Earlier this month we saw European Central Bank (ECB) president Mario Draghi step up to the plate again.
This time he cut interest rates (once again) and announced a package of de-facto quantitative easing in an attempt to counter deflationary forces and boost economic growth to a level that may begin to reduce the high levels of unemployment across the eurozone.
It has been increasingly clear for some time that further action from the ECB was going to be needed.
Given the slowing economic momentum in the eurozone and the most recent data showing inflation at only 0.3 per cent – well below the ECB’s near 2 per cent target – the pressure has been mounting on the ECB not to wait to judge the impact of the targeted long-term refinancing operation scheme (a set of targeted loans) announced back in June, and embark on an easing scheme sooner rather than later.
The size of the scheme may be as large as ¤1trn (£786bn) with the intention of freeing up commercial bank balance-sheets through the sale of asset-backed securities (ABS) packages to the ECB, therefore allowing them to use their capital for lending.
Strictly speaking, this is not pure quantitative easing, which involves the buying of government debt, and the ECB is not yet ready (or possibly legally able) to embark on the full-blown version yet.
The size of the package announced appears to be significant, but it remains unclear if the ECB’s loose monetary policy can offset the austere fiscal policies being pursued by many eurozone governments.
It is also not clear whether Europe’s problems are really a lack of liquidity or actually a structural lack of demand. Mr Draghi reiterated that the ECB could only do so much.
Governments across the eurozone have a responsibility to ensure that structural reform programmes take place to boost employment and revive growth. It is clear the pain endured through reforms in Greece and Spain is beginning to bear fruit – meanwhile France and Italy continue to hold back on implementing any reforms and are once again on the brink of recession.
Germany, also slowing, cannot be relied upon to be the engine for European growth, not least because the ongoing conflict in Ukraine is having a significant impact on confidence.
October will see the first tranche of its targeted loans scheme and the beginning of the eurozone’s version of quantitative easing.
As we have seen with stimulus packages in the US and Japan, risk assets tend to perform well during periods of central bank balance-sheet expansion, and there is potential for this to be repeated in the eurozone.
Funds flow into equities directly or through companies issuing cheap debt and buying back their own shares. Bonds will also find significant support, and government bond yields may fall past their already record low levels.
With easing in the US ending in October, the introduction of so-called money printing in Europe is a timely boost for markets.
The US economy is already out of the emergency room. Meanwhile, Europe continues to struggle to gain any traction and is years behind the US, where the first tranche of easing began in 2009.
The ECB package has the potential to more than offset the end of easing in the USA.
With the US economy and corporate earnings picking up, combined with the start of more easing in Europe, risk assets could find support for the final quarter of 2014.
Gary Potter is co-head of multi-manager at F&C Investments
