What does Euro Area need besides QE?

Much has been said in Europe about the prospect of additional Quantitative Easing (QE), better known as process of printing money. Such measures were already taken in an attempt to ease the financing conditions with a view of ultimately boosting economic growth; simply speaking the reasoning is that lower borrowing costs should lead to higher lending which should translate in higher consumption, job creation and a growth in output. Also, the stress-relief in the financial markets improves the banks’ ability to take risk and thus provides an incentive for lending. A similar recipe was applied with success in the US and UK but Europe continues to struggle as have countries such as Japan. Truth be told, the former QE measures were halted too soon and the new ones are, well, too new. Notwithstanding this, the question remains if QE, which could take the form of corporate bond purchases and/or sovereign bond purchases will be enough to lift growth in the Euro Area. I am among those who are sceptical about this as, in contrast to the US, the ECB is faced with the challenge of accommodating 18 countries with different economic structures, culture-routed behaviours and structural shortcomings. The ECB President Draghi himself is well aware of this and often prompted the European governments to expedite structural reforms so as to complement the monetary measures.

In this context I ran a quick exercise and looked at the results of the World Competitiveness Report published by the World Economic Forum (WEF) in September 2014. This is an annual report which looks at various data and survey-based indicators to take account of a wide variety of factors that can affect a country’s competitiveness. Building on the data set put together by WEF, I shortlisted a sample of indicators and restricted my comparison to the Euro Area. The scope was to gain a feeling of the structural challenges and remove the possibility of them being just a worn out phrase.

Most of the variables I looked at relate to institutions (such as public trust in population, burden of government regulation), labour market efficiency (pay and productivity, hiring and firing practices etc) and good markets efficiency (eg effect of taxation on incentives to invest). After taking 21 indicators, a pattern clearly emerged – Greece, Italy, Slovakia, Slovenia and Spain consistently stand out among the worse positioned countries in the world (just to be clear I did not mean to write in the Euro Area); Portugal is also poorly positioned. Below we reproduce just a few charts to illustrate our point.

As an additional insight, I included below the global rankings (out of 144 countries) of the worse positioned Euro Area countries for some indicators which I deemed critical.

I would also note that even the core Euro Area countries are far from homogenous with France for instance achieving weak rankings for government regulation (121), taxation related investment incentives/disincentives (132) and hiring and firing practices (134).

What would the conclusion thus be? I say that at this stage there is considerable evidence that the ongoing fall in lending that we have been seeing in Europe and, more specifically, in the peripheral countries might have little to do with monetary stimulus or lack thereof. That is, banks are not extending loans not necessarily because the monetary conditions are not favourable enough but because other factors deter the recovery of the local economies and make entrepreneurs reluctant to invest. Furthermore, the data published by WEF suggests that for some countries the advantages that the depreciation of the Euro has on competitiveness could be to some extent offset by internal factors which hinder competitiveness. If this is the case, we could see a growing gap between the core and the non-core countries as many of the former will accrue the benefits of a weaker euro. It all boils down to political measures which need to improve investment climate so as to complement monetary stimulus.

What does it mean for financial markets? I would say that this implies that QE could be efficient in boosting valuations but, at the same time, investors might become more selective when considering exposures into cyclical companies. Since such names are prevalent in the single-B EUR High Yield space we could speculate that the recent widening relative to BB-rated names might take some time to reverse and that name selection is now increasing in importance.

Have a nice day!

Raluca