Radical measures set scene for positive effect on investors, JP Morgan AM’s Stephanie Flanders says of Draghi play
Stephanie Flanders, chief market strategist, UK and Europe at JP Morgan Asset Management, says the measures announced by ECB president Mario Draghi were more than expected, setting the scene for a positive reaction on behalf of investors.
The ECB’s package of measures are more radical and certainly more comprehensive than most people in the market were expecting. Though none of the individual measures are “game changers” from the standpoint of the economy, we expect the package as a whole to have a positive effect on investor expectations and also provide some support to the recovery. But the initial muted effect of today’s moves on the currency shows that pushing down the value of the Euro in the current global climate may be a lot easier said than done.
By digging so deep into its toolbox, the ECB has given a strong signal to investors that it is willing to step out of its comfort level to get inflation moving back towards the 2 per cent target. We believe that the bar to major outright asset purchases – US-style quantitative easing – is still quite high. But if the ECB does eventually launch a programme of QE, history will say that decisions taken at this meeting were an important step along the way. That’s because proponents of QE – inside and outside the ECB – can now say that all other options have been tried. “To all practical purposes”, Mario Draghi said, official interest rates “have now reached their lower bound.”
Today’s measures will provide reassurance to investors that the ECB is committed to supporting the European recovery and should be positive for European stocks in the short run. However, given that the European market overall is already close to fair value, if not somewhat above it, we would continue to point to the importance of earnings growth in Europe to underpin higher valuations over the medium term. The key, for the European corporate sector, will be the impact of today’s moves on the currency.
The message for fixed income investors is that Eurozone monetary conditions are likely to remain exceptionally loose for even longer than previously anticipated. This has already put further downward pressure on sovereign spreads in periphery economies. The initial impact on the Euro will have disappointed the ECB: the currency weakened initially, but then moved a little higher on the day. This underscores that what is good for Eurozone fixed income markets is not necessarily good news for European exporters. That is because further compression of spreads could also attract significant inflows from traditional fixed income investors hoping to protect themselves from the normalisation of monetary policy in the US, making it that much more difficult for the ECB to push down the value of the currency.