germany because … well it’s running the show.
Given this week’s flash PMIs along with the on-going pressure on Spanish and Italian yields I think it is fair to say that we have reached that point. Due to this I had expectation that we would soon see some more decisive action from Europe, one way or another.
Overnight Mario Draghi didn’t disappoint with the following:
“To the extent that the size of these sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate,” Draghi said in a speech at the Global Investment Conference in London today. “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” he said, adding: “believe me, it will be enough.”
Obviously this is, in part, standard central bank open mouth operations and much of what Europe can do next is currently with the German constitutional court. Usually after such announcements we quickly hear from the German camp talking down whatever was just said and the fact that this hasn’t occurred could be read as a positive. It must be noted, however , that Angela Merkel is currently on holiday.
This isn’t the first time we have heard such statements from the ECB, with similar back in September 2011
The European Central Bank stands ready to intervene in the bond market if its low interest rates are not translated into lending rates, ECB policymaker Juergen Stark said on Friday.
“As long as we see the risk that this transmission mechanism is impaired and our low interest rates are not transformed, or not translated into the lending rates … we’re prepared to intervene,” Stark told a programme aired on TV Tokyo on Friday morning.
“However, this is a temporary measure, not a permanent measure. It is one of our nonstandard measures. Again today, we decided and have communicated that these nonstandard measures will be in place as long as needed,” he said.
The ECB went on to implement the 3 year LTRO program in early December which gave the sovereign crisis a 3 month reprieve but failed to avert the downtrend in private sector credit growth.
What makes these latest statements important is that they give the impression that Draghi has finally recognised the need for a true lender of last resort for the Euro and therefore we are going to see some new non-standard policy action from the ECB when it meets next week. This could plausibly include the re-ignition of the SMP but also hints at something much larger.
What I found most interesting about the statement, however, was that it appeared to infer that the scale of the ECB’s action would be measured by how the governing council saw the crisis in the sovereign bond market effecting monetary policy transmission. I actually think this is still an open question.
There is certainly no doubt that the monetary system is becoming further imbalanced. Deposit data for June saw Greece’s private sector deposits fall by another 4%, Portugal 3.5% , Ireland 1.8% and Spain 0.5%. There is no doubt this is why we continue to see the Greece ELA being heavily used and Target2 liabilities continuing to rise. See here for more on this topic.
I do however think it is questionable whether this would be eased by more action from the ECB. Given the 3 year LTRO program didn’t seem to have much of an effect on deposit outflows I am doubtful. A far more effective response would be a euro-wide deposit insurance scheme but this is likely to be part of a greater banking union which, as we saw in the last EU summit, appears to still be a step too far for Europe.
What makes this more of a quandary is the ECB latest banking survey ( available below ) in which Euro area banks were asked specifically about the effect of the sovereign debt crisis on their lending.
As a likely consequence of the re-intensification of the sovereign debt crisis, replies from the July survey indicate a deterioration in banks’ funding conditions in the second quarter compared with the first quarter of 2012 across all channels, albeit below the values reached in the fourth quarter of 2011 (see Chart 8). On balance, 18% of euro area banks attributed a deterioration of funding conditions to the sovereign debt crisis through their direct exposure to sovereign debt, up from 4% in the previous quarter. In addition, on balance 24% of euro area banks reported that the decline in the value of sovereign collateral led to a deterioration in their funding conditions in the second quarter of 2012, after a reported positive impact on funding conditions in the first quarter of 2012 (-3%). “Other effects”, which may include financial contagion effects, also led to a stronger negative impact on banks’ funding conditions (on balance 24%, from 11% in the first quarter of 2012). This suggests that the negative impact of the sovereign crisis on banks’ funding conditions increased again in the course of the second quarter of 2012.
Despite the strong deterioration of the impact of the sovereign debt crisis on banks’ funding conditions, the impact on euro area banks’ credit standards remained contained and changed only moderately compared with the previous quarter. This development is broadly in line with the unchanged impact of the cost of funds and balance sheet constraints on banks’ credit standards for loans to enterprises in the second quarter of 2012.
