
Please try another search
European Central Bank (ECB) President Mario Draghi surprised markets Thursday by clearly signaling that the ECB is highly likely to take action at its December 3 meeting to provide further support to the ongoing recovery in the Eurozone economy:
“We are ready to act if needed … and we are open to the full menu of monetary policy…. The attitude is not wait and see but work and access.’’
Draghi is known to prefer to build a consensus in the governing council for any significant policy action. He must be close to establishing that consensus for further stimulus. While pushback from Germany is still possible, the potential effects of the VW scandal make this less likely. The two factors that appear to have tipped the balance for the ECB are, first, the recent falls in headline inflation, which are having a negative effect on medium-term inflation expectations and, second, weak external demand due to the slowdown in emerging markets and global trade. The recent strength in the euro must also be a concern.
The biggest surprise coming out of Thursday’s meeting was Draghi’s indication that the possibility of a further reduction in the deposit rate the ECB charges on banks’ reserves, currently at -20 basis points, was discussed. Contrary to his statements in the past that -20 bp was the floor for that rate, Draghi indicated that lowering the rate further would not threaten the ECB’s reputation. Now the possibility of a further reduction in the deposit rate in December is already having a negative effect on the euro and Eurozone government bond yields.
A reduction in the deposit rate would have the useful result of increasing the number of instruments the ECB could buy in its asset purchase program. Concerns have been expressed that expansion of the asset purchase program could be hindered by a shortage of some instruments. Under that program the purchases cannot include instruments yielding less than the deposit rate. German yields from one through four years are now below -20 bp, with the two-year yield at -31 bp. Bloomberg reports there are about $752 billion of securities in the Eurozone with yields below -20 bp. An increase in the size of the monthly asset purchases above the current 60 billion euros is likely to be announced at the December meeting.
The expected further stimulus will be applied to a Eurozone economy that, despite inflation back in negative territory and weaker activity elsewhere in the global economy, is experiencing solid growth. Indeed, the just-released flash composite (manufacturing plus services) Eurozone Purchasing Managers’ Index (PMI) for October is one of the strongest in the past four years. Growth in the services sector, which accounts for 74% of the Eurozone economy, provided the acceleration in October as the manufacturing sub-index remained unchanged from September. The composite PMIs for Germany and France, the Eurozone’s two largest economies, also increased in October. We are further encouraged by the gradual improvement in bank credit conditions reported in lending surveys. Lending to non-financial corporations, one of the objectives of the ECB’s policy, is picking up.
The Eurozone’s GDP growth for the present year is likely to come in at 1.5%, compared to 0.9% in 2014. Next year, with the boost of additional stimulus and a weaker currency, growth at a 2% rate now looks possible.
The macroeconomic outlook is positive for Eurozone equities, which have been outperforming despite the mid-year correction in global markets. For US dollar-based investors, hedging Eurozone investments against euro weakness versus the US dollar looks likely to continue to be desirable, as the recent relative strength of the euro has been reversed following the ECB’s announcements. The year-to-date return (as of October 22) for the unhedged iShares MSCI Eurozone (N:EZU), is 3.29%. The iShares Currency Hedged MSCI Eurozone (N:HEZU), which tracks the same MSCI index but hedges against changes in the EUR/USD exchange rate, is up 10.91% over the same period. At Cumberland Advisors we have been using the WisdomTree Europe Hedged Equity (N:HEDJ), which is up 9.24% YTD. This ETF tracks a WisdomTree index that gives emphasis to shares of European exporters, a focus that should benefit from a weaker euro.
We haven’t had to change our subjective probabilities for our three alternative economic scenarios for quite some time. We are doing so today and may have to do so more frequently...
The US, Japan, and parts of Europe had a rough week, while China, Germany, France, and the Euro Stoxx 50 stayed steady. Tariffs, central banks, and the war in Ukraine keep...
The CPI inflation report for February is due to come out Wednesday. Economists expect it to tick down slightly. Oracle and Dollar General are among the key earnings reports that...
Are you sure you want to block %USER_NAME%?
By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.
%USER_NAME% was successfully added to your Block List
Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.
I feel that this comment is:
Thank You!
Your report has been sent to our moderators for review
Add a Comment
We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:
Enrich the conversation, don’t trash it.
Stay focused and on track. Only post material that’s relevant to the topic being discussed.
Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.
Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.