The Euro Zone Question: Is the ECB Doing enough?

The Euro Zone Question: Is the ECB Doing enough?

By: Simon Furman | Where To Trade | On:14-10-2014 05:47
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Key Highlights

  • Internal conflicts in the ECB causing delayed response
  • German Economy  shows slacks
  • Fiscal Austerity hurting growth and recovery
  • Banking system restructuring hurting recovery efforts
  • Bearish EUR ahead of 2015

 

The European economy has been on a tail spin since the banking crisis. We are now at a pivot point where the decisions of the ECB will make or cripple the economy of the block. The US economy is showing strength and resilience even after the poor weather conditions in the first quarter; we have posted a 4.6% growth in GDP for the Second quarter. In the United Kingdom a 3.2% growth was reported for the second quarter. As the rest of the world recovers, the situation in Europe is becoming less and less optimistic. Germany, Euro zone’s largest economy has posted a 0.2% contraction. France has its economy virtually stagnated while Italy has been in a technical recession for two years.

All eyes turned to the European situation when the Markit’s survey of 500 German manufacturers fell below the 50.0 threshold to 49.9 in September, down 1.5 points from 51.4 in the previous month.  A reading below the 50.0 threshold indicates a relative contraction in the manufacturing activity for that period while a reading above the threshold indicates an expansion in activity. Though the market consensus was that the reading would to be about a point lower than the previous reading, we did not anticipate a contraction to be indicated.

Where To Trade - German PMI Falling

The reduced manufacturing activity was mirroring the sentiment in other European countries; Greece PMI was at 48.40, Austria was at 46.47 and France was at 48.80. This is dismaying considering that France is Europe’s second largest economy. Reduced manufacturing activity in Europe means that managers will reduce their hiring and tighten their labor expenses. This will lead to a higher unemployment and a vicious cycle ensures where Europeans have less to spend and manufacturers need to produce even less.

The major problem Europe faces right now is that the decision makers cannot decide on the best way to remedy the situation. The ECB had taken a lax monetary policy and has in place several programs aimed at stimulating growth and supporting the inflation. Despite these efforts however, a recovery is nowhere in sight. Inflation is as low as 0.3% despite having interest rates at 0.50%; more needs to be done.

Draghi has promised to increase the ECB holding of private assets to a record 1 Trillion Euros. The taboo issue is whether the Bank should begin purchase of European Governments’ debts to boost inflation. Germany is out rightly opposed to such a measure. The Bundesbank wants to see more fiscal rigor among its European counterparts; government spending cuts and higher taxes. Of course these measures are at odds with the current objectives of raising inflation and stimulating growth.  Higher taxes will hurt growth as will less government spending.

The ECB commitment to do attempt a banking system restructuring simultaneously with an economic recovery is over ambitious at best. A process of deleveraging the banks while simultaneously attempting to conduct a quantitative easing program aimed exclusively at the private sector is counterintuitive. That is to say, forcing banks to hold more assets for their net risk exposure while attempting at the same time to get the same banks to disseminate money being pumped into the economy through the stimulus package is a  bad idea for a struggling economy.

At the present situation something has to let up, the Germans will have to soften their stance on fiscal policies, the ECB must abandon its attempts to restructure the banks as they are  or recovery will stall for a longer period.

Either way it goes, this is an exciting time for a EUR trader, Any negative news from the Euro zone will see some significant bearish moves. Under these conditions the best trading approach is to maintain a bearish bias towards the EUR; fading the rallies and riding the down trend.

Simon Furman

Simon Furman

Think Global - Act Local

Simon Furman is one of the best financial analyst with 27 years of trading experience

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