'Reality leaves a lot to the imagination' John Lennon

Lunch yesterday with a member of the ECB, who will have to remain nameless, was an interesting affair. The usual hawkish noises around inflation remaining stubbornly high, the need to avoid second round effects and the damage to the Eurozone that would be borne out of an inflationary spiral were entirely expected. Indeed I have some sympathy with the ECB. Their mandate, as I’ve mentioned before, relates to ensuring price stability, which in turn sees the Council target an inflation rate (HICP) of below, but close to 2% over the medium term. Currently HICP is running at more than double this rate and frankly their record of hitting their target is a poor one. Not surprising then that they continue to bang the drum despite some significant developments of late. Indeed Jim has already outlined a very convincing argument for why we should probably be more concerned with deflation than inflation in the medium term (see here). The recent moves lower in commodity prices and this morning’s inflation surprise to the downside for the month of August in France, merely serve to add weight to the argument. 

As I’ve already said this stance was no surprise but, I continue to find myself gob smacked by the ongoing assertion that firstly, lending to non financial corporates remains robust, and secondly that there is little if any sign of a credit crunch. Yes, lending to non financial corporates is still growing at double digits but the data is a) backward looking, b) susceptible to substitution effects and c) further inflated by companies, like Porsche, who are able to arbitrage the system; drawing down on cheap financing locked in at the height of the market (see here).

In an environment where banks are being forced to delever, are faced with huge redemption profiles and witnessing their costs of funding continuing to rise to all time highs, there has to be implications for their willingness and ability to lend in my opinion. This is how the weakness in the financial sector is already being transmitted to the ‘real’ economy in Europe and is set to continue. Admittedly, when pushed, there was some acceptance that if the current difficulties don’t pass anytime soon, then the risks of a downward spiral increase.

Personally I don’t really see an end in sight and nor do I rate my team’s chances against Manchester United in this weekend’s big game at Anfield. I hope I’m wrong about the latter.

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