Euro banks to face stress; LTRO3 likely in 3 months: Parker

After euro zone leaders agreed in principle at the EU summit to establish a joint banking supervisor for the 17-nation single currency area, the nitty-gritty’s still need to be worked out. The first step towards a banking union could eventually feature a joint deposit guarantee and a bank resolution fund

In an interview to CNBC-TV18, Robert Parker, vice chairman, Credit Suisse expects the pressure on the EU regions banks to go on. While he sees a high probability of LTRO 3 within the next two to three months, he says the European Stability Mechanism (ESM), or the European Central Bank (ECB) intervention could have a significant impact on European markets.

Parker says that bond purchase programmes like LTRO 1 and LTRO 2 were driven by the need to provide liquidity, most notably to Spanish and Italian banks and to some extent the French banks. “, I think in the next two-three months, a further round of long-term refinancing is highly likely,” he says.

Below is an edited transcript of his interview to CNBC-TV18. Watch the accompanying video for more.

Q: How are you reading the data has been coming through from euro zone and the kind of action that the ECB announced as well?

A: The overall theme if you look at the euro zone is that the economic numbers in Germany for the last two months as shown by the IFO index particularly, the German economy has clearly weakened. Whereas earlier in the year annualised growth in Germany was running at close to 2% for the second and third quarter of this year. German growth annualized could be lower than 0.5%.

If one looks at most of the rest of the euro zone obviously the numbers are recessionary and demand remains very weak. Draghi for whom I have extraordinary respect for, the head of the ECB, I think he and his colleagues at the ECB are focusing on firstly the downturn in demand and secondly the decline which is ongoing in bank lending in the stressed countries and most notably Spain and Italy. The third factor is that deflation is more of a threat today than inflation.

Q: There was no mention of a fresh round of long-term refinancing operations (LTRO) or bond purchase programmes. Was the market a big disappointed by that, should it have been?

A: LTRO 1 and LTRO 2 were driven by the need to provide liquidity most notably to Spanish and Italian banks and to some extent the French banks. One main feature of capital markets in the fourth quarter of last year, and the first half of this year has been the withdrawal of lending to those banks and obviously, the economic effect whereby they have not been lending to their end customers. So LTRO 1 and LTRO 2 were very successful in meeting that liquidity gap, which as we know was in excess of a trillion euro.

In terms of whether we need LTRO 3 or not, the pressure on the banks in the euro zone will continue. Although we have not had any explicit mention so far of the LTRO 3, I think in the next two-three months, a further round of long-term refinancing is highly likely. One another aspect which has not been mentioned is whether the ECB or the new ESM could intervene in other markets.

One thing that would be very powerful is if they intervene for example in the credit default swap market. There, a small amount of intervention would have a very significant impact. In terms of the ongoing problems in the euro zone, we are still dealing with the elevated level of Spanish and Italian bond yields and we are obviously still dealing with the issue of tight liquidity in the banking system.

Q: What about the US that remains another pressure point where the recent jobs data have not been very encouraging?

A: After the first quarter when growth was slightly lower than 2% annualised, recent data has been mixed from the US. We have had some data for example, retail spending, which has held up reasonably well but clearly labour markets remain weak, unemployment at 8.2% and the non form payroll number that we had announced last week is clearly much lower than the market expectations.

The improvement in the labour market that we have seen since 2009 clearly has stalled. On current projections, I am assuming that over the balance of this year, unemployment will remain close to 8%. On that basis, probably late August or early September another round of quantitative easing (QE), possibly targeting the mortgage backed securities market is highly likely. In any event, what is already a very easy monetary policy from the Federal Reserve will remain exceptionally easy.

Q: The despondency has been most apparent in the currency market. What is it that you expect to see on the euro-dollar over the near-term?

A: We have been forecasting for sometime, a breakdown in the euro-dollar towards 1.2 and we are nearly there. Clearly, interest rate cuts by the ECB, the weak economic data coming out of Europe are all negative for the euro. The only positive for the euro is that we have a very high short euro position on the foreign exchange market. So everybody, whether it be prop traders, whether it be investors are short the euro and long the US dollar.

_PAGEBREAK_

Consequently, my feeling is that further downside is fairly limited. I don’t think there are any catalysts in play for a rebound in the euro-dollar but a test of 1.20 in the coming weeks is highly likely. We may then settle down which would be my central case, probably in the range of 1.17 to 1.20 particularly as the number of those short positions see profit taking.

Q: Where does all that leave EMs like India? What do you expect to see in the second half then?

A: The data coming out of EMs has clearly weakened in the last two-three months. We have seen in most emerging economies, a policy response of an easier monetary policy. I am thinking of Brazil and China and in certain countries notably Brazil, an easing of fiscal policy. In the case of China, further monetary easing, and further fiscal easing is likely because Chinese authorities are determined to try and hold growth in the range of 7-8%. After a weak Q2, we will see some recovery in the Chinese economy.

In the case of India, it is difficult. And the reason why it is difficult is because you have a trade deficit, capital outflow, elevated inflation, plus a weak currency. That very difficult economic combination obviously makes policy response much more complicated. In terms of where we go from here on the Indian economy; two positives, clearly the fall in commodity prices and most notably the stabilisation of the oil prices around a USD 100 per barrel rather than USD 125 per barrel that we saw back in April and obviously the exports sector should respond to the weakness in the currency.

Having said that, we need a more rigorous policy response to kick start growth in the Indian economy. That may involve another round of monetary easing perhaps in the fourth quarter and I think a more precise and coherent longer-term fiscal plan.

Q: Coming back to the euro zone, for the second half of the year, what would you say remains the key risk to the euro crisis and collateral damage for global markets?

A: The key risk is lack of implementation and let me highlight that by just using one example. At the last EU summit, there was an agreement on the Spanish bank bailout of 100 billion euro. That bailout has not yet happened. Consequently, I think the risk in the euro zone is that the summits agreed action points but then that action is not implemented. What clearly worries markets at the moment is this lack of progress in implementing what is agreed at summit meetings. That lack of progress clearly challenges the credibility of the EU leaders.