In the past month a significant euro-zone potential risk has been removed: the results of the banking sector’s AQR and stress tests. This means that markets can go back to focusing on fundamentals to set the right multiple for European markets.

The European Central Bank’s only mandate is price stability, with inflation targeted at 2 per cent. Deflationary pressures are concerning to the ECB: Mario Draghi’s preferred measure of inflation expectations, the five-year forward five-year inflation swap rate is below 2 per cent. This means that to reach price stability in the next few years, there needs to be improvements in the economy such as growth and unemployment. To do this, the ECB needs to keep short interest rates low and to ensure there is enough liquidity in the system. Therefore, two key elements in measuring the progress of the region are the banks’ lending behaviour and the pursuit of structural reforms.

We remain concerned regarding the time frame in which banks will significantly restart lending to the real economy. We believe the ECB, in its new role as a banking supervisor and through its varied announced measures (TLTRO and asset purchases) is trying to orchestrate a structural change in the European lending market. This is why there are some grounds for optimism, as there has been much work done for banks to be able to support economic activity and inflation.

For example, loan books have already been substantially cleaned up, banks have been recapitalised and funding structures have been made a great deal more resilient. The recently completed comprehensive assessment of the banking sector removes the risk of further capital-raising within an unfavourable market environment and helps investors feel more comfortable about the sector as balance sheets are now more transparent.

However, this is not the end of road for European banks as there are still question marks regarding the ECB’s suggestions for increased provisioning and collateral. Therefore, even if the credit engine is on its way to reignition, it will at least take at least a few months into 2015 for there to be meaningful signs of change.

The European Commission and member states are in a continuous negotiation process over structural reforms, as fiscal budgets need to be approved on a yearly basis. Recently, the EC provisionally approved the budgets of the two structural reform laggard countries, France and Italy. The two countries have been pushing for a relaxation of deficit limits to reduce the risk of Europe slipping back into recession, however both countries did agree to make additional deficit cuts in 2015. This is not the final step, as the EC will make a detailed evaluation of budget plans for the euro zone this month and may still seek more austerity measures. Compromising with the EC on the amount of deficit reduction required is positive, but both France and Italy still need structural reforms to boost growth and employment.

In conclusion, the European economy remains slow but steady in its recovery and therefore more vulnerable to exogenous shocks such as the Ukrainian crisis. On the bright side, structural change is on its way, and the ECB is working on a longer-term restructuring of the banking sector and the European lending markets. The largest risk remains the uneven speed of implementation of structural reforms: national governments need to do more. As Portugal’s dealing with the BES crisis showed this summer, the eurozone crisis-fighting architecture is much more robust than it was in the 2010-12 crisis period and under Mr Draghi’s leadership, the ECB has stood up to its promise of targeted action.

Cesar Perez is the chief investment strategist for EMEA at JP Morgan Private Bank

business@thenational.ae

Follow The National's Business section on Twitter