M. Trichet, President of the European Central Bank, has been discussing the necessity of ending the excessive flow of liquidity to the banking system through various news channels, and although any significant dislocation may force him to alter his opinion, or to clarify it in a milder form, we do expect that the ECB will eventually move to effect some sort of mini-tightening in the next two quarters, if only for the purpose of maintaining credibility, barring some kind of shock hitting the financial markets during the same period.
The European banking sector is still tightening lending standards on loans to both the consumer and industrial sectors, yet, the pace of this tightening has slowed down considerably in the last three quarters. Still, and most significantly, an increasing but small percentage of banks continue to report a positive contribution from competition from their peers to the decision to tighten standards.
It is clear that the central bank can influence any aspect of economic activity through its tools of monetary policy, but apparently it is unable to stop banks from competing with others in a rush to consolidate the loan books, solidify balance sheets. It must be admitted, on the other hand, that the severe stresses suppressing the banking sector a few quarters ago have mostly evaporated. If M. Trichet is right in his analysis, it is only a matter of time before realities influence the emotions of lenders, and a more positive outlook is established.
But even beyond the availability of credit, loan demand in the Euro area continues to contract at an alarmingly high level, with barely a sign of any improvement with respect to firms' optimism about future economic conditions. Here the numbers allow us to sense a general air of pessimism, with hardly any respite. Indeed, in the fields of debt securities issuance, and mergers and acquisitions related activity, demand for banking sector support has been contracting even faster.
The consumer is a bit more buoyant, with a positive percentage of banks reporting increasing demand for housing loans for the first time in at least three years, as demand for credit also shows some improvement, albeit at a slower pace. But given the fragile nature of consumer sentiment in Europe, and also as a result of continuing factory closures, and relocations, it is still early to be confident about any sustained improvement in consumption in the region. Ultimately, we believe that the health of the industrial sector will determine the strength of a European recovery, with consumers following the cues from the wider economy in their decisions.
In short, we doubt that the ECB can do much more than refresh cosmetics in the immediate term. Our general analysis of the global economy also remains more or less the same. There is little doubt that beyond the frontpiece of decoration, ebullience, and smiling faces, a large number of problems continue to await some kind of resolution through natural economic processes. We are confident that no amount of indirect stimulus, in the form of increased credit, or cheaper money, will lead to an end of the present period of stagnation. Yet populism, and political extremism of one type or another may eventually create an environment much more conducive to direct government intervention in the economy, through the opening of new jobs, protectionism, or any other textbook method that governments tend to make use of in times of turmoil. In the absence of such socialistic solutions, however, we expect our period of turmoils to run its course through a long period of volatility, until real improvement in productivity, through technological improvement, allowing improved financial infrastructures in the developing world leading to greater confidence, clean up the debris of the past, and allow a real recovery to take place some time in the future.
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