With speculation of helicopter money in Europe spreading like wildfire, here is a simple summary of how the ECB may have no choice but to go with the “final solution” and engage the “chopper” for one simple reason: by pushing bond yields lower, the ECB is now actively impairing the functioning of Europe’s banks, and it’s getting to the point where European bank stocks are now back to crisis lows, leading to questions about their viability. Here is the explanation courtesy of DB’s Jim Reid.
It is fair to say that markets have for a long time exhibited Stockholm syndrome tendencies towards central bank policies – loving the fact that things were so bad that they had to act so aggressively. However they have been rebelling of late especially in Europe and Japan. As we highlighted yesterday its 4 weeks today since Draghi fired his quadruple bazooka and as we also remarked yesterday assets that might have been expected to benefit have been laggards on a global scale since. European banks (-9.1%), the FTSE-MIB (-5.3%) and IBEX (-3.8%) are down notably since the package was announced.
With the recent underperformance of banks one wonders how important their health is to the European economy. Is a weak banking sector holding back the European economy? It probably is as the monetary policy transmission mechanism can’t work effectively without them. But is QE and ultra low yields actually perversely holding back the banks and thus the economy? Interestingly in their latest bank piece our European equity sector analysts suggested that one of the key upside risks were higher rates and one of the the key downside risks was persistently low inflation & QE extension.
So the banks team would seemingly like to see higher yields and less QE for banks to perform. The graph [below] arguably supports this as since December there has been a very strong correlation between 10 year bund yields and the Euro bank equity index. The lower yields go the weaker banks are and visa-versa. However the question mark is whether you could actually have a stable financial system without QE and ultra low borrowing costs.
So maybe banks and the European economy would be better off without QE and ultra low rates in theory but the reality might be that this would leave us with much higher systemic risk. A catch-22 situation it seems to us.
Judging by Visco’s comments from this morning, to the ECB now too. But before celebrations over the demise of central planning commence, keep this in mind: instead of QE, what the ECB will attempt next (and last) is helicopter money. Because with helicopter money it is simple: it is no longer of “if it works” but “how much money to paradrop” in order to stimulate inflation. And stimulate it they will…
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