During my business trip to the US last week the main topic of discussion was the ECB and possible announcements at next Thursday's press conference. I would say that, on average, American investors believe that a more comprehensive program than just a cut in lending rates and a reduction in deposit rates will be proposed; however they are also somewhat skeptical of the ECB's ability to actually kick-start credit growth in the Eurozone.
In our opinion, the fundamental reason that explains the lack of growth in credit in the Eurozone is attributable to the persistent fragmentation of financing conditions for businesses in this area. In fact, while sovereign spreads and those relating to corporate bonds have narrowed significantly in peripheral countries, the spreads on corporate loans have, on the contrary, increased following the OMT programme. Peripheral countries' PMIs are still heavily penalized by the higher cost of capital compared to core countries' PMIs. This statement also emerges from the research conducted by the ECB on financing conditions, a survey in which numerous companies declared themselves very discouraged in asking for a loan from their bank due to the high rates that will be applied or because they know that no credit will be disbursed.
The main reason for the distortion in the financing conditions of SMEs in the Eurozone is related to the relative fragility of banks in peripheral countries. The ongoing AQR, forcing banks to strengthen their balance sheets faster, adds to the deleveraging process of peripheral banks and weighs further on their ability to lend to businesses.
What can the ECB do? It is interesting to note how many American investors have compared the situation of the ECB with that of the Fed. In the USA, thanks to the purchase of MBS and sovereign debt securities and thanks to the good transmission capacity of monetary policy, the Fed has been able to reduce the costs of refinancing businesses, home loans and the government. Currently the objective of the ECB consists in a direct intervention on the financing conditions of the corporate sector. Sovereign bond buying could accelerate the convergence of sovereign rates within the Eurozone, but could be totally ineffective in reducing the cost of financing for SMEs. Consequently, to solve the problem of the imperfect transmission of monetary policy in Europe, the solution is to push the banks to grant loans thanks to a targeted liquidity programme (e.g. by implementing a negative haircut on corporate loans held as collateral) o directly purchase corporate debt securities, possibly securitized.
And what timing? In order for unconventional operations to be profitable, banks must first conclude the AQR process. In fact, as long as the banking system is solely concerned with pursuing the deleveraging of its balance sheets, the action of the ECB will continue to have a rather limited impact on the growth of credit to the corporate sector. Consequentially, even if the ECB will probably announce a program of unconventional measures in June, its implementation will be postponed until at least September. Furthermore, if banks adjusted their balance sheets with a prudent approach to pass the stress tests, then the same ones, following the conclusion of the AQR and the stress tests, will probably have more leeway to grant loans to companies.
From what has been said, we draw several conclusions. In the first place, the consensus view does not believe that there will be growth in the supply of credit in the medium term in Europe.However if the ECB manages to narrow corporate lending spreads in the Eurozone, then a recovery in credit supply growth could also be observed by the end of the year. Secondly, a negative deposit rate could support the economy in the short term, thanks to the slight depreciation of the Euro against the Dollar. Over the last few months, the single currency has already depreciated against EM currencies and its further depreciation against the dollar could support the Eurozone economy (although it could trigger an increase in the volatility of peripheral sovereign debt). Thirdly, we cannot fail to mention the Renzi's success. The Italian people voted for a policymaker belonging to the new generation of politicians who want to change the system and accelerate the reform agenda. It's about a positive signal for Italy and more generally for those who want to speed up the reform process in Europe. At the same time, the protest vote that emerged across Europe shows that there is a limit to people's patience, especially with regard to their ability to wait for the implementation of reforms and the positive effects of wage moderation. The ECB also has a responsibility to prevent deflationary forces from intensifying further, mainly due to the lack of action against the financial fragmentation of the Eurozone.
