The Clock is Ticking on the "Europe is Saved" Narrative
ECB President Mario Draghi, understands the importance of verbal intervention better than most Central Bankers. After all, he “saved” the entire EU and its banking system simply by promising to do “whatever it takes” in the summer of 2012.
Since making that promise, the two biggest problem countries for the EU, Spain and Italy, have both seen the yields on their bonds fall.
Draghi’s promise also lit a fire under EU stocks, with Spanish, Italian, and German markets roaring higher.
It is critical to note that Draghi accomplished this without actually doing anything. All he did was make a verbal commitment.
The only problem with this is that while sovereign bond yields have fallen and EU stocks have rallied, the EU economy has not recovered. GDP growth for the EU as a whole was a measly 0.2% in 2014… the same as fourth quarter 2013.
Indeed as the below chart indicates, the supposed “recovery” Draghi had hoped his promise would create has failed to manifest.
This issue is confounded by the fact that the overleveraged EU banks are still not willing to lend into the economy. As a result of this, the ECB has its back against the wall again:
Bank lending to euro-zone businesses fell in April, marking nearly two years of declines and indicating that a scarcity of credit is still a drag on the currency area's weak economic recovery.
The figures also showed that money supply growth eased in April, while separate data releases showed German jobless numbers rose unexpectedly in May, while French consumer spending fell in April.
Taken together, the data releases suggest the euro-zone economy is unlikely to grow much more rapidly in the second quarter of this year than it did in the first, underpinning expectations that the European Central Bank will ease policy when its governing council meets June 5.
On Monday, ECB President Mario Draghi noted that credit weakness is contributing up to a third of economic slack in countries struggling to emerge from the crisis, adding to disinflationary pressures. Earlier this month, Mr. Draghi said the governing council would be "comfortable" taking action at the next policy meeting, once staff projections on inflation and economic growth are available.
Desperate, the ECB leaked that it had modeled a €1 trillion QE program at its last meeting. This leak was quickly retracted, but it had the hoped for effect of boosting stock prices and pushing sovereign bond yields even lower.
However, Draghi knows his verbal efforts to prop the EU you up are running on fumes. The ECB is largely expected to announce either an interest rate cut or a QE program at its June 5 meeting. It has even leaked this to the press. And now that the ECB has announced negative interst rates and another LTRO program, there's nothing left but outright QE.
The clock is ticking on the "Europe is fixed" narrative. It's only a matter of time before the banking crisis resurfaces.
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Phoenix Capital Research
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