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US and European markets rallied strongly on Thursday as European Central Bank president Mario Draghi, appeared to suggest that further monetary easing is on the way. In a press conference he stated that the ECB is “open to a whole menu of measures.” As result the STOXX50 jumped 2.5%, while the euro fell by 1.5% to US$1.11 and Eurozone sovereign bond yields also fell back.
It was no surprise that the ECB kept rates on hold but Mr Draghi indicated the central bank was also prepared to cut deposit rates further into negative territory. The overnight deposit rate is already at -0.20%, meaning banks have to effectively pay to park their funds at the central bank. I think the move in Europe reflects the age of competitive devaluations that we are in, and this will potentially put even more acid on the Fed to seriously consider launching QE4.
The ECB left rates on hold but now appears likely to expand its asset purchase programme before the end of the year. The current programme is to buy €60bn government bonds a month until at least September 2016. Mr Draghi stated during the press conference that “There was a very rich discussion about all monetary instruments that might be used…and the conclusion was – we are ready to act if needed.”
We of course have heard these words before, and it was classic to hear Mr Draghi comment that “Monetary policy shouldn’t be the only game in town.“ He’s dead right but the reality is that for now it is, with investors conditioned to the support of central banks since the GFC. It was of course the Fed that led the way with quantitative easing, and helped US stock markets to triple from their financial crisis lows. I think that the ECB’s program will also provide similar tailwinds for European equites over the coming years, and provide a kicker to the economic recovery which is well underway.
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Of course simply pumping liquidity into the system will not solve the Eurozone’s economic ills, but it will certainly help, and buy some breathing space. Mr Draghi was also right to point out though that “We have to address also the structural component of this recovery so we can move from a cyclical to a structural recovery.”
The euro not surprisingly weakened on the announcement, and I expect that currency strength will continue to be contained over the medium term. This bodes well for the Eurozone economy generally, and high quality exporters in particular. One of our favoured holdings here in the GO remains BMW which moved back above €90 on Thursday. I believe that the stock remains excellent value at current levels with sentiment unjustly tarnished by the emissions scandal at Volkswagen.
