Today the European Central Bank (ECB) announced further monetary easing measures in order to achieve its inflation target of close to, but below 2%. The ECB:
• Cut the deposit rate from -0.20% to -0.30%
• Will extend the duration of their current QE programme from September 2016 to March 2017
• At the current, unchanged, €60 bn rate of purchases of public sector financial assets, the 6 month extension will inject an additional €360 bn to the current €1.1 tn QE programme. For context, Eurozone GDP is around €10 tn and its debt stock is around €6.5 tn. They will soon own around 20% of public sector debt stock.
• Expanded the pool of public sector financial assets to include regional and local governments
The low inflation environment and its projected persistence gave the ECB reason to ease. Headline inflation is currently at 0.1% and core inflation is only 0.9%. The new ECB staff forecasts put headline inflation at 1.0% in 2016 and 1.6% in 2017. The ECB therefore had to do something to defend its credibility and its willingness to “do what it must”.
The ECB’s announcement is also notable for two reasons. The actions are being taken with a current tailwind behind Eurozone growth momentum. GDP growth in 2015 and projected growth next year is broad based and benefiting both core and peripheral countries. Unemployment, whilst still very high, is declining. The pace of bank lending growth is picking up and financial conditions are easing. The Euro is competitive and the Eurozone’s current account surplus is close to a high.
The actions are also being taken against a backdrop of easier fiscal policy. Across the Eurozone, governments are quietly abandoning fiscal austerity. France gave up the pretence of fiscal rectitude with successive delays to when they can get below the Stability and Growth pact’s sub-3% budget deficit target. Italy’s fiscal stance in 2016 is projected to be 0.7% of GDP, looser than the forecast just 6 months ago. Even Germany expects to miss its balanced budget target next year as it needs to spend to accommodate a refugee influx of around 900,000 in 2015 and 800,000 in 2016.
So we note that 2016 will be a year when the ECB remains on the offensive in terms of its willingness to ease, and ease again in order to raise inflation and inflation expectations. In the context of expected Fed rate hikes, divergent central bank policies (Fed hikes versus ECB easing, and projected further easing from the PBoC and BoJ) may raise fresh tensions in financial markets, not least through exchange rates and cross country flows. The ECB’s willingness to ease in the face of fiscal loosening also reflects austerity fatigue across Europe and a re-focus on growth. Growth must rise to bring down leverage; de-leveraging which damages growth will be futile and debt/GDP ratios will rise rather than fall.
All that global easing may be the spark that re-ignites global growth, or may be the spark that re-ignites global inflation. Alternatively, as seen before, QE may go so far as to mostly raise asset prices. But can asset prices keep running ahead of fundamentals? It is a challenge to navigate in a market which is fundamentally expensive but underpinned by extremely strong technical conditions. Our investment process allows us to integrate analysis of such market technicals with proprietary fundamental research and quantitative model signals in order to deliver strong risk adjusted returns.