5th June 2014
The European Central Bank (ECB) has slashed interest rates in the hope of stopping deflation hitting the beleaguered Eurozone.
The bank cut its key refinancing interest rate from 0.25% to 0.15% and even took its deposit rate into negative territory from 0% to -0.10%.
Within the region consumer price inflation fell to just 0.5% in May, well under the bank’s 2% target and the Eurozone only managed 0.2% economic growth in the first three months of the year and while bank lending continues to retreat.
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We round up the expert reactions…
Good news for peripheral Europe. Trevor Greetham, director of asset allocation at Fidelity Worldwide Investment
From an asset allocation perspective the ECB’s easing moves are clearly good news for euro periphery assets and the financial sector and the direction of travel underpins a negative view on the euro and Swiss franc relative to the dollar and sterling where policy is on a tightening path.
It is significant that the ECB is easing when the economy is growing and peripheral bond spreads are very tight. With the slowdown in China keeping inflation under downward pressure, developed economy central banks are willing to ease to sustain a recovery already in place or on grounds that inflation is too low. Today’s moves are part of the positive growth and liquidity backdrop supporting developed equity markets.
QE for Europe on the cards? Ben Brettell, economics editor, Hargreaves Lansdown
The most surprising thing so far today is that Draghi seems to be laying the foundations for quantitative easing in future.
It is difficult to see how 0.15% interest rates will provide meaningful stimulus when 0.25% has failed. Banks that took funds in the last round of LTROs in 2011 and 2012 have paid back half the cash early, suggesting it never filtered down to the real economy.
Finally there is no real evidence that negative deposit rates work – they are intended to incentivise banks to lend money rather than hold it at the ECB, but they could simply switch cash into other ‘safe’ assets rather than lending it. When this was tried in Denmark and Switzerland, commercial interest rates rose in response as banks sought to pass the additional costs on to consumers.
It’s tempting for UK investors to write Europe off as a basket case. However, our analysis shows it is historically cheap, and buying when markets are cheap provides the best prospects. Many European companies generate most of their revenue outside the region, but have still been marked down because of where they are located. Europe could therefore be seen as a contrarian play for longer term adventurous investors, though they should be prepared for a bumpy ride.
Too late for inflation risk? Neil Williams, group chief economist at Hermes Fund Managers
Today’s ECB moves are a step in the right direction, but look too little, too late to snuff out deflation risk and kick-start growth. The 10 basis point shavings off the refinancing and deposit rates are puny, and look more cosmetic than real. Any drop in the euro on the back of them would be welcome but possibly short- lived.
The ECB hopes the new, negative deposit rate (-0.1%) will deter banks from parking cash at the ECB, instead passing it on to consumers and firms. But this may be a red herring – given still subdued credit demand, pressure for the banks to pass stress tests, and the fact that the bulk of reserves still gets the positive (0.15%) refinancing rate. These rates may have to be cut again.
The ECB’s ground work on private asset purchases may help, but are not the ‘bazooka’ of unlimited sovereign QE it could have fired today. Draghi’s hesitancy to use all his bullets today reflects how empty his policy tool box is. With demand subdued and the likelihood at some stage of rising bond yields, the ECB will have to capitulate on QE.
European economy stronger than many acknowledge, Stuart Mitchell,manager of the SWMC European Fund
Draghi has delivered the necessary measures: prudent stimulus and the necessary ECB rate cuts that will weaken the euro and boost market confidence.
We have to be very careful when we talk about deflation in Europe. A large part of what we are seeing is the effect of cheaper imported products coming from all the over capacity that has been built up over the past few years in the emerging world. A portion, of course, comes as a result of a prolonged period of austerity in the periphery. But this is the area where recovery is building quickest.
In our view, the overall European economic backdrop has always been much stronger than many acknowledge. Our firm belief has always been that the eurozone economies are both fiscally stronger and more business competitive than their Anglo-Saxon counterparts. You only need to look at the modest growth in overall eurozone government debt over the crisis, or at the German trade account surplus, to appreciate the strength of the region relative to the US and UK.
Impact on inflation but only medium term, Andrew Mulliner portfolio manager at Henderson Global Investors
Whether the measures taken have the desired effect will take some time for investors and the ECB to divine; the impact on credit creation and inflation will only likely be boosted in the medium term, although the ECB has sent a clear message to investors today and the market reaction suggests that investors are listening.
Markets have reacted to this large upside surprise with the euro falling to close to year-to-date lows, government yield curves steepening aggressively and peripheral government bond markets and credit markers rallying sharply, benefiting the positioning in our portfolios where we have been positioned for a fall in the euro relative to the US dollar and a steeper yield curve.
We will see the real demand for liquidity from banks, Serge Pizem, manager of AXA WF Optimal Income fund at AXA Investment Managers
The ECB delivered what was expected by markets, namely lowering the refinancing rate to 0.15% and taking the deposit rate to negative territory (-0.10), but also announced ABS purchases of non-financial sector, and finally a new package of 400 billion LTROs focused on business loans for more liquidity. These measures, taken together, should reassure markets whose expectations were high.
The ECB noted the decline and low inflation in the Eurozone by cutting its forecast for the next three years. The objective of keeping inflation below 2%, but which remains close to 2%, was stressed. The ECB will continue to keep rates low in response to continued low inflation rates (that stood at 0.5% in May), as the inflation rate is still far from their goal.
On the other hand, the President of the ECB, Mario Draghi, has provided a way out by saying he is ready to do more if necessary and insisted that the ECB committee was unanimous on these measures. Unconventional measures, such as an asset purchase program on a large scale, could be implemented later if the situation does not improve. Draghi succeeded in his speech in responding to each of the points of market stress and highlighted that the central bank was very conscious of the situation of low growth, lack of progress on business credit and declining inflation.
Markets should welcome this increased visibility and clarity on monetary policy, although other issues may now emerge, such as what the real demand may be for the proposed new liquidity measures for bank lending operations.
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