Europe aims for catastrophe-free tests

By Emily Kaiser

WASHINGTON (BestGrowthStock) – Europe may be hoping its long-awaited bank stress tests are anti-climactic, judging from the confident comments coming from officials.

Jean-Claude Juncker, chairman of the euro zone finance ministers, doesn’t expect any “big catastrophes” when results from the tests of 91 European banks are released on Friday.

Mario Draghi, governor of the Bank of Italy, said the tests will show Italian banks have “adequate” resources to absorb losses if loans go bad.

Patrick Honohan, governor of Ireland’s central bank, said his country’s two biggest banks had already passed domestic tests that were more rigorous than the European ones.

The stress tests are intended to show whether banks have sufficient capital cushions to cover losses if the economy worsens or a simmering government debt crisis boils over. The United States conducted a similar exercise in 2009, and it was widely credited with restoring confidence in banks.

Douglas Elliott, a fellow at the Brookings Institution think tank in Washington, said European Union banks will “pass” the stress tests because they were built to ensure success.

“It is safe to assume that the test scenario was designed to produce broadly positive results,” Elliott said. “If (regulators) are surprised in a major way, it will be evidence of a truly surprising level of incompetence.”

Barclays Capital economist Piero Ghezzi said the stress tests may be a “positive catalyst” because they will probably show that even worst-case scenario losses are manageable.

But if the tests are deemed too easy, they may not lift the cloud of suspicion that hangs over some of Europe’s banks, particularly smaller ones in Spain and Germany that may hold large amounts of souring mortgage or sovereign debt.

The biggest unknown is the economy.

A recent string of disappointing reports on manufacturing and consumption in both Europe and the United States have heightened fears of a significant slowdown.

A worsening economy could trigger a vicious cycle of bad debts, rising unemployment and worsening government finances. All of that would pile pressure on banks’ balance sheets.

SAGGING CONFIDENCE

Europe’s troubles are a primary reason why the U.S. Federal Reserve has grown less sanguine about the recovery. At its last policy-setting meeting in late June, the central bank trimmed its U.S. growth forecasts for this year.

It said financial markets were less supportive of growth than they had been in April and cited Europe as the “leading cause” of rising market tensions.

Fed Chairman Ben Bernanke presents his twice-yearly testimony to Congress this week, and will no doubt face questions about whether another recession is coming.

Bernanke and most private economists expect continued economic growth, albeit sluggish, with unemployment dropping only slowly.

But recent weak readings, particularly on consumer confidence, spending and job growth, have been worrisome. A report on Friday showed consumer confidence fell far harder than economists had expected in July.

Bernanke is likely to receive more bad news before his testimony wraps up on Thursday. Tuesday’s housing starts and building permits are both expected to slip from already low levels, while Thursday’s existing home sales report will likely show a 10 percent drop for June.

Given all those trouble zones, investors will be listening for signs Bernanke has grown gloomier since the last Fed meeting.

Michael Gregory, an economist at BMO Capital Markets, said even with the latest reduction, the Fed’s 2010 forecast “appears optimistic.”

The midpoint of Fed officials’ growth forecasts was 3.3 percent, according to minutes released last week. Since first-quarter GDP came in at 2.7 percent, that implies an average growth rate of 3.4 percent for the rest of the year.

Gregory’s firm thinks growth will average just 2.2 percent in the second half of the year, and many other economists have also trimmed their forecasts in the past two weeks.

“Maybe they know something we don’t know, or maybe they’re just trying to be an economic cheerleader,” he said, referring to the Fed. “The key is that given these hefty headwinds, private sector job creation and business capital spending matter more than ever in skirting a potential double dip.”

(Editing by Andrew Hay)

Europe aims for catastrophe-free tests