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ECB is leaning against political headwinds

The new ECB headquarters in Frankfurt, Germany.
Wolfgang Rattay | Reuters
The new ECB headquarters in Frankfurt, Germany.

Even if one does not entirely share the European Central Bank's (ECB) upbeat view of the euro area's incipient economic recovery, one has to acknowledge its constant efforts to alleviate the socio-political damage done by austerity and reform-at-all-costs zealots.

The ECB has been working for the last six years against unreasonably harsh fiscal policies, whose depressive impact was exacerbated by constant market-jarring statements of north European politicians bent on teaching a punishing lesson to allegedly south European spendthrifts – economies which account for 53 percent of the monetary union. In spite of that, the ECB managed to help stabilize last year the euro area's domestic demand, after an average 1.6 percent annual decline in the previous two years.

The euro area's appropriately easy monetary policies have also set in train export-induced growth dynamics. Last year, for example, net exports accounted for all of the area's economic growth estimated at about 0.9 percent.

The ECB's data on monetary developments in the currency union indicate improvements in the demand for money – a function of income, employment and the cost of credit. Unfortunately, these numbers have yet to show volumes of bank lending to the private sector that could be associated with a steady and sustainable increase in economic activity. Indeed, a mildly accelerating growth of the broad monetary aggregate, M3, still leaves bank loans to businesses and households in the three months to February 0.3 percent below their dismal year-earlier levels.

The hard numbers (not the survey data) on the real economy are consistent with these monetary indicators. Despite some improvement in the first two months of this year (from very depressed conditions of the year ago), industrial production in Germany's large manufacturing sector barely eked out a 0.2 percent growth over that period, while Italy and Spain recorded production declines of 1.2 percent and 0.5 percent, respectively.

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The sustainability of higher consumer spending also looks questionable in view of high and rising unemployment rates – 11.3 percent in February from 11.2 percent in the previous month. Unemployment has risen in the first two months of this year in France (10.6 percent) and in Italy (12.7 percent), while the jobless rate in Spain has come down only a percentage point since the middle of last year to 23.2 percent, despite being Germany's favorite example of the "austerity growth model" driven by flexible labor markets (i.e., easier hiring and firing).

Bank lending is the ECB's test

It is, therefore, not surprising that the euro area banks are not finding many suitable customers for consumer loans. Their balance sheets in January and February showed a declining volume of lending to households. Even the mortgage lending, which the ECB calls "the most important component of household loans," marked no change from the year earlier.

The euro area bank lending will be the ultimate test of the ECB's large asset purchases, because these interventions are supposed to push up bond prices in order to improve the balance sheets of the banking sector, which is a major holder of the euro area government securities. That, in turn, is expected to make banks more capable -- and willing -- to expand their financing of consumer spending and business investments.

It is, therefore, quite possible that ECB's optimistic statements last Thursday may have been based on improvements in the bank lending for March, which will be published later this month.

Greece is Europe's heart and soul

But it is also possible that the ECB was trying to inject a note of sanity in the speculations about Greek debt negotiations fueled by hostile statements of Greece's euro area partners.

If you followed the ECB's press briefing last week, you may have noticed that the bank dismissed the rumors of the Greek exit from the currency union. The bank's president Mario Draghi said that he was not even ready to "contemplate" such a scenario.

Germans apparently think otherwise. While these reassuring words were coming from the ECB, Germans were making the rounds of IMF meetings in Washington to threaten Greece with dire consequences. They even managed to pick a fight with the French by saying that Paris was looking for foreign pressure to do reforms it did not have the political courage to implement on its own.

Greeks and Germans will most probably have it out at the International Court of Justice on a 300 billion euro bill for WWII reparations, but a fight between the French and Germans is a different political dimension: these two countries are supposed to be the engine of European integration.

Alas, there is nothing new here. Similar things were happening during the most acute phase of the euro area crisis, when incendiary statements and foot-dragging of the "virtuous" part of the euro area roiled the markets and aggravated the financial burden of heavily indebted countries by cutting their market access and sending the yields on their securities to default-like levels.

A redux of sorts was in plain view last week. Yields on Greek ten-year bonds increased 135 basis points during the week to 12.85 percent. The cost of long-term funds also rose for other south European countries, ranging from 29 basis points in Italy to 31 basis points in Spain and 37 basis points in Portugal. But German yields for same maturities declined 109 basis points to 0.07 percent.

It took some statesmanship from the U.S. Treasury Secretary Jacob J. Lew to prod Greece and its euro area partners to come to an early agreement on issues blocking their financial relations. While urging Greece to work on its public finances, Mr. Lew warned the Eurogroup (the forum of euro area finance ministers) President and Netherlands Finance Minister Jeroen Dijsselbloem that no agreement between the two sides "would create immediate hardship for Greece, and uncertainties for Europe and the global economy more broadly."

That is the message the markets took home last Friday by marking down 2.07 percent the euro area stocks (euro stoxx 50), while sending also the S&P 500 down more than 1 percent.

Investment thoughts

The probability of Greece's exit from the euro area and from the EU is virtually nil. A solution will be found to allow Greece to service its debt and to relieve problems of a politically intolerable destitution. Greece's recently elected left-wing government has pledged its commitment to the euro area, the EU and the NATO.

If you go to the NATO's website, you will see that Greece is hosting the NATO Deployable Corps Greece in Thessaloniki, the Combined Air Operations Centre in Larissa, the Multinational Peace Support Operations Training Center in Kilkis, the NATO Maritime Interdiction Operational Training Centre at the naval base of Souda Crete, NATO Missile Firing Installation, Athens Multinational Sealift Coordination Centre and the Naval Base of Souda.

Washington will keep an eye on the Greek debt negotiation to make sure that things stay that way. And the ECB will be helping along.

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Michael Ivanovitch writes about world economy, geopolitics and investment strategy: @msiglobal9