Opinion

Hugo Dixon

ECB faces severest stress test

Hugo Dixon
Feb 24, 2014 10:25 UTC

A lot is riding on the cleanup of euro zone lenders being overseen by the European Central Bank. The progress so far is encouraging. But clarity is needed on a few points to ensure that lenders really do get a good scrubbing and are therefore able to support the zone’s fragile economic recovery.

The ECB is in the midst of a so-called comprehensive assessment of euro zone banks. This has two elements: an “asset quality review” (AQR) to determine whether the loans and other assets held on their balance sheets are valued properly; and a “stress test” to check whether they could withstand a severe economic downturn.

To pass the test, banks are supposed to have a “common equity Tier 1 capital ratio,” a measure of balance-sheet strength, of 8 percent in the baseline scenario; and a ratio of 5.5 percent in the adverse scenario. The whole exercise is supposed to be finished by October before the ECB officially takes over from national authorities in November as lead supervisor for the zone’s banks.

The hope is that investors will at last have confidence that the numbers in bank balance sheets are accurate, so they can lend to banks more freely. Banks would also lend to each other. With the money markets functioning normally again, banks would have more confidence to lend to companies and consumers, giving a boost to economic activity.

That is what happened when the United States put its banks through severe stress tests five years ago. Unfortunately, the euro zone put its lenders through a series of sham tests. They gave clean bills of health to Irish, Spanish and Cypriot banks which virtually blew up soon after.

A workable euro zone fitness regime

Hugo Dixon
Feb 17, 2014 09:42 UTC

The euro zone has gone from the emergency room to rehab. As often with patients, the question is how to maintain a stiff exercise regime now the immediate danger is over.

Germany has an idea. At December’s summit, it got the rest of the zone to agree in principle to what are called “partnerships for growth, jobs and competitiveness”. The idea is that governments will sign contracts committing them to do things like reform their labour markets, liberalise product markets and improve the efficiency of their public sectors. Countries such as Greece and Cyprus, which are already in bailout programmes, wouldn’t be covered.

The snag is that the leaders haven’t yet been able to agree on what sort of carrot to give countries in return for signing these contracts. They have, though, set an October deadline to reach conclusions.

Renzi rolls the dice

Hugo Dixon
Feb 14, 2014 10:06 UTC

When Julius Caesar crossed the Rubicon in his bid to take control of Rome, he is reputed to have said “alea jacta est” (the die is cast). Matteo Renzi, soon-to-be Rome’s new master, has also rolled the dice. In doing so, he is taking big risks. Given Italy’s mess, one can only pray that his gamble pays off.

There are a lot of good things about Renzi, who became leader of the centre-left Democratic Party in a landslide election last December. He is young, energetic and pro-enterprise. He wants to shake up a political and economic system that has been gridlocked for a couple of decades or more – the consequence of which is an economy that has shrunk 9 percent since 2007, youth unemployment of 42 percent and government debt at 133 percent of GDP.

Still, Renzi has embarked upon a high-risk strategy by kicking out the prime minister, Enrico Letta, who is a member of his own party. His majority is unstable, he knows little about governing and he is relying on Silvio Berlusconi, arch-rival of Italy’s centre left, for a critical reform of the constitution.

Euroscepticism may have silver lining

Hugo Dixon
Feb 10, 2014 09:43 UTC

Many eurosceptic treatises, such as the recent report saying the Netherlands would be better off quitting the European Union, are exaggerated and unconvincing. But mounting euroscepticism could still have a silver lining if it helps those wishing to reform the EU advance their agenda.

Few people think the Netherlands is close to quitting the EU. In this way, it is different from the UK, where exit is a genuine possibility. That said, euroscepticism is on the rise following years of economic stagnation. The right-wing Freedom Party, led by Geert Wilders, is leading in the opinion polls and is likely to be the largest party in May’s European Parliament elections. Other eurosceptic and nationalist parties such as France’s National Front and Britain’s UK Independence Party are also likely to perform well.

To see what is wrong with the eurosceptics’ arguments, look no further than the study on “Nexit” – the Netherlands’ potential exit from the EU – commissioned by Wilders and written by Capital Economics, a London-based consultancy. Although the case for Nexit has been dressed up about as well as it is possible to do so, it is still full of holes.

QE is the way for the ECB to go

Hugo Dixon
Feb 5, 2014 10:35 UTC

The European Central Bank needs to start taking the risks of deflation more seriously. This danger should be top of its agenda when its governing council convenes for its monthly meeting this week.

The ECB’s line is that it does not see deflation on the horizon. True, the inflation rate has been below the target of close to but below 2 percent for over a year. The flash estimate for January was a mere 0.7 percent. But this still amounts to rising prices – not deflation’s actually falling prices.

True, too, that the ECB itself expects inflation to be below target for at least the next two years. But it doesn’t think the euro zone is close to repeating the experience of Japan which has suffered 20 years of flat prices.

Independent Scotland won’t keep the pound

Hugo Dixon
Feb 3, 2014 09:44 UTC

An independent Scotland will not keep the pound. That’s despite this being the express wish of the Scottish government, which is campaigning for independence in September’s referendum. The reason is that it’s hard to see the rest of the UK agreeing to such a deal – except on terms that would affront Scotland’s amour propre.

One can understand why Edinburgh is keen not to change its monetary arrangements. If Scotland had its own free-floating currency, it would be less economically integrated with the rest of the UK. Given that 60 percent of its exports and 70 percent of its imports are with the rest of the UK, such a separation would hit hard.

A separate currency would also cause trouble for the outsized Scottish banking sector. Banking assets are more than 12 times GDP – nearly double the ratio for Iceland, Ireland and Cyprus before their banking industries blew up. The Scottish people might also worry that a Scottish currency could fall in value, devaluing their savings.