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.

ECB really must act on deflation

Hugo Dixon
Nov 4, 2013 15:00 UTC

The case for looser monetary policy should be clear when the European Central Bank governing council convenes in Frankfurt on Thursday. The question is what tools to use: lower interest rates, spraying the banks with more cheap long-term money or the ECB’s first dose of “quantitative easing”. The answer should be a mixture of all three.

Mind you, there are enough inflation hawks inside the governing council that it’s not certain it will even agree that more needs to be done. Some central bankers may argue monetary policy is already loose enough. After all, the ECB’s main interest rate is 0.5 percent and back in July the central bank said, in its first experiment with “forward guidance”, that it expected interest rates to “remain at present or lower levels for an extended period of time”.

What’s more, the euro zone is gradually recovering. In the second quarter, GDP rose 0.3 percent compared to the previous three months. As if this were not enough, Germany’s Bundesbank has started warning that property prices are getting overvalued in some German cities. Why stoke an emerging bubble with still cheaper money?

Euro zone needs anti-boom activism

Hugo Dixon
Sep 23, 2013 09:11 UTC

A big problem with the euro zone’s one-size-fits-all monetary policy is that it risks fitting nobody. That, indeed, was a key cause of the crisis. Early in the century, countries such as Spain and Ireland were booming, while Germany was in the doldrums. Setting interest rates at a level that worked well for the euro zone on average had the effect of inflating the Spanish and Irish property bubbles while pushing up wages so their economies became uncompetitive. When the bubbles burst, the damage was devastating.

It would be hard to argue that any part of the euro zone is currently booming. Even Germany will eke out GDP growth of only 0.3 percent this year, according to the International Monetary Fund. But it may not be long before the problems of a one-size-fits-all monetary policy are back to haunt the zone. Even though the German economy isn’t growing strongly, it is still outperforming the average. What’s more, labour is in short supply in Germany and house prices are rising at a moderate clip – a big contrast to the average, let alone recession-inflicted countries such as Italy.

The European Central Bank’s policy of keeping interest rates at the current 0.5 percent level or lower for an “extended period” is right for the euro zone on average. The weaker countries would benefit from even looser monetary policy. Germany, though, may already need something tighter. If the “extended period” of low interest rates goes on for years, it could experience a boom.

Why Draghi likes London

Hugo Dixon
May 27, 2013 09:26 UTC

When Mario Draghi was appointed President of the European Central Bank, the German tabloid Bild gave him a Prussian helmet because it admired his Teutonic anti-inflation credentials. The Sun, Bild’s British equivalent, should give him keys to the City of London because of his pro-market credentials.

Draghi likes London. The Italian still has a flat in the city, kept from his time as a Goldman Sachs banker. He is a man with a natural affinity for the markets.

Last week Draghi was in London, the scene of his July 2012 promise to “do whatever it takes to preserve the euro”. The ECB President’s message this time was that Europe needs a more European UK as much as the United Kingdom needs a more British Europe.

Italy could reignite euro crisis

Hugo Dixon
Feb 26, 2013 10:15 UTC

Can the Italians be serious? That is likely to be the reaction of financial markets and the country’s euro zone partners as they ponder a disastrous election result, which could reignite the euro crisis. More than half of those who voted chose one of two comedians: Beppe Grillo, who really is a stand-up comic; and Silvio Berlusconi, who drove Italy to the edge of the abyss when he was last prime minister in 2011. Both are anti-euro populists.

This comedy could easily end in tragedy. The inconclusive result has echoes of last year’s first Greek election – except that Italy is bigger and more strategic. The country faces political paralysis, while its economy is shrinking and its debt is rising. The European Commission forecast last week that GDP would fall a further 1 percent this year after last’s year 2.2 percent drop. Debt, meanwhile, would reach 128 percent of GDP by the end of this year.

The euro crisis went into remission after the European Central Bank’s president Mario Draghi promised last summer to do “whatever it takes” to preserve the single currency. But, if Italy proves ungovernable during this critical time, even the ECB’s safety net may not work.

Mario Draghi’s poisoned banking chalice

Hugo Dixon
Feb 4, 2013 10:01 UTC

When euro zone governments agreed last year to give the European Central Bank the power to supervise its banks, that looked like another victory for its president Mario Draghi. It is more like a poisoned chalice.

