Euro: Improving Conditions in the Euro-area Set to Continue, NBOC

The euro-zone should continue recovering in Q1, according to analysts at the National Bank of Canada.

Despite recent dismal data, showing a basis point dip in France’s third quarter GDP, the euro-zone as a whole is expected to have a bright start to 2016, according to a recent research note from the National Bank of Canada (NBOC).

“the Eurozone should see growth-friendly increases in expenditures to address the migrant crisis, e.g. on housing and social services.” Says the research. 

NBOC sees an improvement in the transmission of credit is further reason to be optimisitc:

“The European Central Bank’s stimulus is starting to bear fruit as evidenced by improving household credit and business loans, the latter even managing to grow on a year-on-year basis for the first time since 2012.”

The weaker euro is also helping growth, according to the research note:

“The cheaper euro resulting from the ECB’s ultra-loose policies should also support exporters as they face challenges brought by softening demand from emerging markets (one of the zone’s major customers) and the emissions scandal which is likely to hurt auto exports.”

ECB unlikely to increase QE 

Whilst market expectations are that the ECB will increase easing in the new year – possibly March – in order to foster continued growth and possibly curb the appreciating euro, fixed income strategists at Banca IMI believe this is unlikely given the lack of supply of available bonds, especially German and Portuguese debt.

The recent increase in the possible length of the programme to March 2017, which equates to an rise of 230bn in asset purchases, was a sizeable increase according to Banca IMI, despite market disappointment.

“Despite the disappointment of the market, which had built up exaggeratedly high expectations, the decision taken at the latest ECB meeting, which extends the EAPP until at least March 2017, implies 280 billion euros in additional purchases of government bonds and agencies, marking a 35% increase over the old programme.”

German report still sees transmission as blocked

Economists at the Cologne Institute for Economic Research are not as optimistic as strategists at the National Bank of Canada, arguing the euro-area’s transmission of credit remains impaired.

They see continued lack of credit as a fundamental obstacle to the recovery in the euro-zone.

Previously the lack of transmission was caused by the crisis, but now it has actually been caused by increased bank regulation, including Basel III, which has made euro-area banks more risk averse, and more likely to invest in sovereign debt, limiting resources left for other debt:

“the impairment of monetary transmission is now caused by banks’ reduction in risk-weighted assets, which are an effect of the implementation of the new Basel III capital ratios.

“Instead of lending to businesses and households banks increased their exposure to sovereigns.

This effect is due to the preferential treatment of sovereign debt in bank regulation and is exacerbated by the low interest rate environment.”

The report goes on to outline in further detail what is blocking transmission, and the steps required to remedy it, which include the “abatement of the preferential treatment of sovereign debt in banking regulation”:

“It seems more and more that banks’ capital regulation hinders the credit channel of monetary transmission to function, on which the ECB has to react by further increasing policy accommodation.

“It seems doubtful that further policy rate cuts into the negative territory will increase bank lending as long as bank lending is restricted by a lack of equity capital.

“For inflation to return to normal, banks’ capital regulation has to be adjusted in such a way that the credit channel of monetary transmission is working properly again. 

For achieving this, the abatement of the preferential treatment of sovereign debt in bank regulation is highly necessary.”