Tyndall Monthly Commentary

Only two months ago, financial market participants and, it seems, many companies within Europe's real economies were convinced that the European Central Bank, under the stewardship of its new Italian Chairman Mr Draghi, had saved the Euro project from an imminent and potentially catastrophic crisis.  What Draghi chose to do, or perhaps was forced to do by circumstances, was to add at least EUR 1 trillion (in fact, we would argue that the true amount was closer to EUR1.5 trillion, or 12 times the size of the entire New Zealand economy) in new funds to the European financial system and to the banks in particular.  The injection of seemingly so much money naturally brought forward claims that the ECB had finally embraced a worthwhile Quantitative Easing Policy similar to those that had already been used by the US authorities and many evidently believed that this would suffice to save the Euro and restore economic growth to the Euro Region.

Certainly, it is apparent that financial markets - although perhaps not the foreign exchange markets - believed this positive interpretation during the first quarter and perhaps more significantly many companies in Europe and particularly in Germany seemed to believe this positive spin on events as well.  Therefore, just as we saw in mid-2008 when the world (wrongly as it transpired) believed that the Federal Reserve had somehow fended off a global financial crisis, measures of business confidence picked up following the ECB's actions and in some cases this new-found confidence resulted in an upturn in employment growth as some companies sought to prepare themselves for the expected strong recovery.  However, what is apparent is that the revival in the business confidence indices that was so lauded by the financial markets was almost entirely the result of a pickup in businessmen's expectations of a recovery and crucially it was not based on their actual experience of current conditions or even realised order flows.

Businessmen evidently became more confident because policymakers and the markets told them that everything would be ‘all right' and, as the business confidence indices increased, the financial markets then continued to run and so encouraged yet more expectations of a recovery in a peculiar self-reinforcing, if somewhat erroneous, process.