Waiting for Action: Euro Zone Challenges Continue During Long Coalition Negotiations
There is growing unease in Germany and abroad about the lengthy negotiations between the Christian Democrats of Chancellor Angela Merkel and their potential coalition partners, the Social Democrats. Some commentators doubt that the SPD base will allow a grand coalition to emerge. Conservative observers are worried about a social democratic drift—the controversy surrounding the possible and likely introduction of a minimum wage being only the tip of a dangerous iceberg. Indeed, some fear that the grand coalition will reverse course and bring Germany back to the precarious state of affairs, which forced Merkel’s predecessor, Gerhard Schröder, to launch his “Agenda 2010” reform package.
Meanwhile, European partners are once again waiting for Germany to decide internal matters before making any crucial decisions about the future of the euro zone. This time key features of the banking union cannot be addressed. Indeed, even the Constitutional Court in Karlsruhe is in a holding pattern. It will not rule on the European Central Bank’s (ECB) bond buying Outright Monetary Transactions program this year. A decision on Mario Draghi’s promise to do “whatever it takes” to save the euro is, therefore, postponed until politicians in Berlin make up their minds.
The political uncertainty even seems to affect the European economy. The fragile and uneven recovery is already losing steam, and France’s economic position is still weakening, although this is largely due to its own domestic political paralysis.
Banks are among the few institutions most definitely not waiting for politicians. They are aggressively deleveraging in anticipation of next year’s asset quality review and stress tests that the ECB and the European Banking Authority (EBA) will undertake. While banks’ balance sheets continue to shrink, their corporate lending also continues to fall. If this trend is not reversed, small and medium sized companies will suffer and, with them, overall economic growth.
This mix is once again putting the ECB in very uncomfortable position—forced to react to weak economic activity and falling prices across the euro zone with both a rate cut and a very public debate about further unconventional monetary tools, while maintaining that it cannot address member countries’ structural economic weaknesses.
Even more than in the past, the ECB finds itself between a rock and a hard place. It needs easy monetary conditions in order to keep inflation below—but close to—2 percent and support credit across the monetary union on one hand, but at the same time, it is warning financial institutions to get their houses in order in anticipation of next year’s balance sheets assessments. Banks are reacting by quickly repaying their cheap LTRO (longer term refinancing operations) loans. As a consequence, monetary conditions in the euro area are tightening rather than easing.
Indeed, in order to restore healthier credit flows, the ECB is thinking about issuing a new tranche of LTROs. Unfortunately, given the stigma attached to the ECB’s lifeline to banks, such an offer could very well find very few takers, especially as both the ECB and EBA assess the strength of banks. Hence the very public debate among ECB officials about more dramatic steps tasked with easing monetary conditions, such as a negative deposit rate or even a form of euro area quantitative easing program.
It is not that the ECB is about to embark on any of that; Draghi made that much clear at a conference in Berlin on November 21. But publicly stressing its bias towards easing could at least help getting the message through to investors that while the U.S. Federal Reserve gets closer to the beginning of its reduction in asset purchases, the ECB will keep its foot firmly on the gas pedal.
For banks that are more worried by a stricter regulatory environment than the promise to keep money cheap, the message remains that the ECB is trying to accelerate and brake at the same time. Thus, they will likely stay cautious.
Even a speedy resolution to the coalition talks in Berlin can do very little to change this state of affairs.