European policy making has been the focal point of market worries. The key point is that the Eurozone economy needs cooperation between fiscal, monetary and structural policies, but instead it is getting conflict.

## Rebound in European markets


## Conflicts proceed in a typical European manner
In all these conflicts it is important to emphasise that their severity is a far cry from the 2011/12 existential crisis conflicts. However, they do proceed in a typical European fashion: an initial apparent stalemate is eventually resolved on the back of additional market and/or political pressure.

The main question is when this will happen and in the meantime markets are faced with a small winter of policy paralysis. This allows the corrosion of growth momentum and inflation expectations to fester on. So markets probably fear that this corrosion will reach levels that will bring the region dangerously close to the brink of deflation. In particular, the fear may be that sovereign QE (ECB buying government bonds) will not arrive in time or sufficient force. As long as the fiscal conflicts are raging it may be politically difficult for the ECB to start buying sovereign bonds. Even once this conflict is resolved, government and public opinion opposition in Germany may be a bigger hurdle than we currently believe.

## Stress tests are next step towards banking union
Having said all this, we should also emphasise that there is still considerable monetary policy easing in the pipeline. The effectiveness of the measures already taken by the ECB could well receive a positive boost from the results of the asset quality review (AQR) and the stress tests which are initially well-received by the market and are an important next step towards a banking union. History (US in 2009/10 and Japan in the 1990’s) shows that it is hard to over-emphasise the importance of cleaned up and recapitalized bank balance sheets.