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Finance

Finance Friday 18.03.16

Finance Friday

By Nikola Kedhi.

Draghi’s bazooka — that is what they are calling the ECB’s latest decision regarding a more aggressive monetary easing. The ECB President not only delivered what he had promised, but he actually exceeded investors’ expectations as the central bank lowered interest rates deeper into negative territory.

Last Thursday, Mr. Draghi announced that the European Central Bank would expand its quantitative easing program from €60 billion to €80 billion a month. The ECB will purchase non-bank corporate bonds in addition to the financial ones that are already in the program. Moreover, the deposit rate was decreased by 10 basis points to -0.4%. The President said that interest rates will continue to remain low, however there are no current plans to decrease them further. GDP and inflation were also revised down for this year and the next two as well: 1.4%, 1.7% and 1.8% for GDP and 0.1%, 1.3% and 1.6% for inflation, in 2016, 2017 and 2018 respectively.

Immediately after the announcement, the Euro decreased by up to 1.6%. However, after 90 minutes, the currency went up 0.6%. Stocks reacted positively, not only in the Eurozone, but in US markets too. One day after the declaration of the ECB, the S&P 500 reached its highest level for this the year (2022.19), extending gains for a fourth consecutive week. This increase was led by rallies in the stocks of energy providers, financial firms and technology companies. Furthermore, the Stoxx Euro 600 reached a six-week high, boosted not only by the decision of the central bank, but also by gains in financial firms and automakers’ shares, according to Bloomberg.

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Nevertheless, banks are not as happy as other market participants about the negative rates. As Mr. Draghi admitted last week, negative borrowing costs have an adverse impact on banks’ profitability. However, he assured everyone that the ECB’s Governing Council expects the additional quantitative easing to support the recovery and balance the effect of negative rates.

After the excitement of last week’s unexpected surprise, this Monday began with small declines in stock markets. This continued on Tuesday when the S&P 500 dropped 0.3%, while the Stoxx 600 suffered a greater loss of 1.1%. Even though this volatility remains far away from the uncertainty at the beginning of the year, it raises a valid question: Can the central banks provide a long-lasting growth boost, or are they now powerless after a long recovery filled with non-traditional measures?

In Europe, interest rates are in negative territory and monetary easing has never been of this magnitude, but inflation still remains near zero. Instead of increasing and going towards what is perceived as the normal level, it is actually moving in the opposite direction. This has caused analysts to question this 2% inflation threshold that has long been considered as the right standard. A report made by the Wall Street Journal states that several economists are of the belief that a new target for inflation should be set. However, they do not agree if it should be lower or higher. Yet, should we change the established threshold simply because we are unable to reach it?

Market participants are trying to solve this dilemma, while finding the real reasons behind the sluggish growth in the Eurozone. Mario Draghi repeats his vow that inflation will reach 2% in a few years and at the same time he is trying not to lose credibility in the eyes of the investors. For the time being, he managed to please the markets, which are regaining most of their losses.

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Nevertheless, although many fail to mention it, one thing is sure: For as long as there will be a unified front only on the monetary side, while fiscal reforms are weak and uncoordinated, this fragile status quo in the Eurozone will continue to persevere.

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