So 1 in 4 European banks state that the sovereign debt issues are effecting their funding but overall there has been limited deterioration in credit tightening. This is also backed up by other survey questions:
Despite the re-intensification of the sovereign debt crisis in the second quarter of 2012, the July 2012 bank lending survey (BLS) shows that the net tightening of banks’ credit standards was broadly stable at the euro area level in the second quarter of 2012 compared with the first quarter, both for loans to enterprises (10% in net terms, compared with 9% in the first quarter of 2012) and for loans to households (13% for housing loans, compared with 17% in the first quarter of 2012, and 7% for consumer credit, compared with 5% in the first quarter of 2012). The net tightening in the second quarter of 2012 was much lower than in the fourth quarter of 2011. The impact of banks’ cost of funds and balance sheet constraints on the net tightening of credit standards was, in the case of enterprises, stable vis-à-vis the first quarter of 2012, whilst there was some deterioration in the case of households.
The broadly stable net tightening of credit standards in the second quarter of 2012 was reflected in overall limited changes of terms and conditions on loans to enterprises by euro area banks. Specifically, the widening of margins on average loans to enterprises changed little compared with the first quarter of 2012 (25%, compared with 22% in the first quarter). By contrast, the widening of margins for average housing loans as well as for riskier loans to enterprises and households declined considerably further. These price developments seem to reflect a somewhat less pronounced degree of risk-related price differentiation by banks.
Looking ahead to the third quarter of 2012, euro area banks expect a similar degree of net tightening in credit standards for loans to enterprises (10% in the third quarter of 2012), and a further decline for housing loans (to 5% in the third quarter of 2012) and for consumer credit (to 2% in the third quarter of 2012).
So again, there has been some effect but overall it doesn’t appear to be something that requires heavy intervention. Demand however is quite a different story.
Turning to loan demand developments, euro area banks continued to report, on balance, a significant fall in the demand for loans to enterprises in the second quarter of 2012, although the balance was somewhat less negative than in the first quarter of 2012 (-25%, compared with -30% in the first quarter). As in the first quarter, according to reporting banks, the fall in the second quarter was mainly driven by a substantial negative impact from fixed investment on the financing needs of firms. The ongoing decline in net demand for loans to households for house purchase abated in the second quarter compared with the first quarter (-21%, from -43% in the first quarter), whereas net demand for consumer credit remained broadly unchanged (-27%, compared with -26% in the first quarter). Looking ahead to the third quarter, banks expect a continued decline in the net demand for loans, both for enterprises and households, even if less negative than in the second quarter.
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For the third quarter of 2012, euro area banks expect a considerably smaller decline in the net demand for loans to enterprises (on balance 8%). As in the first quarter, according to reporting banks, the fall in loan net demand was mainly driven by a substantial negative impact from fixed investment on firms’ financing needs (-36% in the second quarter of 2012, unchanged from the first quarter of 2012). Mergers and acquisitions (-13%, compared with -17% in the first quarter) and internal financing of enterprises (-12%, compared with -8% in the first quarter) also contributed considerably to the continued decline in net demand for loans. By contrast, on balance, the issuance of debt securities no longer contributed negatively to loan demand by enterprises (0%, compared with -5% in the first quarter) according to reporting banks.
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Net demand for consumer credit continued to decline strongly in the second quarter of 2012, at -27% according to euro area banks, compared with -26% in the previous survey round. According to euro area banks, the protracted decline was mainly driven by less household spending on durable goods (-28%, unchanged from the first quarter of 2012) and a decrease in consumer confidence (-26%, compared with -28% in the first quarter of 2012).
Looking ahead to the third quarter of 2012, euro area banks expect a substantial deceleration in the decline of net demand for consumer credit (-8% in net terms).
So, once again, this looks far more like a demand side issue than as supply side one. In fact these poor results appear to have even surprised the banks who were expecting far less of a deterioration. But are these results really surprising? Not to me. With private sectors in many economies under financial strain from deteriorating economic conditions and , in many a cases, rising tax burdens this is completely expected behaviour in my opinion. Households under stress don’t have the capacity to take on new credit, no matter what the rates and business therefore have little reason to invest.
Importantly, what this data suggests is that this problem isn’t really something that monetary policy, no matter how unconventional, is going to solve. This looks very much like a job for fiscal because until private sector balance sheets are repaired monetary policy is a lame duck. Obviously the fiscal compact is not going to provide this fiscal relief.