The Euro Area’s Rooted Rot Rotation
As the average PMI passed 50 and banks cited better lending conditions in terms of supply, the IMF circulated its annual euro-zone report card assigning a good grade for “tail risk reduction” but otherwise charting deeper crisis permutation. It found that the ECB’s bond support and the EU’s single supervisory programs improved the currency union foundation, but that private borrowing costs in periphery countries remained “too high” with stubborn capital flight Long-term liquidity facilities have been repaid mainly from stronger core member banks, and real GDP is below the pre-crisis level on incipient deflation and 12 percent unemployment. Financial market fragmentation has reduced original cross-border participation and small firms cannot get credit. The upcoming EBA stress test will spotlight lingering capital holes, although deleveraging is apparent through asset sales. All economic sectors are overextended with household and business balance-sheet cleanup stymied by antiquated bankruptcy codes and the absence of securitization techniques. Recession is predicted for the remainder of the year and medium-term stagnation is a likely scenario without a “comprehensive policy response.” The Fund recommends third-party independent evaluation to add credibility to banking health checks and an ESM window for recapitalization under strict burden-sharing criteria. Legislation must still be approved in the European Parliament for common oversight rules as resolution authority has yet to be decided apart from a general bail-in hierarchy at an 8 percent minimum of total liabilities protecting insured depositors. Although the central bank recently allowed simpler pooling to qualify as collateral for its resources, it could more directly assume small enterprise exposure with pilot efforts. In its monetary stance negative interest rates could be considered alongside the “low for long” forward guidance to preempt a deflationary spiral. On the structural front, labor norms are rigid and globally uncompetitive and single-market services integration and external free trade agreements could go further. An initial round of transatlantic talks was held in Washington and East Asian bilateral and multilateral commercial openings could likewise expand. Internal rebalancing has cut current account deficits but traditional surplus powers like Germany have not switched to domestic demand. The euro’s value has fluctuated to extremes since 2009 but is roughly in equilibrium with a 10-15 percent real decline over the period.
It has rallied over the summer lull both against developed and emerging market currencies as commodity, output and geopolitical drags weigh on the latter group. Their lending conditions have also deteriorated for the first time in years as the IIF’s quarterly indicators went below 50 on souring officer sentiment across all regions. Bad credit increased and trade finance was scarcer as bellwether China revealed poor import and export statistics along with capital account outflows. The renimbi has long been ballyhooed as an eventual euro rival, but the vanguard yuan-denominated dim sum bond market is now shunned and Hong Kong officials had to inject liquidity to stem the decay.
