The falls have been blamed on bad economic data, particularly from across the Channel. German exports, dependent on faltering investment spending in emerging markets, fell 6 per cent month on month in August, worse than economists had expected. The fear is that Europe's largest economy - and until the spring its most reliable growth engine - has fallen back into a slump, dragging the continent with it. The IMF now gives the eurozone a four-in-10 chance of recession, defined as two consecutive quarters of negative growth. Definitions aside, it is revealing that Poland's central bankers cut their benchmark interest rate by 50 basis points this month to a record low of 2 per cent. Germany buys almost a quarter of Polish exports (and a ninth of Britain's).
It is not obvious how things will improve. There is no debate in Germany about whether fiscal policy should be used to support growth: all mainstream parties agree that deficit spending is bad. France and Italy want to loosen the fiscal taps, but are constrained by government deficit targets. That leaves the European Central Bank (ECB) alone trying to jump-start the economic engine with monetary policy.
How? As ECB President Mario Draghi explained in Washington on 9 October, its approach so far has been essentially passive: open credit lines to banks at ever cheaper rates. Now it is "transitioning... to a more active and controlled management" of its balance sheet: in other words, quantitative easing. But for now it is not buying government bonds, which comes too close to pan-European risk-sharing for German comfort. Instead it is buying "simple and transparent" asset-backed securities (ABS) and covered bonds, worth up to €1 trillion.
A complication is that the ECB is simultaneously in the process of subjecting the eurozone's 120 or so biggest banks to "stress tests", as part of the EU's hugely ambitious plan to create a banking union. The tests involve on the one hand scrutinising bank balance sheets and writing down dubious loan collateral (the "asset quality review"), and on the other hand making sure banks have enough capital to withstand a financial crisis scenario. Due on 26 October, the results are a precursor to the ECB taking over the regulation of big banks from national authorities on 4 November.
The stress tests are designed to create a more stable banking system in the long run. Paradoxically, however, they could spark instability in the short run by drawing attention to the weak capital position of some banks. Guy de Blonay, a fund manager specialising in financial stocks at Jupiter Asset Management, downplays this risk on the basis that "the pools of problem assets are already known". Perhaps, but the current market mood is unforgiving.
The banking system matters because it is the transmission mechanism for quantitative easing. To caricature, the efforts of one ECB department trying to stimulate lending to the real economy by buying ABS are undermined if another ECB department is writing down the value of the assets backing those securities. Previous ECB attempts to engage in unconventional monetary policy - most recently the cheap four-year loans offered under the so-called Targeted Long Term Refinancing Operation, take-up of which has been much lower than hoped - have been frustrated by blockages in the system. With their stress tests, the ECB plumbers may eventually unblock the pipes, but meanwhile the eurozone has no hot water.
The UK suffered much the same problem as recently as two years ago. In the freezing winter of 2012-13, there was lingering talk of a triple-dip recession. Then consumer confidence suddenly started to improve, buoyed by ultra-cheap mortgages and housing subsidies.
Without full-scale quantitative easing or the hope of fiscal stimuli, the eurozone cannot count on these triggers. That explains why more and more economists are worrying about a Japan-style 'secular stagnation' on the continent. If this scenario comes to pass, it will be hard for the British economy to maintain its poise. This wouldn't be such a problem if stock markets weren't highly rated, but even after the recent falls current valuations leave little room for error. The stage is set for a stormy fourth quarter.