The ECB will certainly get a chunk of extra power. But it will also be blamed when banks run into trouble, as they inevitably will. Draghi himself is experiencing this first hand following the scandal at Monte dei Paschi di Siena (MPS), which has had to be rescued by the Italian state. He has been lambasted for failing to supervise the country’s third largest bank properly when he ran the Bank of Italy – although the criticism seems overdone and has often been fuelled by his political opponents back in Rome.

The potential reputational risks for the ECB from banking snarl-ups on its watch are probably even bigger than they are for national central banks. This is because it doesn’t yet have the full set of tools to do the job properly. Moreover, a huge amount is at stake since the ECB is the euro zone’s most credible institution. If its reputation gets tarnished because of perceived supervisory failures, that could rub off on its ability to conduct monetary policy or manage crises effectively.

Why Mario Draghi scores AAA on PPP

Hugo Dixon
Dec 17, 2012 10:07 UTC

Who is Europe’s most powerful man? If one phrased the question as who is Europe’s most powerful person, the answer might well be Angela Merkel. But the deliberate use of the masculine excludes Germany’s chancellor, leaving the field open to Mario Draghi.

This answer can, of course, be disputed. How can one compare power in economics with power in, say, religion? Is it possible to rank the technocratic European Central Bank boss on the same scale, for example, as the Pope?

The best place to start is with an attempt to understand what power is. Bertrand Russell, the British philosopher, said it was the production of intended effects. By contrast, Steven Lukes, one of the top contemporary power theorists, said in an interview last week that power is the capacity to make a difference in a manner that is significant.

Can EU defend supranational interests?

Hugo Dixon
Sep 17, 2012 09:56 UTC

European integration tends to advance first with squabbling then with fudge. Every country has its national interest to defend. Some politicians appreciate the need to create a strong bloc that can compete effectively with the United States, China and other powers. But that imperative typically plays second fiddle to more parochial concerns with the result that time is lost and suboptimal solutions are chosen.

Amidst the europhoria unleashed by the European Central Bank’s bond-buying plan, it is easy to miss the immense challenges posed by two complex dossiers that have just landed on leaders’ desks: the proposed EADS/BAE merger; and a planned single banking supervisor.

Look first at the plan to create a defence and aerospace giant to rival America’s Boeing. This has been under discussion since at least 1997 when the UK’s Tony Blair, France’s Jacques Chirac and Germany’s Helmut Kohl called on the industry to unify in the face of U.S. competition. London, Paris and Berlin are the key players in this game because they have the major assets.

Spain and Italy mustn’t blow ECB plan

Hugo Dixon
Sep 10, 2012 08:23 UTC

The European Central Bank’s bond-buying scheme has bought Spain and Italy time to stabilise their finances. But if they drag their heels, the market will sniff them out. It will then be almost impossible to come up with another scheme to rescue the euro zone’s two large problem children and, with them, the single currency.

Mario Draghi’s promise in late July to do “whatever it takes” to preserve the euro has already had a dramatic impact on Madrid’s and Rome’s borrowing costs. Ten-year bond yields, which peaked at 7.6 percent and 6.6 percent respectively a few days before the ECB president made his first comments, had collapsed to 5.7 percent and 5.1 percent on Sept. 7.

Most of the decline came before Draghi spelt out last Thursday the details of how the plan will work. What makes the scheme powerful is that the ECB has not set any cap to the amount of sovereign bonds it will buy in the market. The central bank’s financial firepower is theoretically unlimited, whereas the euro zone governments’ own bailout funds do not have enough money to rescue both Spain and Italy.

Can Super Mario save the euro?

Hugo Dixon
Jul 30, 2012 08:45 UTC

Can Super Mario save the euro? Mario Draghi said last Thursday that the European Central Bank’s job is to stop sovereign bond yields rising if these increases are caused by fears of a euro break-up. While this represents a sea-change in the ECB president’s thinking, it risks sowing dissension within his ranks. He will struggle to come up with the right tools to achieve his goals.

Draghi seemingly stared into the abyss and had a fright. Spanish 10-year bond yields shot up to 7.6 percent on July 24 while Italian ones rose to 6.6 percent. The high borrowing costs are not simply a reflection of the two countries’ high debts and struggling economies. Investors also fear “convertibility risk” – or the possibility that the euro will break up and they will get repaid in devalued pesetas and liras.

The central banker’s statement that dealing with convertibility risk is part of the ECB’s mandate is therefore highly significant. He rammed home his message, saying: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”