The eurozone grew in the first quarter despite no mending of balance-sheets at the macro-level and stagnation in France and the Netherlands, said David Owen, Chief European Economist at Jefferies International. The building blocks for a sustainable and strong-based recovery were not simply there. Inflation in May is likely to print at or below 0.5 percent, which will put pressure on the European Central Bank President Mario Draghi to act in June, he noted.
Asked if Darghi will use traditional tools when the ECB meets in June, David said Draghi should have initiated unconventional tools such as quantitative easing way back in 2011. QE will be a less powerful tool now than back then. As asset prices have reflated and spreads have been coming down across the eurozone, quantitative easing is obviously not on the agenda for the ECB right now.
Rather, cutting the refinance rate into the negative zone almost looks like a done deal now after the ECB’s press conference last week. The other thing that the ECB is looking at is the LTRO and linking it to public lending like they have done in the UK, particularly for SMEs (Small and Medium Enterprises). It is important for the ECB to communicate clearly to the markets that banks can lend at close to zero (interest rates) for four years, only if they lend to SMEs, which will be a very powerful message.
The other thing that the ECB is also thinking about is holding fewer meetings and press conferences in a year. They would probably only publish the minutes and not disclose how the governing council members voted during policy meetings, he observed.
Asked to comment about the asset-backed securities market, David said the key question is who actually owns the legacy of ABS securities. If institutional investors own them, that’ll be one way to directly deal with the problem. Also, linking loans to SMEs and bundling them with ABS securities make sense. The point however, is rates in the eurozone are down on the floor and they are not going to get up for a very long time in order to bring the currency down.
That matters for GDP numbers; and that matters hugely for both France and Italy. Naturally France and Italy are going to push for the euro’s devaluation compared with the Germans since German GDP grew by 0.8 percent during the quarter, he noted.
Asked if he is optimistic about Europe’s prospects and European assets, David said investors need to distinguish between the financial markets and the ground realities in Italy and France since the outlook is not particularly encouraging. But in terms of financial markets, if the ECB takes down the refinance rates by a couple of notches and further anchor down expectations along the yield curve in the 2-5 year region, the currency will start falling, which will be great news for spreads and financial activities.
The other key thing for the ECB will be Asset Quality Review (AQR). They need the banks to raise their capitals and plug the holes in their balance-sheets before publishing their AQR results.
For that they need financial market conditions to be really good so that the banks that need to raise capital can do so at a decent price running into the AQR publication. That means they need to keep everything sweet between now and the end of the year while hoping the currency weakens in the interim, he concluded.
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