The European Central Bank (ECB) has signalled that a significant package of monetary easing will be launched in September as it aims to bolster the Eurozone economy and stimulate inflation. This softer outlook, combined with additional further stimulus is a stark contrast to the stringent approach initially forecast by investment experts last year when the industry was enduring a rocky final quarter.
Ian Samson, markets research analyst, Fidelity International, believes that the more adaptive approach is likely to include a cut in key rates, a ‘tiering’ mechanism to mitigate potential downturns in bank profitability, and a further round of asset purchases.
Commenting on prospective inflation rates, Mr Samson added that the emphasis of the ECB and its departing president Mario Draghi was on aiding the economic recovery of the continent while minimising risk.
He said: “Ultimate cover for dovish policy is given by still-subdued core inflation, which looks unlikely to reach 2 per cent in the next year or so. Underlying price pressures do seem to be gradually building, which is to be expected as the Eurozone’s recovery matures. But the ECB clearly does not want to leave this grinding recovery to chance, with Draghi pointing to declining inflation expectations and limited passthrough from a tight labour market into wage-push inflation.”
His expectations of ECB policy are very much in line with the views of other experts across the investment sector. Most believed that the shift in ECB policy was not a significant surprise to investors, who were likely to welcome the news even if the bank and European economy would continue to have long-standing issues to deal with.
Hetal Mehta, senior European economist at Legal & General Investment Management noted that the ECB was being open with their strategy for the coming months. It was looking to display both its capabilities and the array of options it had at its disposal. In an increasingly volatile economic climate, it was important the ECB maintained a sense of authority to reassure investors.
She said: “The ECB might have disappointed those looking for an immediate rate cut after the spate of weak sentiment data, but their statement of intent is clear: easing is coming, and soon. A tiered deposit rate, more QE and rate cuts are all options on the menu; Draghi and the rest of the Governing Council are trying to show that they have not run out of tools. Shoring up their credibility is clearly a key priority and they cannot deny any longer that inflation expectations are anchored.”
Rupert Thompson, head of research at Kingswood, argued that the ECB was likely to find itself under growing pressure to ease its monetary policies and was adapting its position before it was forced to by circumstance.
He said: “The news earlier this week of a further fall in manufacturing business confidence in the Eurozone can only increase the pressure for the ECB to ease. Options being considered include a cut in rates and a re-starting of its QE programme. The ECB has already updated its forward guidance to keeping rates at or below current levels through mid-2020. Exactly what the ECB ends up doing in September will most likely depend not only on whether the gloomy economic news continues but also on whether the Fed decides to cut rates by 25bp or 50bp next week.”
Gloomier insight was provided by both Wolfgang Bauer, fixed income manager at M&G Investments, and Phil Smeaton, chief investment officer Sanlam UK.
Mr Bauer reflected that Mario Draghi’s ECB presidency was “likely to end not with a whimper but a bang” with the upcoming interest rate cuts in September.
Listing the number of problems with the loosening of monetary policy, he highlighted the risk of complacency of investors, even if they support the news.
He said: “Unsurprisingly, Bund yields hit fresh all-time lows immediately after the announcement. Simultaneously, European risk assets rallied upon the ECB’s dovish signals. Market reactions once again proved that central banks currently trump any economic woes. And these have been mounting in Europe: Not long before the ECB’s announcement today, and hardly registered by market participants, the Ifo Pan Germany Business Climate Index had dropped to its lowest reading since April 2013. The danger is that investors become too complacent, relying fully on accommodative monetary policy, and ignore the late-cycle risks that are lingering in the background.”
Meanwhile, Mr Smeaton suggested that the ECB’s measures had not previously proved successful. Commenting colourfully on the Eurozone he said that its “fragile banking systems remain on life support, with LTRO and similar acronym-based initiatives trying to support lending and growth.”
He was also not confident in the ability of Mr Draghi to positively influence matters.
“The markets rallied, the Euro fell, and the Trump tweeted, when Mario Draghi last snatched the steering wheel to send the institution back towards the road of deeper interest rate cuts as the prospect of rate normalisation fades in the rear-view mirror. With its bond buying programme and low interest rates, the ECB has made lending excessively cheap and mainly fuelled the housing market, while these policies have failed to deliver the necessary stimulus to EU,” he argued.
He also suggested, in theme with the political instability felt around Europe in recent years, that the decisions made by the ECB could have notable political implications.
In the conclusion of his statement, he said: “We struggle to see how doing more of what has failed will help the European banking system get back to lending, and as believers in capitalism, we have concerns that the longer the ECB continues to give hand-outs to big business without any improvements in the economy, the more Europe’s political establishments will struggle to defend the actions to the electorate.”
