European Financials: ECB shifts to case by case approach on NPLs – The ECB has provided an update of how European banks should provision for future non-performing loans. The update was greeted with a sense of relief for the banking sector, as it represented a far softer stance than the tough proposals that were suggested last November. Of particular importance is the notion that the ECB will now treat each bank on a case-by case basis allowing essentially for discretion. The ‘requirement’ to provision has also been replaced with the softer ‘expected’ to provision concept, another supportive factor for banks. Furthermore, the expectations will apply only to new NPLs, and the ECB has pushed back the start date to 2019. The NPL problem is isolated, and we do not see a significant impact for the larger European banks based on this NPL report.
Although good news, this still does not resolve the European problem for existing loans. Banks within Greece, Italy (smaller banks) and Portugal will still have to sacrifice many future years of profitability to address the legacy NPLs. If we take some illustrations, Greece has an NPL ratio of roughly 47%, while the Italian banks hold roughly one third of the European outstanding NPLs, at EUR 305bn. Fortunately, the NPL issue in Europe is a concentrated issue, just in a few nations. Many banks and nations on the continent simply do not have the same issues. Indeed, numerous countries have NPL ratios at generally acceptable levels. Sweden, Luxemburg, Czech Republic, United Kingdom, Finland and Norway all for instance have an NPL ratio below 2.5%. In fact, we calculate the loan weighted median NPL ratio in Europe to be just 3.1%. The NPL provision guidelines from the ECB will allow the struggling banks more time to catch up, but they are far from out of the woods yet. (Tom Kinmonth)
Fed View: Wages are a bigger driver than inflation – Inflation has picked up in recent months, but we do not think this will be the main driver of next week’s (expected) Fed rate hike. Indeed, we do not think the present drivers of the inflation pickup are sustainable, and expect inflationary pressures to remain broadly muted this year. So what is driving the Fed to continue hiking? We think labour market developments are key, and that strengthening growth momentum and the corresponding impact this is having on wage growth are likely to be the more important driver. This is corroborated by past experience, and it makes sense given that monetary policy works with a lag, with wages being a better leading indicator for sustainable trends in inflation than current inflation. All told, we expect three 25bp hikes from the Fed this year, with the risk of a fourth, should wage growth accelerate to the highs we saw prior to the financial crisis (c.3.5% yoy). However, the bar for hiking at a quicker pace than this is very high, in our view. (Bill Diviney)