The key chart – brutally exposed

**Sharp falls in large European banks’ share prices reflect dramatic weakening in macro foundations – “macro building blocks matter” (% change YTD to 9 March 2020, SX7E index heavyweights)**
Source: FT; CMMP analysis

A crucial week

This is a crucial week for European policy makers. The coronavirus has weakened the European banking sector’s macro foundations in a dramatic fashion and has exposed wider policy weaknesses. The SX7E index of European banks has fallen 32% YTD and underperformed the wider SXXE index by 16%. This performance is consistent with my CMMP narrative that (1) macro building blocks matter, and (2) that last year’s bounce was a relief rally rather than the start of a period of sustained recovery.

GDP growth expectations, that are stable and subdued at best, now face obvious downside risks, credit growth is showing early signs of peaking, ST and LT rates are at new lows and the yield curve is inverted. In this adverse environment for European banks, attention now switches to policy makers. They are equally exposed.

QE has already shifted the balance of power from lenders to borrowers and carries hidden risks in terms of future growth, leverage, financial stability and income inequality. In recent posts, I have argued that the EA remains trapped by its debt overhang and outdated policy rules, and that a major policy reboot is long overdue. It makes little sense for collective fiscal policy to be about as tight now as any period in the past twenty years at a time when the private sector is running persistent net financial surpluses.

The immediate risk is that this week’s policy responses remain limited. The ECB meets on Thursday with expectations of GDP downgrades, a cut in rates (to -0.6%), liquidity measures (and a possible adjustment to macroprudential tools) potentially discounted already. Far more helpful, indeed necessary, is clear co-ordination between political leaders and central bankers globally. A policy reboot would be a silver lining to the current storm gripping financial markets and global economies.

Watch this space, this is a crucial week.

The charts that matter

Mind the gap

SX7E “heavyweights” have fallen sharply from their 2020 highs – Soc Gen, Credit Agricole, Deutsche, ING, UCI, BNP Paribas are all more than 35% below peaks (% change from 2020 high to close on 9 March 2020)
Source: FT, CMMP analysis

MBB#1: Subdued GDP forecasts likely to be revised down

The ECB is likely to revise down its forecasts for GDP growth this week – current forecasts are based on global growth forecasts that have already been downgraded by the OECD, who have also downgraded EA GDP to 0.8% (2020e) and 1.2% (2021e)
Source: OECD; ECB; EC; Haver; CMMP analysis

MBB#2: Credit growth remains a “relative” bright spot

**HH (3.7% YoY) and NFC (3.2% YoY) credit growth is subdued in relation to past cycles but well above the levels associated with recession in the EA**
Source: ECB; Haver; CMMP analysis

MBB#3: ST rates locked at the base of the ECB corridor

A further cut in the deposit facility rate (t0 -0.6%) this week will be negative for NIMs in those countries (Austria, Italy, Portugal and Spain) and market segments (NFC lending) that are characterised by floating rate lending
Source: ECB; Haver; CMMP analysis

MBB#4: LT rates at new lows and firmly in negative territory

**10Y bond yields have returned to August 2019 lows of -0.71%**
Source: Haver; CMMP analysis

MBB#5: EA yield curve inverted again

The inversion of the yield curve has negative consequences for NIMs in countries (Belgium, France, Germany and the Netherlands) and market segments (HH lending) that are more exposed to fixed-rate lending
Source: Haver; CMMP analysis

Current policy has “hidden risks”

**QE risks fuelling the growth in less productive FIRE-based lending with negative implications for leverage, growth, stability and income inequality**
Source: ECB; Haver; CMMP analysis

Policy needs to match context #1 – a favourite graph again!

**The gap between the supply of money (M3) and the demand for credit has started to widen again, indicating an on-going deficiency in credit demand (and debt overhang)**
Source: ECB; Haver; CMMP analysis

Policy needs to match context #2 – what are balances saying?

**The private sector continues to run financial surpluses in spite of negative/low rates (4Q sums, % GDP)** **a clear message that the debt overhang remains**
Source: ECB; Haver; CMMP analysis

Finally, does this make sense?

**Does it make sense to run tight fiscal policy (1) at this point in the cycle, and (2) when the private sector is running persistent financial surpluses?**
Source: ECB; Haver; CMMP analysis

Conclusion

This remains a crucial week for European (and global) policy makers. The ECB is widely expected to downgrade its GDP growth forecasts and to cut the deposit facility rate to -0.6% (from -0.5%). Further liquidity support and adjustments to macroprudential tools are also probable. Unfortunately, this is unlikely to be sufficient to address market concerns, the impact of the debt overhang and slowing global growth. Far more hopeful, indeed necessary, is clear co-ordination between political leaders and central bankers globally. If there is to be a silver lining to the current storm, this would be it.

As noted in “Are we there yet?”, the EA is positioned better to ease fiscal policy than the UK (where both the private and public sectors are running simultaneous financial deficits) but we are more likely to see fiscal stimulus in tomorrow’s UK budget than in the former this week. Watch this space, this is a crucial week.

Please note that the summary comments above are extracts from more detailed analysis that is available separately.

chris@cmmacroperspectives.com