As I explained again last week I think the markets have got ahead of themselves in terms of the risk profile they are applying to Europe for the coming year. Market reaction to “emergency” monetary policy across the globe, as described by Gavyn Davies this week, is understandable ,but that doesn’t remove the risk from what is happening in the real economies of much of the eurozone.
Contagion has always been a slow moving process and as it has slid across the eurozone we have seen an ever-rising monetary response from the ECB. The “unlimited” OMT is the latest weapon of defence, but interbank liquidity and implicit sovereign-default support does very little for the private sector of an economy being squeezes between falling economic activity and fiscal tightening.
As I’ve explained repeatedly over the last two years the current policy settings of the European periphery guarantee economic retrenchment over the medium term and, unless there was a credible plan to deal with the existing debt loads, the chance of a self-defeating race to the bottom between these economies was relatively high.
As an economy weakens you tend to see asset prices and industrial production fall, followed by employment which, after some period of time, begins to manifest in rising bad debts in the banking system , leading finally to a banking crisis. This was pretty much the path of Spain which has now instigated a plan to attempt deal with the banking crisis including the creation of a bad bank . The issue, of course, is that this hasn’t actually dealt with the underlying cause, and so the problem continues.
Spanish banks’ bad loans rose to 11.2 percent of their outstanding portfolios in October, reaching a fresh record high, Bank of Spain data showed on Tuesday.
Loans that fell into arrears increased by 7.4 billion euros ($9.7 billion) from September, reaching 189.6 billion euros in October. The rate was up from 10.7 percent in September.
Non-performing loans on the books of the country’s crippled banks have risen steadily since a decade-long property boom ended four years ago, with the country now in its second recession since 2009 and one in four Spaniards out of work.
My understanding of the creation of the European firewalls was that they were ultimately there to guard Italy. This was simply because on top of Spain I couldn’t see any credible way that the rest of Europe could build a rescue mechanism big enough to save both countries once it became apparent that Italy too had been caught in the contagion spiral. Remembering that Spain and Italy combined have a GDP roughly equivalent to Germany.
Bad debts at Italian banks rose to nearly 120 billion euros at the end of October and lenders continued to cut loans to businesses, data showed on Tuesday.
The Italian banking association ABI said gross bad loans, which have become a major concern for lenders as Italy’s recession affects credit quality, rose by 16.6 percent in October from a year ago and accounted for 6.1 percent of total loans.
Two years ago, bad debts totalled 74 billion euros.
Lending from Italian banks to households and non-financial companies fell by 1.9 percent in November, declining for the seventh consecutive month although at a slower pace than in October.
On the bright side, retail funding for banks continued to increase, posting a 1.3 percent rise in November. Deposits by Italian residents were particularly strong, posting a 5.8 percent growth, while bank bonds fell by 6.75 percent.
Foreign deposits however dropped 17.8 percent on an annual basis. In the 12 months to October, net foreign funding to Italian banks has decreased by 69 billion euros.
The question now, given Italy still has some economic strengths, is can Europe arrest the fall of this economic giant before it joins Greece, Cyprus, Portugal and Spain in the spiral downwards and then drags the rest of Europe with it.