German election: stability-led complacency

Economic policy uncertainty in Europe has risen to extraordinarily high levels. This stands in stark contrast to conventional measures of financial market uncertainty which are at historical lows. Uncertainty surrounding economic policies has negative spillover effects to the rest of the economy. It tends to be transmitted to capital markets and to result in higher financing costs for companies. Significant cross-country transmission of economic policy uncertainty is observable within the EU, with the UK being a net exporter. In addition, banks could turn out to be a central channel through which economic policy uncertainty is transmitted to the real economy, via subdued lending to non-financial corporations, in particular to SMEs. [more]

The Basel Committee’s recent agreement on final capital rules for global banks is set to have only limited effect on overall capital requirements, but will impact EU banks more strongly than their peers. In recent quarters, European banks have already strengthened their capital ratios substantially and have become more profitable, thanks to moderately better revenues, lower costs and lower loan losses. Balance sheet size and risk-weighted assets have declined, underscoring the continuing lack of growth momentum in the industry. This might change somewhat next year, as European banks could benefit from the strong performance of the economy via a pickup in lending, which so far has remained sluggish. Further tailwinds from declining loss provisions and falling expense levels are less likely though. [more]

No real surprises hidden in the “Saint Nicholas” reform package from Brussels, a detailed set of reform proposals and communications that the European Commission published as a “roadmap” for deepening EMU. The proposals build on Commission President Juncker’s September State of the Union speech and, in essence, match closely with the French vision of more stabilization and risk-sharing in the EU, while they also try to meet German demands for better supervision of fiscal rules. The strong focus on anchoring any further integration of the Monetary Union - such as the reform of the ESM and the introduction of a Eurozone budget - in the institutional framework also illustrates the wariness in Brussels of being sidelined in its fiscal competencies and to allow the euro area to further develop on its own. [more]

The EU Commission proposed new mandatory CO₂ targets for passenger cars. These targets cannot be achieved with combustion engines alone. Stricter regulation thus enforces the electrification of the power train. However, the average car buyer currently does not play to the tune of regulatory policy and turns a cold shoulder on most alternative fuels. There are other climate policy instruments that outperform the CO₂ targets for passenger cars in terms of meeting the environmental targets and economic efficiency. [more]

The fluid political situation in Germany threatens to stall EU policymaking in a number of fields, above all the build-out of the euro area. The EU summit on Dec 14/15 is unlikely to yield an agreement on a potential roadmap for reforming the monetary union making it even more difficult to take final decisions in June 2018 as envisaged by the EU Commission. This will in return dampen optimism that a French-German tandem will provide a fresh impetus to the EU as a whole before the European Parliament elections in 2019. [more]

Beyond the Catalan referendum, independence movements in Europe seem to enjoy a revival. But calls for greater autonomy or even secession are not just about cultural identity - financial discrepancies between regions also play a major role. Unsurprisingly, most of the regions with strong separatist tendencies are amongst the wealthiest in their respective countries. Calls for (more) independence seem to be loudest when national financial equalization mechanisms lead to results that are perceived as disproportional, such as in Spain or Italy. [more]

On 15 December EU leaders will discuss integration. One proposal that is mentioned in the debates in France and Germany is a repurposing of the ESM as a “European Monetary Fund”. Using a Q&A format, we consider what reforms might mean for the euro area bailout fund. [more]

Money market funds in the euro area managed assets worth EUR 1.16 trillion in mid-2017. Low interest rates did not hamper the impressive growth by EUR 260 billion during the past three years. But new EU regulation taking effect in 2018 will impose stricter rules on fund managers. However, the measured regulation will probably not cause a major restructuring of the euro area market, in contrast to the reshuffling seen in response to the US money market fund reform. In the future, Brexit could lead to competition for non-EUR denominated money market fund business between the EU and the UK. [more]

Optimism about Europe’s future surged after the French elections, while the EU is increasingly losing patience with British “divorce tactics”. Franco-German initiatives will be key to set the path for European reforms but the debate is expected to only gain speed after the formation of a new German government towards the end of the year. Meanwhile, the refugee challenge and EU external relations will remain on top of Europe’s political agenda. [more]

It is remarkable what and how much has changed in the European banking industry since the global financial crisis erupted almost exactly ten years ago: comparing H1 2017 to the peak of the boom in H1 2007, revenue composition has shifted towards more sustainable sources, with the share of net interest income up to more than half of the total and trading income much diminished. Expenses are down, but only moderately, resulting in a fall in profits to just half of the pre-crisis level. Both the absolute amount of capital and capital ratios have risen dramatically. On the other hand, total assets have declined substantially over the past decade, contributing to a massive de-risking of the sector. [more]

Yields on German government debt securities have fallen rapidly in the aftermath of the global financial and economic crisis and provided a considerable relief to the public sector budget. At the moment, federal government securities have negative yields for maturities up to 6 years and the yield on 10 year German Bunds stands at just roughly 0.4%. [more]

The benign economic and public environment allows to fundamentally address shortcomings of the E(M)U. The next German government’s term is faced with numerous challenges ranging from Brexit and its impact on the next EU Budget to migration and the upgrade of the euro area. A revitalised relation with France provides the opportunity for substantive steps to further stabilise the euro area albeit Germany and France need to find common ground on many issues and seek the support of EU partners. European politics is still less of a topic for the German electorate not least as mainstream parties are all various shades of pro-European. However, the next government’s party composition is likely to matter for both speed and scope of changes on European level. [more]