Five views on the ECB rate cut and ‘disappointing’ QE extension

3rd December 2015

Mindful Money rounds up investment experts’ views on the ECB decisions

Good for equities but hedge the euro

Wouter Sturkenboom – senior investment strategist at Russell Investments

“Super Mario” Draghi has a reputation for exceeding the market’s expectations but his reputation got a serious knock today. As widely anticipated, the ECB cut already negative interest rates even further from -0.2% to -0.3%. That means banks keeping money with the ECB will have to pay even more for the privilege. Extending the asset purchase programme (APP) by six months through March 2017 was slightly disappointing as some observers had speculated about a 12-month extension. The market chose to ignore the third significant measure of today’s decision whereby the ECB will re-invest the principal from the APP, which should keep the ECB’s balance sheet large for a long time to come.

While the ECB package was a pretty good gift to European economies, expectations had been so high that equity markets were initially disappointed and the euro rallied strongly.

However, looking beyond the initial discontent, the ECB’s moves reinforce our positive view on European equities. Our goal has been to be over-weight European assets, but in a currency-hedged way. This is intended to protect against further weakening of the euro, which is still likely in light of the ECB’s moves despite today’s strong rebound in the single European currency.

Conversely, we remain cautious about U.S. equities, as the strong dollar is hurting corporate earnings and we think that a probable U.S. Federal Reserve rate hike may dampen U.S. assets.

Europe to keep its foot on the accelerator for longer, but not harder

Jason Hollands, managing director Tilney Bestinvest

While there is a fierce debate over how effective QE stimulus packages have been for the real economy, where implemented they have proved supportive for stock markets and the prices of other assets (but weakened currencies), so a potential divergence in approach between the U.S. and Eurozone at this time is significant. This is one of the reasons that might prompt investors to be more upbeat about European equities than U.S. equities in the current environment notwithstanding the disappointment today that the ECB didn’t come up with something more punchy.

While not at bargain prices, European shares also look less expensive than U.S. shares which have surged higher during the years of low U.S. interest rates as companies have been able to issue inexpensive debt and use this to finance the buying back of their own shares.  With borrowing costs expected to nudge upwards in the U.S., that support for U.S. markets could be set to slow, meaning top line revenue growth really needs to deliver to justify current stretched valuations. Therefore in our view, European equities still have an edge over U.S. stocks.

The key message – QE is working

Nutmeg chief investment officer Shaun Port

A key message is that QE is working. The evidence given is the rising CPI forecast, moving towards 2% in 2017. Other evidence includes the fact that economic growth is being driven more by consumption than by exports; this is a healthy re-balance and a sign of improved household confidence. President of the European Central Bank Mario Draghi also noted that households were not reducing savings rates, so income is keeping up with expenditure – a sign of stable growth going forward.

Another key message is that the ECB expects fiscal policy to be more growth-friendly than when QE first began. So he sees monetary and fiscal policy as ongoing partners in accommodation. This, together with the seeming success in turning future inflation around, may be the reason the ECB balked at increasing the size of the monthly program.

Investment implications are that European policy is more balanced (fiscal and monetary), and the recent Euro weakness is also a help to the economy. That is a positive equity story, although we do expect the market to take a few days to get over the initial disappointment.

Hawkish Ease in Eurozone and we wait for a Dovish hike in US

Toby Nangle, Columbia Threadneedle global co-head of multi asset & head of asset allocation, EMEA

The outcome surprised us, but in advance of the meeting we found it hard to anticipate more cuts and more QE than the market and so pared duration positions in fixed income portfolios into the meeting. We had already been running meagre European interest rate exposure in multi-asset portfolios and no changes were made in advance of the meeting.

The ECB knew that they were disappointing market expectations. But there is an open question as to the degree to which Draghi has in the past sought to move market expectations in order to gain leverage inside the Governing Council when persuading them of the need to deliver monetary easing. The non-unanimity of the decision is important, and the market’s disappointment is important for the future. It limits President Draghi’s ability to guide markets who will naturally become more suspicious of his power to deliver the Governing Council.

What we are left with is a ‘hawkish ease’ from the ECB, ahead of what is commonly expected to be a ‘dovish hike’ by the US Federal Reserve later this month. We continue to focus on the real economy when positioning client portfolios.

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