Investors should look at the ECB’s bigger picture
The European Central Bank (ECB) is developing a habit of delivering policy shifts which are initially greeted with scepticism and selling pressure, only for that to reverse towards buying and enthusiasm days later.
After the ECB president Mario Draghi gave what has become a much-analysed speech in an innocuous setting in London ahead of the Olympics, markets in Europe rallied hard in anticipation of more significant intervention in peripheral bond markets, then only to give way to selling when little was delivered the following Thursday after the ECB meeting.
If that is not enough to confuse you, markets have subsequently rallied again and look dangerously close to breaking out of the trading range that has existed since the first onset of the euro crisis in 2010.
Sometimes it is helpful to take a step back to view the bigger picture. Indeed, the different perspective afforded by some time away from the City was beneficial to my analysis of the situation.
We need to establish if a more bullish stance can be taken on equities for the remainder of the year or whether we are merely once again at the top of that trading range.
To do that we need to answer two questions – is monetary easing on the way from the ECB?, and are leading economic indicators bottoming?
Carrot and stick policy
Regarding ECB policy, my own view is that once again this is not the all-encompassing bazooka that some people would like, but yet another step in the ‘carrot and stick policy’ of the ECB and Germany.
I interpret Mr Draghi’s move as a calculated gambit to move forward the German government’s agenda of ensuring that pooling financial risks among eurozone members is conditional upon fiscal and economic reform.
Getting Spain into some kind of formal euro support mechanism was the first step, the second being that the ECB will unconditionally support the bond market of those countries abiding by German conditionality but who cannot access private savings. This is the key element.
If Spain and Italy will implement the reform asked of them by Germany then the ECB will buy the debt of Spain and Italy alongside fiscal mechanisms such as the eurozone’s bailout.
This dramatically increases the size of the buying pot without having to develop tortuous mechanisms to lever the fiscal funds.
Effectively it shifts the burden of policy adjustment to the monetary side and away from the fiscal side, provided those in need abide by fiscal and structural reform.
In this sense I believe Mr Draghi’s move to be significant but not an end solution to the crisis. As I have said before, that can only come with a grander agreement between Germany and France. Germany’s price for its risk-pooling offer is that sovereignty is given up to euro-wide supra-national bodies.