Limited impact of looser monetary policy

The ECB’s announcement of extra financing for banks is welcome, but the marginal benefits of easing monetary policy seem to be diminishing. Rory Bateman, Head of UK & European Equities at Schroders, thinks that it may be time to wait for the existing measures to take effect.

Eurozone data over recent weeks has been disappointing and market expectations were for the European Central Bank (ECB) to make a notable response at the 10 March meeting. The policy measures were indeed substantial but a disappointing market reaction indicates concern around the effectiveness of ongoing monetary expansion.

As expected Mario Draghi delivered a 10 basis point cut in the deposit rate from -0.3% to -0.4%. The scale and scope of quantitative easing (QE) was increased substantially from €60 billion to €80 billion per month with investment grade corporate bonds now included in the purchase programme. In addition Draghi highlighted a continuation of QE and very loose monetary policy until the 2% inflation target is achieved.

Perhaps the most radical change came in the form of "TLTRO II" – another round of targeted long-term refinancing operations whereby the banks will be paid to take financing from the central bank depending on the size of their loan books. The rate they pay (i.e. receive) can be as low as the deposit rate of -0.4% depending on how much credit the banks extend. This is uncharted territory that offsets the pain from negative interest rates that the banks have been complaining about and is designed to further stimulate lending to the real economy.

The ECB’s growth forecasts were reduced from 1.7% to 1.4% for 2016 whilst the headline inflation forecast for this year was also reduced to just 0.1%, primarily given the decline in energy prices.

Growth is slow, not stagnant
The initial market reaction was a reflection of the concerns around the effectiveness of further loosening of monetary policy given the apparent lack of impact since the programme started in the first quarter of last year.

Whilst we acknowledge global growth forecasts over recent months have come under pressure, largely because of China (though inevitably Europe has not been immune). Schroders would refute the idea that Europe is entering a deflationary environment and stagnant growth at this stage. There has been an improvement in growth across the eurozone which they expect to continue.

Many of the recent surveys that were carried out during the volatile period in the first part of this year and do not reflect the underlying gradual recovery in Europe. Markets across the board are susceptible to sentiment swings. Just a few weeks ago there was massive pessimism around excess inventory in the oil sector, only to witness over the last week or so optimism around declining US production.

Recent market moves suggest that China will avoid a hard landing, to the extent that there was recently a 20% bounce in the iron ore price in one day. The volatile short-term trading dynamics and sentiment are exacerbated by a lack of liquidity as market makers and the sell-side are squeezed by the regulator and onerous capital requirements.

Looking to the long-term
Rory Bateman suggests to try not to get wrapped up in the daily volatility across every asset class. As Schroders stated in their February commentary, the declines represented a market correction were felt rather than a dramatic change to the underlying economy.

Given this view it seems that Mario Draghi may be wasting his time trying to respond to short-term headline inflation data. Over the last two years crude is down 65%, copper down around a third, soybeans -40%, sugar -20%. It is therefore hardly surprising that there is downward pressure on inflation. The year-on-year comparisons will begin to normalise and the picture should significantly improve. The deflation is good for consumers because it puts money in their pocket.