XM Group - Analytics

    XM Group

    599.50 7.00/10
    70% of positive reviews
    Real

    Draghi’s big stimulus unappreciated by markets

    There was massive anticipation ahead of the European Central Bank meeting this week and it turned out this was well justified. Thursday’s trading following the announcement and during the press conference of ECB President Mario Draghi produced some stomach-churning volatility in Europe’s currency and stock markets. Stocks liked the initial announcement out of the ECB, which also led the euro to drop. The measures exceeded expectations by all accounts, but during Draghi’s press conference there appeared to be a change of heart. Stocks sold off and the euro climbed sharply after Draghi indicated that it was likely that no further interest rate cuts would take place following the latest move.

    Why markets behaved as they did was the subject of a lot of discussion among analysts. It was suggested that the latest action by the ECB smacked of desperation and that the unused ammunition available to central banks in a similar position, was extremely limited. Indeed the ECB could be taking a big risk in using measures that should normally be reserved for conditions of deep economic recession or depression. What happens if there is a sudden and unexpected economic downturn? What will be the tools available then? Of course forecasters do not see a recession ahead, but it is rare for economic forecasts to capture turning points before they actually occur.

    Another criticism of the ECB measures is that monetary policy by itself will not solve the many problems that the Eurozone economy is facing. The ECB President has of course admitted this himself and called on Eurozone leaders to take advantage of the breathing space that the Bank was offering them in order to enact much-needed reforms.  However, it appears that politicians across the Eurozone might be using the breathing space that the ECB is providing exactly to avoid much-needed reforms. Plans for reforms that would boost competitiveness, allow for greater labor and goods and services markets flexibility, enhance the capital markets union, enhance the banking union and deal with the banking sector problems such as the high level of non-performing loans and use targeted fiscal policy such as investment in infrastructure, remain safely tucked away in the drawers of bureaucrats as politicians remain afraid of the high political cost they may entail. In this way, the ECB’s ultra-loose policies could be delaying the very policies that the Bank has been consistently asking for.

    Another reason for the negative reaction is that maybe markets are starting to doubt the effect this stimulus will ultimately have on the economy and on inflation. Although the ECB has claimed that without QE and negative rates the Eurozone would be deeply mired in deflation, a whole year’s worth of QE and low rates has done little to boost inflation as the ECB has intended. This has also been demonstrated in Japan where the QE program is actually much larger than the ECB’s. Therefore despite the well-meaning efforts, one could be excused for doubting the effectiveness of such measures. Comparing the United States’ experience with QE is also interesting as the US has deeper and better integrated financial markets, which are central to the functioning of its economy in which central bank intervention may bring benefits. In the Eurozone’s case, the banking system is much more important than financial markets in providing capital to firms.

    To sum up, the fact that the ECB’s ambitious measures did not have the intended effect on markets, could have some ominous implications.  It could be that markets are starting to dispute the power that central banks ultimately have in shaping economic developments. The myth of the all-powerful central bank that can stabilize and bring an economy out of a crisis seems to be challenged; in the Eurozone on Thursday it looked like the ECB was pushing on a string. Economic policymakers around the world would do well to take this message into account and perhaps reassess calls for more and more aggressive monetary policy action in the form of ever more negative interest rates and additional quantitative easing.

    Risk Warning: Forex, Commodities, Options and CFDs (OTC Trading) are leveraged products that carry a substantial risk of loss up to your invested capital and may not be suitable for everyone. Please ensure that you fully understand the risks involved and do not invest money you cannot afford to lose. Please refer to our full Risk Disclosure.


    To leave a comment you must or Join us


    By visiting our website and services, you agree to the conditions of use of cookies. Learn more
    I agree