Mario’s next move – OMGI’s Lilley comments
It looks as though Draghi has done enough to keep deflation at bay and boost growth, says Kevin Lilley, manager of Old Mutual European (ex-UK) Equity Fund.
In 2012 markets rose strongly on the back of Mario Draghi’s promise to do “whatever it takes” to get the eurozone economy back on its feet. The President of the European Central Bank is now delivering against that promise, in a bid to counter the unwanted strength of the euro and the resultant threat of deflation.
June’s composite PMI data, a key forward looking indicator for measuring manufacturing and services activity was consistent with quarterly GDP growth of 0.3%-0.4%.
While that was an improvement on first quarter 0.2% growth, deflationary pressures in the region continue to build. Eurozone inflation undershot the ECB’s target of 2% by a considerable margin, coming in at an uncomfortably low 0.5% for May.
No coincidence then that despite Germany’s fixation with keeping inflation under control this time the Bundesbank is openly backing the ECB’s moves.
Draghi’s package of stimulatory measures is designed to target price stability throughout the region, effectively introducing growth via the back door.
Since the beginning of the year, critics have argued that the strength of the euro, in particular against the US dollar, has put a brake on recovery. That trend is something Draghi can ill afford to maintain.
Exports, traditionally the driver of the German economy, rose by 3% in April but that came after a fall of 1.8% the previous month. In Spain, exports are the main bright spot in the economy growing by an impressive 18% for the period March 2007 – December 2013.
The methods by which Draghi intends to boost the real economy are essentially twofold, although his reference to “we are not finished” means that further measures, such as buying asset-backed securities, will more than likely be announced in the autumn.
Going forward, if banks want to deposit money with the ECB they’re going to have to pay for the privilege. By introducing negative interest rates, the first major central bank to do so, Draghi hopes that banks will actually start to lend to the real economy rather than keep their cash balances at the central depositary.
The second innovative move, not unlike the UK’s Funding for Lending Scheme, is the introduction of €400 billion of new commercial loans (Targeted Longer Term Refinancing Operations or TLTROs).
These are specifically aimed at small to medium sized companies – an area where firms have been starved of credit since the outbreak of recession.
Unlike the previous round of LTROs, these are of four year duration and have a very low fixed rate of interest, so they are attractive. While inevitably these measures will take time to filter through to the economy, some think they will boost growth quite significantly.
The Deputy Governor of the Bank of Italy for example sees Italian GDP increasing by a further 0.5% over the period 2014-2016. That’s not insignificant given the overall growth of the eurozone region is forecast at around 4.2% over the same period.
Inevitably, if growth does accelerate, the economically-sensitive stocks, which I continue to favour, will benefit. Automotive companies, such as Renault and Fiat are already seeing rising levels of profitability.
Banks and financial services companies are benefiting from historically low Spanish and Italian bond yields, their dramatic decline a sign of improving confidence in the region.
As for the euro, the differing stages of monetary tightening in the US and UK and the effects on respective currencies should stop the euro from strengthening significantly. Ironically, this time it may not just be the actions of Draghi alone but equally those of Carney and Yellen that help the Eurozone on the path to recovery.