Quantitative Easing: Draghi and the ECB Opt for Moderate Approach

So the divergence of central banks continues. On Dec. 3 the European Central Bank (ECB) took the widely anticipated step of providing more stimulus to the European economy. It’s the first move in a December pas de deux that we expect will include a hike in U.S. interest rates after the Dec. 15-16 meeting of the U.S. Federal Reserve’s (the Fed) Federal Open Market Committee.

By now you’ve likely read about the moves taken today by the ECB and its president, Mario Draghi, but let me recap. The bank made two widely-anticipated moves. In one, it cut its already negative interest rates even further – from -0.2% to -0.3%. That means banks keeping money with the ECB will have to pay even more for the privilege. The hope is that instead they’ll take that money and put it to work, lending it for construction, home loans, and so on, to help stimulate the European economy.

The second expected step was to extend the period of quantitative easing (QE)now suggesting the current monthly purchases of €60 billion worth of bonds will continue for another six months, through March 2017, rather than their originally announced potential plans of ending in Sep. 2016. They could extend beyond March 2017 if the ECB has not achieved its goals.

That’s significant, as the QE program was already seen as aggressive when it launched a year ago. More easing in Europe may have much the same impact as it did in the U.S. – adding money to the economy and pushing up inflation. The latter is Draghi’s real worry, as inflation is very low and the ECB’s expectations for hitting its 2% target now stretch out to 2017.

In a third measure that was not much talked about beforehand, the ECB will also re-invest the principal payments from the quantitative easing policy. That ensures that the bonds from the QE program will stay on the ECB’s balance sheet for a long time to come. Fourthly, the ECB will extend the scope of asset purchases by including regional debt.

In today’s announcement, Draghi and the ECB stopped just short of going “all-in”. They declined to outright increase the amount of QE purchases, after some speculation they might opt to boost purchases to €75 billion a month. Some thought he would take this extra step too, even if for no other reason than to cement inflation expectations at 2%.

Investment implications

While today’s update to the ECB’s stimulus package was a pretty good gift to European economies, expectations had been so high that equity markets were initially disappointed. We’d already seen some promising growth in the eurozone, and our expectation is that growth will stay healthy going forward. Inflation is in a wait-and-see mode with the hope that we will see at least some movement toward the ECB’s desired goal of 2% inflation.

The ECB’s moves reinforce what we as investors have been acting on and talking about throughout 2015. Our goal has been to over-weight European assets in global portfolios, but in a currency-hedged way. This is intended to protect against further weakening of the euro, which is still likely in light of the ECB’s moves despite the rebound in the single European currency. Conversely, we remain cautious about U.S. equities. The strong dollar is hurting corporate earnings and we think that a probably December Fed rate hike may tamp down appetites for U.S. assets.


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